GMO’s latest letter – Grantham on the Increased Monopoly Power and what it means for Margins.
He notes PE’s have not reverted below trend really for 25 years – oscillating around a higher PE
Moving away from 4 most dangerous words “This time is different” .. to “it can be very dangerous indeed to assume that things are never different”
What’s changed over the years – PE’s and US profit margins re-based higher .. interest rates re-based lower.. Population growth/ageing, globalisation, indicators of monopoly, income inequality, below-trend GDP, productivity VERY VERY DIFFERENT
Thinks main driver of HIGHER US PROFIT MARGINS ARE LOWER RATES AND MORE GEARING
BUT Unlikely to normalise quickly as – Increased globalisation means US has better brands/brand strength, Increasing Corporate Power, Lack of action from Justice Department, Slight decline in capital spending, increased monopoly power of US corporations..
SO STOCK PRICES HELD UP BY ABNORMAL PROFIT MARGINS which are in turn produced mainly by lower real rates, the benefits of which are not competed away because of increased monopoly power etc
He can’t see interest rates rising a lot anytime soon..
Therefore doesn’t expect PE ratios to revert to pre 1997 levels
ALSO 3 FACTORS WHICH WILL HELP US MARGINS THIS YEAR – Commodity prices bottomed, Trump likely gets moderate reduction in tax rates this year, and benefits of lower taxes will be stickier due to increased monopoly power and US regulation removal will lower corporate costs in short term
NET NET – UNLESS SOME SUBSTANTIAL UNEXPECTED NEGATIVES.. US COPORATE MARGINS WILL BE UP MEANING LIKELY UP YEAR IN MARKET AT LEAST UNTIL LATE IN YEAR
Regular bear market of 15-20% can always occur for any one of many reasons.
Note from Ben Inker titled “Up at Night”.. basically about thinking about risk in a portfolio
Interesting chart showing how expensive it is to protect a portfolio with S&P Puts – in fact a strategy of selling puts returns the same as S&P500 since 2017.. while buying puts massively underperforms … suggest reducing weight in risky assets likely to be superior to buying insurance [obviously timing everything!]
Suggests trying to take advantage of correlations to try and get cheap insurance
GMO think emerging markets cheap and likely outperform developed markets by 5%pa.. but KEY RISK is USD rally induced by US border tax .. USING KOREAN WON as hedge . see note for details..
other risk they see is higher inflation hurting equities and long bonds – hold TIPS and alternates to hedge