James Montier of GMO delivers a sobering assessment of the stock market:
In order to believe that U.S. equities are going to generate a “normal†return from these levels, you have to believe some quite extraordinary things. Perhaps you believe that P/Es are going to soar to levels not even seen at the height of the TMT bubble; or perhaps you believe that profitability is going to rise (from already extended levels) so that every firm in the U.S. looks like a FAANG stock; or perhaps you believe that growth is simply going to reach unprecedented levels. We, however, are not so prone to flights of fancy that require multi standard deviation outcomes. Unless you believe one of these extreme scenarios, you should be skeptical about the ability of the U.S. market to continue its outstanding performance. Ask yourself how much exposure you have to the U.S. stock market. Then ask yourself what is the minimum amount you could own. We at GMO own essentially zero in our unconstrained portfolios, but then again we are used to career risk and would rather run it than allocate to such an expensive and risky asset.
It’s full of interesting and thought-provoking insights, not the least of which is that over the years there has been a dramatic transition from institutions being the primary purchasers of equities to households (including mutual funds) to the present situation in which non-financial companies are the primary purchasers of stocks.
That’s an example of what I’ve have complained about from time to time around here. Who’s minding the store? I understand the motives behind large companies transforming themselves into stock-trading companies. But it’s no foundation for an economy.
All you need to know is that stocks go up 200 pts. in the AM, and then drop 600 pts. after that till market close. Every day.
The article is far too long with too many concepts going on to really comment on in its entirety. However, yes it was interesting.
I found the quantitative way they took apart valuations into numerator, denominator and yield chase rational. They failed to identify just what they mean by “institutions.†Pensions and endowments? It would have been helpful. And the notion of operating companies becoming stock traders was just flat silly. Further, this notion of zombie companies who can’t even service interest is just flat wrong. Somebody is not telling the whole story there. Only the (IMHO somewhat immoral) practice of credit card debt does not require at least interest service, instead capitalizing interest into the principal balance. C&I loans not so much.
But after valuations, the most interesting issue is the notion in the article is of an overleveraged S&P 500 (or Russell or Wilshire sampling) group of companies. Although I’m someone who lives in an LBO world, I wouldn’t recommend it to the general corporate population. But that’s the issue – how much is too much? There is no correct answer, and unfortunately you only know by inspecting the default rate after it’s too late. The canary in the mine may be, however, the current behavior of the high yield market.