The latest quarterly asset class return forecast from Jeremy Grantham’s Boston-based fund management group GMO makes for interesting reading. For the first time in a long time, the seven year forecast envisages that equities will produce annualised real returns that are above their long term average. In the case of high quality stocks (those with strong balance sheets, positive cash flow and so on), GMO is projecting real returns of 11.4% per annum. For US stocks in general the figure is 7.4% and for emerging market equities 10.7%.
Since GMO is a value investor, it is no surprise to see that it sees little or no value in Government bonds at today’s very low yields. In fact it expects US Treasuries to produce negative returns over the next seven years. It is more positive on emerging market bonds, which it sees making a 4.5% real return over its seven-year forecast horizon.
Although he has been widely dismissed as a perma-bear, that is, someone who is always negative on the outlook for stocks, to my knowledge Jeremy Grantham is a more complex prognosticator than that description would suggest. His warnings that stocks were overvalued during the Greenspan bubble years, and that investors were becoming myopic about risk, have proved to be amply borne out. But in his last quarterly letter (strongly recommended for those who do not know it) he takes a very different stance. The greater risk facing most investors, in his view, is that they will miss out on the market recovery when it comes.
At the same time however, historical analysis tells him that most bull markets over-correct on the downside before they are done. So while stocks are now back to somewhat better than fair value, in the short term they could get worse before they get better. Grantham says his worry is that he will get back in too early, as he has done many times before. This seems to me a good summary of where we stand today. Equities have certainly started to look good long term value, and comfort lies in the fact that, while it is possible they could fall another 20%-30% from here, those losses will be recoverable quickly whereas the 30%-50% losses experienced from extreme 2007 levels might not be recouped for many many years. Investors will need to be selective however.