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Wednesday, January 15, 2014 2:29 PM


Bubble Valuation Blues; GMO 7-Year Outlook for U.S. Stocks is Negative


Value investor Grantham, Mayo, Van Otterloo (GMO) now estimates US stocks are poised for annualized losses for the next seven years.



*The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward-looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward-looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward-looking statements. US inflation is assumed to mean revert to long-term inflation of 2.2% over 15 year.

A year ago the chart looked like this.



Charts from GMO Asset Class Forecasts.

Reflections on Extreme Valuations

Was GMO wrong last year? Of course not. Expected returns are just that. Extreme valuations can always become even more extreme (and they did).

My Thoughts:

During periods of market excess, avoiding bubbles and instead investing in out of favor but attractive assets can be quite painful to live through in the short-term. But those who remain disciplined and on the right side of the somber judgment eventually get rewarded with significant gains amid widespread losses for those favoring that which has been working well during the period of excess.

GMO 10-Year History

Let's step back a bit and look at GMO's 10-Year history from 1999-2009. Please consider a chart from What a Decade!



Highlighting in yellow is mine.

In December 1999, GMO thought the S&P 500 would deliver negative returns for a decade. In 2007 that prediction probably looked ridiculous. Yet, it happened.

When GMO predicts negative returns, it's smart to pay attention.

Here are GMO's "Lessons Learned in the Decade".

Lessons Learned

  1. The Fed wields even more financial influence than we thought.
  2. Low rates have a more powerful effect on driving financial assets than on driving the economy.
  3. The Fed is capable of being extremely out of touch with the real world – “what housing bubble?” – plus more doctrinaire – “no, the low rates had no effect on housing” – than anyone could have imagined.
  4. Congress is nearly dysfunctional, primarily controlled by large corporations, and hamstrung by the supermajority now routinely required in the Senate.
  5. Government administrations can be incompetent for long periods.
  6. Poor leadership can really damage a country’s hard- won reputation in a mere 10 years.
  7. Obama is not a miracle worker!
  8. The two time-tested investment tools, value (P/E ratios and P/B ratios) and price momentum, are now much more heavily used and not so reliable as they once were, say from 1977 to 1997.
  9. Asset classes really are more inefficiently priced than individual stocks on average, and therefore offer greater opportunities for adding value and reducing risk.
  10. Developed countries, including the U.S., are past their prime compared with developing countries: it is indeed a new world order.
  11. Education and training are the keys to increasing wealth on a sustainable basis and the U.S. is in danger of losing its once large edge here.
  12. We all live on an island, which can be overexploited and turned into a barren Easter Island if we are not careful. Resources are finite and biodiversity is fragile, and both must be protected. Carbon emissions are the single greatest threat.
  13. Being a global policeman is expensive, and somewhere between difficult and impossible.
  14. The Fed learns no lessons!

Fed Uncertainty Principle Revisited

The only point I disagree with is number 12 "carbon emissions are the single greatest threat" to finite resources and biodiversity.

Arguably the most important points are 1-3 and 14 "The Fed learns no lessons".

Readers will recognize those points as part of my Fed Uncertainty Principle, written April 3, 2008, before the big collapse.

Fed Uncertainty Principle:
The fed, by its very existence, has completely distorted the market via self reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed's actions. There would not be a Fed in a free market, and by implication there would not be observer/participant feedback loops either.

Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.

Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Three:
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.

Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Bubble Valuation Blues

It's not just GMO singing the bubble valuation blues. John Hussman has independently concluded the same thing.

On November 11, 2013 in Textbook Pre-Crash Bubble Hussman commented "The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blazing red since late-2011."

Such is the nature of the game. Everyone thinks they can get out at the top. Few ever do.

Hovering With an Anvil

Please consider this snip from Hussman's Hovering With an Anvil from January 13 (emphasis mine).
The ratio of nonfinancial equity market capitalization to GDP is about twice its pre-bubble norm, and is presently associated with an expectation of negative total returns for the S&P 500 over the coming decade. Measures based on properly normalized earnings are a little bit more favorable, with the overall outcome that we broadly expect nominal total returns for the S&P 500 of about 2.3% annually over the coming decade, with negative total returns on horizons of less than about 7 years.

Keep in mind that the 2000-2002 decline wiped out the entire total return of the S&P 500, in excess of Treasury bills, all the way back to May 1996. The 2007-2009 decline wiped out the entire total return of the S&P 500, in excess of Treasury bills, all the way back to June 1995. Our present expectations are rather conservative by comparison.
I side with GMO and Hussman.

Wine Country Conference II

I am pleased to again mention that John Hussman is a speaker and host of the second annual Wine Country Conference will be held May 1st & 2nd, 2014.

We have an exciting lineup of speakers for this year's conference.

  • John Hussman: Founder of Hussman Funds, Director of the John P. Hussman Foundation which is dedicated to providing life-changing assistance through medical research
  • Steen Jakobsen: Chief Economist of Saxo Bank
  • Stephanie Pomboy: Founder of MacroMavens macroeconomic research
  • David Stockman: Ronald Reagan's budget director, best-selling author, former Managing Director of The Blackstone Group 
  • Mebane Faber: Co-founder and the Chief Investment Officer of Cambria Investment Management
  • Jim Bruce: Producer, Director, and Writer of Money For Nothing: Inside the Federal Reserve 
  • Chris Martenson: Reknown speaker and founder of Peak Prosperity
  • Mike “Mish” Shedlock: Investment advisor for Sitka Pacific and Founder of Mish’s Global Economic Trend Analysis

In addition, we expect confirmation from a number of other highly respected fund managers and speakers. This year's event is two days and will include additional "break-out" groups.

For speaker bios, please check out Wine Country Conference Speakers.

This Year's Cause: Autism

$100,000 of the money raised last year came from a generous matching grant from the John P. Hussman Foundation.

Some of us in the industry who have done well are making an effort to give something back. John Hussman is at the very top of that list.

One of John's kids has severe autism. This year, all net proceeds will go to support autism programs.

Conference Details

For further details about the 2014 conference, please see Wine Country Conference May 1st & 2nd, 2014

Nothing Like It!

This event is not just another "come and hear someone talk" kind of thing. Attendees and their significant others can expect an educational, fun, and relaxed time.

Last conference, we arranged wine tours. They were a big hit. We will do so again. One of the wine estates we visited had a Bocce Ball court. On a couple of miracle shots, I won both games I played.

Stay an extra day and golf or travel. I did. The conference hotel is a fun place in and of itself.

Unlike many other conferences, you will have easy access to speakers.

Want to chat with me, Steen, John, or anyone else at the conference? You will have an easy chance.

Not only do we have an excellent lineup of speakers, you will have an opportunity to meet with them, have intimate discussions on important investment topics, with a lot of fun on the side, including wine tours and great wine.

There's nothing like it in the investment business. And your money goes to a great cause! What can be better?




Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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