Over the last two decades, Jeremy Grantham made noteworthy forecasts. In 2000 and 2007, he, almost alone, argued stocks were overvalued. He was also one of the first to catch the income and home prices dichotomy and predicted at least one major U.S bank would fold. With stock markets almost assured of double-digits returns in 2017, Grantham's more pedestrian 20-year vision of five percent stock returns seems out of step.
Famous investor Sir John Templeton once said, “The four most dangerous words in investing are 'it’s different this time.' ” Stock valuations by any measure are at dizzying heights and have traditionally reverted to their historical mean. What goes up must come down, or mean-revert. Earlier this year, Grantham shocked investors with his pronouncement, “This time is different,” but context matters.
Grantham sees high corporate profit margins keeping valuations up. Companies have traditionally used brand power to prop up profit margins. Just next to me there is an HP printer, case closed. But in The Wall Street Journal (Nov. 6, 2017) Grantham railed against corporate “new-fashioned bullying.” Companies bully for favorable legislation, relaxed regulations, and less judicial oversight. But this arrogance will foster a citizen pushback he warns.
Also supporting higher valuations is the Federal Reserve’s apparent insistence on keeping short-term interest rates low. Grantham points out the two economic shocks of the 21st century (tech and the housing bubbles) were mitigated by the Federal Reserve dramatically lowering short-term borrowing costs, aka coming to the rescue.
The combination of the Fed’s low-interest rate policy and high corporate earnings are different this time, but valuations will revert. When, where, and how the snapback happens no one knows. Grantham gives us two decades, which coincidentally matches most retirement periods. If he were the only one with a mid-digit single stock return prediction, I would not worry, but he is not. One way to boost returns is international diversification, but don’t take unnecessary risk and make sure your portfolio is appropriate for your goals and time horizon.
The best way to look at mean-revision is the “Deep South’s Oldest Rivalry.” Auburn won convincingly this year but had lost three in a row. Georgia leads the series by one game, and that should explain mean-reversion.
Ivy League Endowments Falter
Speaking of getting beat, endowment funds at Harvard and Yale have earned 8 percent and 11 percent, respectively, dramatically lower than the S&P 500’s 18 percent mark. Both endowments invested heavily in venture capital, hedge funds, and leveraged buyouts, aka alternative investments. Recently, Warren Buffett savaged hedge funds for high fees and underperformance, and he is poised to win the “Million Dollar Bet” with Protégé Partners, a hedge fund that lost badly to the S&P 500. All proceeds go to charities. Alternative investments are off-limits to small investors, and we should be thankful.
You can’t always get what you want, but Buz Livingston, CFP can help figure out what you need. For specific recommendations, visit livingstonfinancial.net or come by the office in Redfish Village, 2050 Scenic 30A, M-1 Suite 230.