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GMO is Cautious but Selectively Optimistic

Jeremy Grantham, co-founder and chief investment strategist of GMO LLC, has an excellent reputation among investment managers due to many of his prescient statements of the past.  He and his asset allocation team garner attention when they publish their commentary and 7-year forecasts on asset class returns.  GMO is currently cautious about the US stock market but selectively optimistic about pockets of opportunity.  Their comments reflect a defensive stance at the present time.

In his March 11 commentary, Jeremy Grantham writes that “the U.S. is really enjoying itself if you go by stock prices.  A Shiller P/E of 34 (as of March 1st) is in the top 1% of history.  Total profits (as a percent of almost anything) are at near-record levels as well.  Remember, if margins and multiples are both at record levels at the same time, it really is double counting and double jeopardy.”  However, while U.S. stocks are generally overpriced, he believes that there are some relatively attractive investments.  He highlights quality, resource, and deep value stocks.

Quality stocks are defined at GMO as stocks with a high stable return on equity and a strong balance sheet.  Grantham argues that they have “a long history of slightly underperforming in bull markets and substantially outperforming in bear markets.”

Grantham likes resource stocks that provide raw materials which are finite and getting scarcer.  He also likes the diversification benefits because “at longer horizons (10 years) resources are the only sector of the stock market to be negatively correlated with the broad stock market.”

There has been a divergence in valuations among U.S. stocks.  Deep value stocks (the cheapest 20% of the US market) “are in the best 7% of their range” while the most expensive 20% of U.S. stocks “are in the worst 10% of their 40-year range (compared to the top 1000 stocks).”

As of February 29, 2024, GMO is forecasting an annualized real return (for 7 years, after inflation) of -4.1% for US large cap stocks and -2.6% for US small cap stocks.  They have higher expectations for international stocks, with a range that varies from a low of 1.1% for international large cap stocks to the highest ranked category of emerging market value stocks at 5.8% (after inflation, in local currency terms).  In terms of US dollars, GMO expects an additional 2 to 4% per year from currency gains for international stocks.

GMO has modest expectations for fixed income.  At the end of February, their 7-year forecast for fixed income has real returns (after inflation) for U.S. bonds and U.S. inflation-linked bonds of 1.7%.  The highest ranked category is emerging debt at a 3.5% real return.

GMO does not provide any forecasts for precious metals, but they are starting to receive more attention.  Central banks and investors continue to buy gold, primarily due to the rapid growth of US government debt and interest expense.  Also, the geopolitical landscape is changing and the world is less willing to follow America’s lead.

Silver demand is picking up as well.  India imported a record 2,200 metric tons of silver in February 2024, a portion of which will be used for lithium-ion battery production at a new factory.

If you would like to read more research directly from GMO, it is available to the public here: https://www.gmo.com/americas/

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA

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Reading the Fed’s Tea Leaves

Financial markets price securities based upon future expectations.  Based on the shape of the yield curve, financial markets reflect anticipation of the Federal Reserve (Fed) cutting rates aggressively in response to a recession.  Given the recent market rally and high equity valuation levels… READ MORE

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The Shifting Multipolar World

Looking at the website for ForeignPolicy.com, a nexus for foreign policy wonks, there is still much debate about the nature of relative power around the world.  Here is a sample of some of the opinion titles:

      • “Yes, The World is Multipolar;”
      • “No, The World is Not Multipolar;”
      • “America is Too Scared of the Multipolar World;”
      • “The GOP Plan to Bring Back a Unipolar World.”

Emma Ashford and Evan Cooper, senior fellow and research associate, respectively, with the Reimagining US Grand Strategy at the Stimson Center provide some background.

Polarity typically takes on one of three forms: unipolarity (in which one state is by far and away the most powerful), bipolarity (in which two states are about equally powerful), and multipolarity (in which power is more diffused among several states).  It’s a common misconception that multipolarity must involve many states of roughly equal capabilities (i.e., that it must be balanced).  But in fact, multipolar systems are often unbalanced, with two or three big powers and several middle powers all jockeying for position.

For the last 30 years, the United States has been the undisputed global leader.  But today, opinion is divided.  Some argue that the United States will remain the global hegemon for the foreseeable future, others say we’re headed for a new bipolar competition with China, and still others believe that a multipolar era is dawning.

The Stimson Center’s conclusion regarding where we stand: “The United States simply does not hold the level of military and economic power it did during the early decades of the Cold War.  Nor does today’s China match the Soviet Union at its peak.”

In August, the BRICS summit was hosted by South Africa in Johannesburg.  The five founding states are Brazil, Russia, India, China, and South Africa.  While 40 countries expressed an interest in joining BRICS, 23 officially applied for membership (including 7 of 13 countries in OPEC) prior to the meeting in South Africa.  Six of the applications were accepted and will become effective on January 1.  The new members are Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates (UAE).  However, Argentina President-elect Javier Milei who will be sworn in on December 10, plans to withdraw Argentina’s commitment after he takes office.

The current five countries of BRICS represent 42 percent of the world’s population and 33 percent of the world’s GDP on a purchasing power parity basis.  The G7 (Canada, France, Germany, Italy, Japan, United Kingdom, and United States), by contrast, account for 10 percent of the world’s population and 30 percent of GDP.

At the initial summit in 2009, the BRIC nations (South Africa had not yet joined) announced the need for a new global reserve currency which would be “diverse, stable, and predictable.”  While the BRICS alliance has not yet established an alternative global reserve currency, they continue to make progress towards that goal.  At the 2014 BRICS summit, an agreement was signed to create and fund the New Development Bank with $100 billion.  A reserve currency pool was also established with over $100 billion.

Another example of the diminished influence of the United States occurred in Africa earlier this year.  On July 28, the final day of the Russia-Africa Summit in St. Petersburg, Russian President Vladimir Putin announced that Russia had signed agreements for military cooperation with over 40 African countries.  The agreements included a broad range of weapons and technology, some for free “with the aim of enhancing the security and sovereignty of the countries.”  In addition, President Putin reiterated that Russia would continue to be a reliable supplier of grain to African countries.

Ukraine seemed to demonstrate the limits of US/NATO military support.  The US Government has spent $113 billion on Ukraine, appropriated in 4 spending authorizations, since the war with Russia began in February 2022.  In October, President Biden requested a supplemental bill for national security of more than $100 billion, which would include another $61.4 billion for Ukraine and $14.3 billion for Israel.  Congressional negotiations have stalled despite a warning by the White House that the US will “kneecap Ukraine on the battlefield” if funding is not approved.  Colonel (Retired) Douglas Macgregor frequently offers his opinions on a variety of YouTube and Rumble channels.  On a December 4 interview with Cyrus Janssen, he had this to say about Ukraine and US involvement.

The Ukranian nation is destroyed….  I don’t know how many civilians have been killed.  I don’t know exactly how many wounded, but I know that you’re looking at 500,000 dead Ukranian soldiers…. You’re looking at World War I scale of losses on the human side that we just can’t begin to comprehend it.

He continues:

What’s clear is it’s over because the United States government, and American media, and finance committees have all changed the topic.  It reminds me of what happened in Vietnam.  What happened at the end of Vietnam?  We left.  People stopped talking about it.  It was over….  We are preeminently a maritime and aerospace power.  We are not a land power anywhere in the world except in the Western hemisphere.  So, what this means is at the end of the day, if things don’t go our way, we don’t like what happened, it doesn’t suit us, we fly away, we sail away.  We’re finished.  But for the Chinese, the Russians, the Iranians, for the Arabs, for whomever, the Africans, wherever your go – they live in the region.  They’re stuck with it.  And they’re stuck with the consequences of our intervention.  And our interventions have always distorted the dynamics of the region.

Israel has always relied on US support.  Perhaps in deference to the United States, countries such as Turkey, Jordan, Saudi Arabia, and Egypt maintained a peaceful coexistence with Israel.  However, after the Hamas attack on October 7, the Israeli response has united Muslims around the world.  Yemen is the only country to declare war on Israel and so far, their attacks have been limited in nature.  But there is now popular support in many Muslim countries for military action against Israel.

How the conflict in Israel/Palestine resolves itself remains to be seen.  But the decline of US economic and military power, and influence in recent decades is clear.

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA