Good things come to investors who wait
GMO's James Montier, one of the best-regarded strategists in the business, believes long-term investors "look doomed to a purgatory of low returns".
In GMO's latest quarterly letter, Montier says every asset class is at risk of
declining amidst a market vulnerability rarely seen in history.
Quantitative easing has increased the relative attractiveness of almost all assets.
Rock-bottom rates made investors reach for yield, causing a "near-
rational bubble".
If rates rise, there is no obvious asset class that would be expected to do well – that’s why assets across the board fell in late May, when markets detected hawkishness from Federal Reserve chief Ben Bernanke.
Today, emerging markets are priced for decent seven- year returns but bonds and stocks are largely overpriced.
A standard 60/40 equity to fixed income strategy is likely to produce a “paltry” real return of just 0.7 per cent annually over the next seven years, he warns.
Best advice?
Be patient – when assets are “priced for perfection”, it “doesn’t take a lot to generate disappointment and thus a repricing”, as was seen this summer.
"Good things come to those who wait," he writes.
What makes US unattractive
Rob Arnott of Research Affiliates shares Montier's valuation concerns, especially towards US equities. The S&P 500's cyclically adjusted price-earnings ratio now stands at 23.6, notes Arnott, just behind 2006's peak and 44 per cent long-term norms.
The 2.1 per cent dividend yield is just above 2006 levels, and 52 per cent below its long-term average. Corporate profit margins, now above 2006 levels and 42 per cent above historical norms, look unsustainable. In the past, current valuations have been followed by annual returns of just 1 per cent over the following decade, says Arnott.
In contrast, emerging equities have recorded 10-year annualised returns of 13.8 per cent when at current levels. US equities trade at premiums of 50 to 100 per cent when one looks at price-book, price-sales or price-cash flow ratios, he adds, while EM’s 2.9 per cent dividend yield is 34 per cent above US levels. US equities are “among the least attractive in the world”, says Arnott. As for emerging equities, investment bargains are “always frightening and difficult to consider”, but the current valuation gap is “well worth a bit of discomfort”.
Forecasting may be a waste of time
Trading companies in advance of quarterly earnings is popular, if risky.
However, whether a company beats or misses estimates is not as important as assumed, says Saxo Bank’s head of equity strategy on the trading strategy team Peter Garnry.
Garnry analysed the first 103 earnings announcements of the current quarter, and found an earnings surprise explains only 9 per cent of the variation in the excess return over the two days afterwards.
Stocks are more likely to be influenced by company guidance and management statements. Analysts should focus on guidance rather than wasting time on spreadsheet models that compute earnings per share, he says, adding “the latter does not matter”.
"Even if you were the best earnings forecaster in the world, you would not be able to make consistent trading profits," says Garnry.
No end to the bull in sight
US markets may be destined for low long-term returns but the current bull market will likely not end soon, says S&P's Sam Stovall.
There have been 11 bull markets since 1949, lasting on average 57 months. All-time highs were set on 7 per cent of all trading days during those bull markets, Stovall found. During a typical cyclical bull market in long-term secular advances – for example, 1982 to 2000 – the first all-time high occurred one-third of the way through the average bull market, with 9 per cent of days in all-time high territory.
The stats were less impressive during cyclical bulls in secular declines. Here, the first all-time high occurred 70 per cent through the bull market, with all-time highs occurring on 4 per cent of all days.
This year’s first all-time high was on March 28th. If the bull market is over, then the first all-time high occurred 93 per cent of the way through its bull run. Additionally, there have been 21 new highs since – just 2 per cent of all trading days during the 52-month bull market. History indicates the S&P 500 “has many more new highs to record before finally running out of steam”, says Stovall.
In numbers
241
Gold last week closed above its 50-day moving average for the first time in 241
days.
81
Facebook's 25 per cent jump following last Thursday's earnings announcement gave it a market capitalisation of $81 billion – $23 billion below last year's IPO valuation.
13
Microsoft's 12 per cent share price fall following disappointing earnings was its worst one-day decline in 13 years.