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Weekend reading: The ‘fair value’ market is probably overvalued in the US

Weekend reading

Good reads from around the Web.

I hear every day in the news, on CNBC, and even from investors in real-life that the market is “fair value”.

If it’s fairly valued now, then everyone must have thought shares were a screaming buy five years ago at half the price, right?

Sadly, history – or a bit of Googling – and the mere fact that it was 50%-off in the first place tells us otherwise.

One forecaster who does change his mind when his valuation techniques point to under- or over-valuation is Jeremy Grantham, of the US firm GMO.

That’s one reason his quarterly reports are widely read. The other is he’s an excellent (and often funny) writer.

Alas, Grantham isn’t as sanguine as all those fair weather fellows I keep hearing from. GMO’s famous 7-year forecast (via TRB) looks decidedly sickly for equities and bonds in its latest incarnation, especially in the US.

Only timber is predicted to offer a really decent return, and it’s hard to buy a forest:

Click to see the big (miserable) picture.

Click to see the big (miserable) picture.

Are Grantham and his number-crunchers right?

For my part I still have my doubts about this “new normal” of years of miserably low returns from equities, but they are certainly far more likely from here – after a 50-100% move higher – than back when the worrywarts first started predicting them a few years ago… 😉

But outside of the expensive-looking US I’d still plump for… fair value. (For what it’s worth, which is no more than anybody’s finger in the air).

Third time unlucky

Grantham isn’t any sort of perma-bear – he said shares were cheap in 2008 and 2009. In his new quarterly letter [PDF] he explains the trouble he sees ahead, which he blames on low interest rates from central banks:

My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up.

And then we will have the third in the series of serious market busts since 1999 […]

In our view, prudent investors should already be reducing their equity bets and their risk level in general.

One of the more painful lessons in investing is that the prudent investor (or “value investor” if you prefer) almost invariably must forego plenty of fun at the top end of markets.

Most Monevator readers are mainly passive investors (I hope) and shouldn’t take this as a call to change asset allocations – doubly so if this is the first you’ve heard of Mr. Grantham!

Valuing the market is impossibly tough, and forecasts from anyone are extremely unreliable. If you’re fascinated by investing and can adopt the appropriate air of amused intellectual detachment then it can be fun to follow and make predictions, but for very few people is market timing a route to extra riches.

There’s also the issue of how would you rearrange things anyway, assuming you’re already well-diversified? The returns graph above shows not much is predicted to do well, and a quick 20-30% missed from equity returns could take decades to recover in cash or bonds at today’s rates, leaving you banking on a crash. Probably best not to play that game, and keep focused on the long-term. It might be best to use any extra free cash to pay down your mortgage, or even to invest in non-financial assets like professional qualifications or similar.

At the least though, Grantham’s message is a good reminder to stick to your plan and not start chasing what nearly everyone finally seems happy to call a bull market in equities.

(And it must be a bull market – if everyone is now confident enough to talk about “fair value”…)

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: HSBC has waded into the murky Help to Buy waters with two competitive deals, including a five-year fix at 4.99% on a 95% deposit. But The Telegraph quotes says that affordability tests will be tough.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • The techno-elite are investing in ETFs on autopilot – Yahoo

Active investing

  • Investing is still more art than science – Motley Fool
  • Guru ETFs versus investing gurus – Reuters
  • A few US stock ideas from great stock pickers – Morningstar
  • Bolton says China’s reforms could boosts its market – Telegraph

Other stuff worth reading

  • Rich people make the same money mistakes [Search result]FT
  • Number of affordable homes built falls 26% – Guardian
  • Stupid things finance people say – Motley Fool
  • Write your own investment policy statement – MorningStar
  • How to IPO yourself – NY Mag
  • An algorithm that can predict start-up failure – FastCoLabs

Book of the week: I forget if I’ve sung the praises of Conscious Capitalism before, but as I just bought it for a friend to try to sway him from the path of unthinking neo-Marxism (in its modern form of endlessly citing The Guardian, taking foreign holidays, speculating on property and buying designer trainers, yet condemning the profit motive at every turn) I might as well recommend it again!

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  1. Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” []

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{ 12 comments… add one }
  • 1 John Kingham November 23, 2013, 11:39 am

    I’m in two minds about these long-term forecasts. I agree with the general idea, and in fact produce my own 7-year forecast for the FTSE 100 (the 7-year period was pinched from GMO). However, both my approach and GMO’s produce a single number for annualised returns, whereas a probability distribution would be better.

    Technically this isn’t hard to do and is on my to do list, and I might suggest the idea to Mr Grantham. I guess they must have thought about this and perhaps settled on the single number approach because it’s easier for clients to understand.

    But I do think there is merit in providing a range of values. A nice simple good old fashioned chart with a bell curve on it would work; one for each asset class.

    At least that would graphically convey the uncertainty of it all.

    The same thing applies to everybody saying that the US market is expensive because of its historically high CAPE value. Yes it is expensive, but that doesn’t mean it can’t stay this high or go higher for years to come. A probability distribution (even if it is just an estimate) would show that while the probability of lower returns is the more likely outcome, they are not guaranteed and high returns are still possible, though less likely, in the future.

  • 2 Tyro November 23, 2013, 12:52 pm

    @ John Kingham

    I agree that probability distributions would be more helpful. As to the graphics, instead of a bell curve I’d prefer the rainbow-like thing the BoE uses in its charts – I don’t know why but that makes it easier to grasp the info immediately.

  • 3 BeatTheSeasons November 23, 2013, 2:07 pm

    Has there ever been a Monevator article on the differences between investment and speculation? Perhaps your neo-Marxist friends think they are investing in property and you are speculating on risky shares!

  • 4 dearieme November 23, 2013, 6:52 pm

    “it’s hard to buy a forest”: is it? Free of inheritance tax too, apparently.

  • 5 dearieme November 23, 2013, 7:01 pm

    Stupid things finance people say: my favourite is “We’re all contrarians now.”

  • 6 SemiPassive November 24, 2013, 12:08 am

    Grantham mentions 2 years, which seems to fit in with the consensus time when interest rates might start climbing, whether or not he thinks that will be a catalyst I’m not sure.
    But that means equities and bonds could well be dropping in tandem (they rose in tandem for 2-3 decades, if not on the same individual days) , so diversification across those two asset classes alone may not give great returns.

    Under such expected circumstances paying the mortgage down first seems preferable to buying more shares and bonds.

  • 7 ermine November 24, 2013, 7:19 pm

    Only timber is predicted to offer a really decent return, and it’s hard to buy a forest:

    I dunno howsabout iShares WOOD 🙂

    and I have an investment of about 5 cubic metres under cover on a field, what with the recent stormy weather, though that’s not really a long term (or financial) investment 😉

  • 8 The Investor November 24, 2013, 8:41 pm

    WOOD is pretty useless for getting exposure to timber as an asset class, as much of it is in cyclical pulp processors etc and the resultant ETF is very correlated to the s&p.

    A couple of investment trusts looked promising, but they’ve disappointed and have nothing like the stability of owning your own forest. Fees/costs are sky high, too. When I last looked (last summer) they were on high discounts, which might be tempting, but that’s a different sort of investment. One looked like delisting/selling up.

    Small hobby woods (£20k or so) are pretty useless from an investment standpoint and can easily be cash flow negative. I wouldn’t mind owning for other reasons.

    Now and then very clearly defined funds giving part ownership of a defined wood plantation are available but tend to have high minimums. (£50k or so).

    I’ve looked into this in some detail! In the end I owned plum creek timber for a while; it’s by no means a pure timber play so does not solve the problem but is very well run. I sold when REITS started wobbling in May. Again, hardly pure asset exposure.

    A real timber asset is a thing if beauty. You harvest when profitable and just let keep growing and adding value in lean times. There have long been tax breaks in the uk too, which is why there are plantations of conifers in wales, Scotland, etc. But it’s best played if your already rich.

  • 9 dearieme November 24, 2013, 9:25 pm

    Ah, but bow + arrow + deer = venison. Yum, yum.

  • 10 Paul Claireaux November 25, 2013, 2:10 pm

    To the Investor.
    Nice to see GMO’s work noted here. Bright guys.
    To John Kingham.
    I suspect GMO wouldn’t subscribe to the idea of normally distributed ranges of outcomes.
    The normal distribution is of course behind the complete mismanagement of risk by all the banks in the run up to the crisis of 2008-09

  • 11 John Kingham November 25, 2013, 2:51 pm

    Paul, yes the normal distribution doesn’t apply exactly, but I would guess that the actual distribution of forward returns isn’t that much different. And I don’t think a misapplication of normal distributions in risk management has much relevance here.

    The historic distribution of CAPE to 7-year forward returns isn’t that hard to calculate so I’ll whizz them up at some point when I have some spare time, unless I can find somebody else who has already done it.

  • 12 Paul Claireaux November 25, 2013, 2:57 pm

    John,
    That would be very interesting.

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