A record number of fund managers
believe global equities to be overvalued, with an overwhelming majority
seeing the US market as the most overvalued in the world. Is it time to
“just say no” to the S&P 500?
The “just say no” message refers to the title of a new white paper co-authored by high-profile GMO strategist James Montier. GMO, headed by iconic investor Jeremy Grantham,
has $77 billion in assets under management and is famous for having
predicted past market crises, such as the Japanese bubble that burst in
1989 as well as the 2000-02 dotcom implosion and the 2008 global
financial crisis.
The title of Montier’s latest paper sounds like an
anti-drugs warning, and the content of the paper is similarly stark.
Those US gains have been largely
driven by an expansion in profit margins and valuation multiples to
historically lofty levels. Future gains, says Montier, require either
that dividends and earnings start growing at a much faster pace –
unlikely, as both are “remarkably stable” over time – or that valuation
multiples and margins continue to expand.
“The historical record for this
assumption is quite thin, to put it kindly,” says Montier. Margins and
multiples tend to revert to the mean over time, so buying US stocks “now
requires a belief that ‘it’s different this time’ with respect to the
valuations that people will put on stocks, and the margins that
companies can command”.
The S&P 500, Montier notes,
has “trounced the competition” over the last seven years. It has risen
173 per cent, compared to just 71 per cent (in dollar terms) for the
MSCI EAFE, the most widely-followed index tracking non-US developed
markets. Emerging markets lag even further behind, rising just 30 per
cent over the same period.
Still, while Montier’s bearish
message may be an especially blunt one, he is far from being a lone
voice on the subject of US valuations. Out of 20 valuation metrics
tracked by Ned Davis Research, 16 suggest US stocks are extremely
overvalued. As noted earlier, Merrill Lynch’s latest fund manager survey
shows a record number see global equities as overvalued, with concerns
largely centred on the US investment universe.
The last time fund managers were
nearly as concerned was back in the late 1990s. Goldman Sachs recently
cautioned that 10-year returns have been negative or below historical
norms 99 per cent of the time when valuations were as high as they are
today. Vanguard founder John Bogle,
who has spent his life preaching the buy-and-hold message, estimates
the US market will be hard-pressed to deliver annualised returns of more
than 2 per cent over the next decade.
While there is broad agreement that US stocks are overvalued relative to
history and that low future returns are likely, most observers agree
valuation cannot be used as a timing tool. An expensive market is not
necessarily ripe for a fall; it simply means future long-term returns
are likely to be disappointing. Rather than selling, concerned
commentators like Robert Shiller suggest investors rotate into non-US
markets or underweight the US in their portfolio.
Read more: Is it time to ‘just say no’ to the US stock market?
