Ben Inker, GMO’s head of asset allocation for over two decades, says that the recent stock market rally has priced in an “an optimistic resolution to the coronavirus crisis, while leaving investors in a dangerous position if something goes wrong.” This according to a recent article in Barron’s.
According to Inker, the current economic downturn will be “twice as deep as the 3.25% gross-domestic-product hit the U.S. suffered in the financial crisis.” Here are some key takeaways from the article:
- GMO has recently reduced the stock allocations in their flagship funds by more than half because, Inker said, “We were getting very nervous about how much the markets had gone up,” adding, “value stocks at his point are trading at some of the widest spreads we have ever seen.” He explained that, in an optimistic scenario, the U.S. quickly develops a vaccine or an effective treatment for Covid-19 that allows us to “go back to a normal economy. In a less optimistic scenario, Inker said it takes “a few very difficult years before we’re back to anything approaching normal.”
- The S&P 500 was “quite overvalued” before the pandemic, according to Inker. “Even at the March lows, he said, “it didn’t look cheap to us.”
- According to GMO, the S&P 500 “got cheap in 2008-2009. It was reasonably priced from 2000 to 2003. But in most of the period, it has been somewhere between moderately and significantly overvalued.”
- Inker explained that GMO’s analysis of market performance over the past 20 years shows that profitability across the globe has been largely stable, with the exception of U.S. large-caps, “which have seen profitability, and their apparent return on capital, move up in a way that is fairly unique.” He notes that some of it has been driven by secular shifts (healthcare and tech seeing higher returns and heavier weighting in U.S. markets). He also notes that a large number of profitable U.S. industries have become more concentrated. “We’ve created oligopolies,” says Inker, “and oligopolies have a pretty good return on capital.” He notes, however, that “it’s always dangerous to assume it’s going to continue.” A more likely outcome, Inker said, is that over the next 20 years “the world will probably be less friendly to the giants than it is today. And I would bet that the next 20 years see a slowly deteriorating return on capital for U.S. large-cap stocks.”
- According to Inker, U.S. anti-trust regulation needs some attention. “It’s pretty straightforward: We used to have a world where we would not have allowed four wireless companies to turn into three, or seven major airlines to turn into four, because we wanted to maintain enough players to have competitions, which is good for consumers.”
- On the fixed income side, GMO is seeing opportunity in emerging sovereign debt and in asset-backed debt: “They are pricing in not so much the V-shape recovery but the U-shape recovery. You have to make sure you can live with what happens if we get the L-shape instead.”