In “The Gentleman” series on Netflix, a young British army officer named Eddie Horniman finds out that his father has died in England. When he returns home for the funeral, READ MORE
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
Are We There Yet?
Egon Von Greyerz is the Founder and Managing Partner of Matterhorn Asset Management and Gold Switzerland. Matthew Piepenburg joined their firm last year. Both provide thoughtful commentary and interviews. Piepenburg acknowledges that they are “Swiss-based gold bugs.“
In his September 24 commentary, Piepenburg asks, “Why is Gold Not Rising?” Good question given that:
-
- Other commodities are reaching new highs.
- Inflation rates are rising.
- Interest rates are low and several percentage points below inflation rates.
- Central banks around the world continue to expand their balance sheet assets at a rapid rate.
- Governments show little or no fiscal discipline.
Piepenburg’s written commentary about Federal Reserve policy and gold’s purpose in an investment portfolio is located here: https://goldswitzerland.com/why-is-gold-not-rising/
If you prefer a video, Matthew Piepenburg was interviewed by Tom Bodrovics and discussed the international monetary system and related topics. The video link is here (51 min): https://www.youtube.com/watch?v=CZ9bNTl5kTE&t=599s An index of the topics covered with time marks is located in the right margin of the video.
If you have any questions or comments, please contact me.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA
Bonds, the Dollar, and Leverage – 4/6/2021
In the title of his latest commentary, Ray Dalio, Founder of Bridgewater Associates, asks “Why in the World Would You Own Dollar Debt?” He argues that the current dynamic is “typical of the late stage of the long-term debt cycle.”
The world is a) substantially overweighted in bonds (and other financial assets, especially US bonds) at the same time that b) governments (especially the US) are producing enormous amounts more debt and bonds and other debt assets. This is particularly true for US bonds. US bond holdings are over a third of global bond holdings held by central banks, sovereign wealth funds, and international investors with the next largest country/currency bond being euro bonds at only roughly 60% of US bond holdings. Their overweighted position in US bonds is largely because of the “exorbitant privilege” the US has had being the world’s leading reserve currency, which has allowed the US to overborrow for decades. The cycle of becoming a reserve currency, overborrowing, and being overindebted threatening the reserve currency status is classic.
Some international investors are shifting a portion of their fixed income allocation from US$ bonds to Chinese bonds, which now account for about 6% of global portfolios. Given the low interest rates in many countries, investors have also been willing to invest more in common stocks and precious metals. However, bonds still have a place in portfolios for now, given valuation levels in the stock market that have already priced in a strong recovery.
The recent disclosure of some large bank losses due to business with Bill Hwang’s Archegos Capital raises some questions about derivatives and capital markets. A record level of margin debt has contributed to higher prices in the stock market, but derivatives have added another source of leverage for speculators.
Bloomberg estimates that derivative contracts with Archegos caused the forced liquidation of more than $20 billion in holdings. Much of the leverage used by Archegos was provided by Nomura Holdings Inc. and Credit Suisse Group AG via equity swaps and a type of derivative contract called contracts for difference. Archegos may never actually have owned most of the underlying securities, preferring to bet on the highly levered derivatives contracts instead. Among the stocks impacted by the forced liquidations was ViacomCBS which has dropped nearly 60% since March 22. The prime brokerage losses have not been fully disclosed yet, but Credit Suisse has reported a loss of $4.7 billion so far due to their business relationship with Archegos. Total losses for all banks are likely to exceed $10 billion.
Some of the large banks also have exposure in the precious metals markets with large short positions in silver, platinum, and gold. Futures contracts for these three metals have a higher level of contractual open interest relative to global production than other commodities. The short positions are highly concentrated among among eight large bank trading groups. For example, the eight largest traders are net short silver an amount that would require 180 days of global mine production. They are also net short platinum by 117 days and gold by 86 days of global mine production.
Investment demand for bullion and coins has picked up considerably from prior years. Sprott Asset Management compared the total demand for coins and bars at three government mints: the US Mint, Perth (Australia) Mint, and Royal Canadian Mint. For 2020, sales of gold coins and bars at the three mints was 157% higher than 2019, while the sale of silver coins and bars was 54% higher. Gold and silver bullion ETFs have increased their inventories of bars. Buyers of COMEX contracts are also requiring delivery of physical metal at higher levels than they did in past years. Given government and central bank policies around the world, investment demand for precious metals is likely to continue or rise from current levels. Higher prices should follow.
If you have any questions or comments, please contact me.
Robert G. Kahl
CFA, CPA, MBA