The letter describes GMO’s bearish views on the US economy. They think the recovery is mostly week and seems to be faltering. While the notion of a bond bubble is rejected, the letter points out that investors buying bonds at such low yields have to be content with very low returns.
The strategy of GMO remains:
Buy high quality stocks: (the chorus of investors calling blue chip stocks with high dividend yields very attractive especially in the low yield environment we are in).
Maintain exposure to emerging markets: The letter notes concern about the bubble in China, but GMO is generally bullish on the company.
Inflation not a worry … for now: However, timing interest rate rises and when inflation will rise is a game GMO has no interest in. Instead they are buying TIPs and short term bonds.
Hold cash and cash “plus” as dry powder: It might be painful to hold cash and low yielding instruments but it is prudent if you think bargains might be available in the near future.
Where possible, invest in conservative absolute return strategies: Try to diversify and buy securities with equity like returns. I am not sure exactly what is being referred to here.
First there were green shoots and, in short order, a fully blooming V-shaped recovery. It has been over a year since the chairman of the Federal Reserve employed his horticultural metaphor and economists began to speculate about the shape of the recovery. In the interim, asset prices have substantially recovered, the real economy has stabilized, and even the recession dating committee at the NBER called June 2009 as the trough of the recession. Given our belief that mean reversion drives almost everything, we suppose it is only to be expected that by the time the third quarter of 2010 rolled around, the pendulum has swung all the way back to talk of another recession. Just as night follows day, recovery has been supplanted by relapse. The warning signs were there from the beginning. After all, GDP growth had been almost entirely made up of an inventory rebuild and a reduction in the trade deficit. Hardly the signs of a healthy recovery, normally driven by increases in the three Cs: construction, consumption, and confidence. High and persistent unemployment was similarly dismissed in the face of ever-rising corporate profits. But now that the fiscal stimulus has begun to fade and the variety of programs designed to reach into the future and pull demand into the present have ended, the underlying weaknesses are once again exposed. Without the artificial support, second quarter GDP was revised down from 2.4% to 1.7%.
Below is the full document in scribd format. For best reading view in full screen mode.
3Q 2010 GMO Quarterly Update