U.S. equities have performed incredibly well since the 2008 to 2009 financial crisis. Since those lows, the S&P 500 has gone on a tear, exploding nearly 260% in just seven years.
According to GMO LLC—a $120 billion asset manager co-lead by Jeremy Grantham —those days are over.
The huge run in U.S. markets, coupled with weak returns in emerging markets, has created an asymetric valuation across global markets.
“Relative to what we were thinking five years ago, emerging equities have done surprisingly badly, and the U.S. equity market has done surprisingly well," said Grantham. "Was that the luck of the draw, which has no bearing on future returns? Was it a temporary phenomenon that will soon reverse? Or does it tell us something important about emerging being a value trap and/or the U.S. being extraordinary that we need to take into account in our forecasting of the future?”
John Hussman (Trades, Portfolio) also sees the U.S. market as wildly overvalued.
“Unless we observe a rather swift improvement in market internals and a further, material easing in credit spreads – neither which would relieve the present overvaluation of the market, but both which would defer our immediate concerns about downside risk – the present moment likely represents the best opportunity to reduce exposure to stock market risk that investors are likely to encounter in the coming 8 years,” Hussman said.
Grantham is willing to bet on valuations mean-reverting. This leads to GMO's latest forecast, which highlights emerging markets as one of the only asset classes expected to generate positive annual returns over the next seven years. In fact, it is the only class, other than timber, that will experience annual returns above 1%.
A low-growth world indeed.
Valuations do, in fact, control long-term returns. The higher the price you pay for a stream of earnings, the lower rate of return you will receive. Even with rosy assumptions, the current multiple on the U.S. market just seems too high. It could take years to work out the premium that investors pay at the peak of a market cycle.
To show this example in practice, just ask anyone who was invested in 1928 to 1955, 1936 to 1951, 1964 to 1977, 2000 to 2014 or 2007 to 2014. In all of those periods, investors would have made 0% annual returns.
For now, long-term historical valuation trends point to emerging markets as your best option. With expected annual returns of just 3.3% however, even that undervalued asset class is underwhelming.
Disclosure: I have no positions in any of the stocks mentioned above and no intention to initiate a position in the next 72 hours.
Start a free 7-day trial of Premium Membership to GuruFocus.
