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Bram de Haas
Bram de Haas
Articles (318)  | Author's Website |

GMO's James Montier's 4 Solutions to Deal With a Terrible Market Outlook

Montier recently talked about his market outlook

May 27, 2018 | About:

James Montier of GMO’s was interviewed by Meb Faber on his excellent podcast. Montier is a member of the GMO Asset Allocation team which has a great reputation for accurately predicting market returns. Montier is also the author of "Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance,” “Value Investing: Tools and Techniques for Intelligent Investment,” and “The Little Book of Behavioural Investing.”

Currently GMO's outlook isn’t particularly optimistic, but that is based on extensive research into fundamentals and knowledge of behavioral economics. Montier first talked about market valuation levels before proceeding to lay out the four solutions he identified. I’ll very briefly discuss the valuation part of the conversation because I’ve laid out that case in other articles before.

Montier on valuation

His message is you are looking at every asset being expensive. There's not a very good escape from that conondrum. That means we've gone from a TINA -- There Is No Altnernative -- environment to what I'll dub a TIN environment, meaning There Is Nothing. To quote Montier directly (emphasis mine):

"Now, now you can get very similar results from a pretty wide measure of evaluation measures. So you don’t have to use that kind of decomposition based framework. You can look at something like Shiller PE. The Shiller PE, as you well know, we are now the second most expensive we’ve ever seen. We have now surpassed 1929, we’re now second with only 1999.

You could look at things like approaching the median stock, you don’t want to look at the market cap average, you could just look at the average stock. You get a very similar picture if you’re looking at something like the average stock’s price sales, it’s multiple. It has never been higher. (Both are shown below.)"


These valuations lead him to a pretty bleak outlook for U.S. equities:

"And the point is that these various different valuation measures is really to help you triangulate. If it was just one particular indicator that was kind of giving you a signal, you guys want to have a lot of faith in that particular signal, or you’d be saying, “Okay, well, look, it’s just one.” But when you look at a wide range of valuation-based metrics and they are all pretty much telling you the same thing, then you could have more certainty in your view. From our perspective, pretty much every measure, we look at shows U.S. equities to be. What I’ve often described as seemingly expensive. So, on the baseline of all forecast going back to normal, you end up with a forecast that’s something like -3% to -4% per annum for the next seven years after inflation. So, it’s in real terms, which is a pretty damn depressing kind of outlook to have."


Montier doesn't just leave with that depressing message but also gives us some options of what we can do about it, which are all extremely tough things to do. Or to do well.

His solutions to the overvaluation across asset classes on a global scale are to:

1) Concentrate.

2) Employ leverage (the risk parity solution).

3) Seek alternatives like private equity and private debt.

4) Do nothing (Montiers preferred option).


This means to concentrate in the least bad asset classes. GMO currently views emerging market value stocks as one of the least bad places to be. His colleague Jeremy Grantham (Trades, Portfolio) earlier this year described how he put 70% of his sister's pension portfolio into emerging markets. He believed he should have done 100%. That's a really extreme example, and it primarily goes to show how much they dislike the outlook for other assets.


Interest rates are low, so one possibility is to employ leverage. Montier doesn't love this himself. It is pretty much despised among value investors and Warren Buffett has often warned against it. Montier interestingly points out that it's especially poorly suited to combine with a value approach where you avoid trying to predict the short term or intermediate future.

"Now, the problem I have with leverage is that it is largely incompatible with a valuation-based approach, right? A valuation-based approach is kind of what Howard Marks (Trades, Portfolio) referred to as, “And I don’t know a way of investing,” by which he means that value investors are essentially agnostic about the path and asset takes. So, cheap assets can always get cheaper, expensive assets can always get more expensive at least in the short term. If you are using leverage, you are saying, “Hey, I know something about the past that this asset will take back to fair value.” That is a… It’s a difficult statement to make for a lot of value investors. It’s not one that I feel terribly comfortable with."


Alternatives could be a good asset class to explore as a private investor because they are not always full of opportunities ready to absorb institutional size investments, but there could be interesting investments for the individual investor. Montier still doesn't think it's a perfect solution (emphasis mine):

"The problem I have with alternatives is most of them are not genuinely alternative, by which I mean they are not magic beans. They’re not unicorns. They’re not somehow uncorrelated sources of return.

Best example is probably private equity. If you think about private equity, what does private equity do? Well, it takes public companies and turns them private and then uses leverage. So, in essence, private equity returns in aggregate should be public equity returns plus leverage minus costs.

So you can clearly see that the private equity is very much going to be a function of public equity. They’re going to be highly related. You know, if you’re looking for companies to take private, where are you taking them private from? Oh, you’re taking them from the public market. We’ve established the public markets are expensive, therefore, these deals are being done at expensive valuations and therefore your returns are likely to be lower."

One area he explains GMO got more active in is mergers and acquisitions. M&A is still very correlated with equity markets. Deals can often be called off in case of a crisis or very bad market circumstances. Even if you invest in a diversified set of them you'll still deeply suffer at times because the blowups cluster. Like Montier puts it:

"But it’s something you only want to engage in when merger arbitrage or the deals you can find are attractive, clearly. So, it’s valuation-dependent as anything else you do in investing."

Do nothing

Montier's favorite solution is to do nothing. By which he means hold cash. There are very few people who can actually do this, however. Buffet is sitting on $100 billion of cash. Murray Stahl (Trades, Portfolio) of Horizon Kinetics is sitting on a lot of cash. Seth Klarman (Trades, Portfolio) is reportedly sitting on something like 50% cash. But these people have earned the confidence of their investor base over decade after decade. Montier may like this solution the best. He does admit it is terribly difficult especially for professional investors with career risk:

"And so, it is unfortunate in the short-term because you’re sitting there, looking, let’s say, holding cash looking conservative, being patient, waiting for that opportunity set to change. If it doesn’t change, you are wrong, and if it does change, well, nobody’s gonna thank you anyway because they probably had a lot of investments that were once worth a lot more than they are right now, and therefore you’re not gonna be terribly popular. So, no matter what you do, you’re kind of doomed and that I think is one of the challenges to being patient. But to me, it is the most sensible thing to do when there is nothing to do, which is I think a good description of the current asset environment in general. Don’t do very much, right? Just sit there, be patient, wait until a better opportunity set present yourself that the risk you’re running, of course, is in never doubt."

Disclosure: no positions.

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio.

Visit Bram de Haas's Website

Rating: 5.0/5 (2 votes)



Timjaeger premium member - 7 months ago

Agree with this sentiment. Nothing great out there. Maybe some low CAPE / low P/B markets overseas but really it’s all meh.

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