Jeremy Grantham on Investing in Emerging Markets

The head of investment firm GMO recently said U.S. stocks could continue to rise for a while, but he’s more interested in emerging market stocks because of their lower valuations. He elaborates on his emerging market views in a recent interview. Longer-term, Grantham is fairly pessimistic. He expects low returns from U.S. stocks over the next 10 years and believes emerging market returns will be only a little higher.

Here’s the macro picture he presents: there are a very few number of bubbles in US equity market history. There’s the one that ended in 1929 and the one in the 1950s and the one that ended in 1999. But that’s it. So, it makes statistical analysis very hard. Moreover, it’s even more difficult to predict a bubble because they start out of nothing. Grantham believes it’s only moderately possible to predict that last phase of a bubble, the melt-up, because there the telltale signs of overvaluation and euphoria are all around. And that’s why he’s made his call now.

Grantham says that, “by traditional standards, the market is very expensive, extremely expensive.” Yet, at the same time, here we are, going into the 10th year of an economic expansion and cyclical bull market. And we are seeing a synchronized global expansion. In Grantham’s view, this is fertile ground for a bubble. In fact, the essence of every bubble is “wonderful fundamentals, euphorically extrapolated”. Good fundamentals are “a base for real optimism”. But combine them with a late cycle environment, high valuations, and unrealistic extrapolation and you have the makings of a bubble. And Grantham says, “there’s never been a bubble when the fundamentals did not shine.”