Jeremy Grantham of GMO isn’t optimistic about U.S. stocks and bonds for at least 10 years. He’s anticipating a 1% to 3% return from a traditional diversified portfolio. Here he makes the case for increasing your allocation to emerging market stocks. He also is recommending that his clients (institutional investors) make big bets in favor of emerging market stocks.
But the severe market breaks of 2000 and 2007 showed one thing very clearly: that at the asset class level there was not even a hint of increased efficiency. The peak of 2000 offered perhaps the all-time best packet of mispriced asset classes – one versus another. Value and small cap had never been cheaper compared to growth and large cap. Small cap looked as if it could rally 70 percentage points to catch back up, which it duly did. Even more remarkably, perhaps, US REITs yielded 9.1% at the very top of the market against the all-time low yield on the S&P 500 of 1.5% – all to be justified by a 1% per year faster growth in dividends! By the time the S&P was down 50%, the REIT index was up close to 30% (and small cap value was up 1% or 2%, also not bad). The new long real bonds, or TIPS, yielded 4.3% and regular long bonds yielded 5% or 3.5% real. All amazing. Then more recently in 2007-08 there was the broadest overpricing across all countries, over 1 standard deviation, than there had ever been. So, major opportunities at the asset class level have been alive and well in this period of the last 20 years and compare, for once, favorably to the “good old days.” Why?