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Jeremy Grantham And Lou Stanasolovich Discuss Market Valuations

Jeremy Grantham of Grantham, Mayo, Van Otterloo and Co., LLC and a legend in the investment industry with over forty years experience, discussed his views on investing recently with Lou Stanasolovich, CFP™, CEO and President of Legend Financial Advisors, Inc. (Legend). Many regard Jeremy in the same light as investment veterans Warren Buffet, Bill Gross, Steven Leuthold, Robert Arnott, and Cliff Asness.

Grantham discussed his valuation models of numerous asset classes and how they historically relate to the financial markets currently. His financial data is rivaled only by that of Steven Leuthold with regard to historical comprehensiveness. A review of the data revealed that large U.S. stocks (S&P500) are still grossly overvalued. Investors optimistically should expect no more than a 1.5% compound return for the S&P 500 over the next seven (7) years before inflation and income taxes. Other asset classes such as domestic small cap stocks should double the performance of large S&P 500 stocks turning in a 5.9% compound return. Although not a great return, it is superior in comparison to the alternative. The valuation models also revealed that U.S. bonds should provide a moderately higher return than the S&P 500. Asset classes that should do well because of their low market valuations include; REITs, hedge-type investments, small and large international stocks particularly those with a value orientation, emerging market bonds and emerging market equities, as well as commodities. Returns from these types of investments should provide returns of 8% to 12% due to their low valuations over the same seven (7)-year period.

Historically, when price-to-earnings ratios (P/E = prices of stocks divided by their earnings – a common measure of value) have been in the top 20% of valuations as they currently are (actually despite three years of a falling stock market, current valuations are the third highest of all time), the average return for a ten (10)-year period when the market is as highly valued as it is, has been 0.2% above inflation- (currently projected at 2.2%). That’s correct, 0.2%. Grantham believes that current valuations on the S&P 500 causes even this minuscule return projection to be optimistic.

While discussing “bubble markets” (this includes stock markets around the world, currencies, commodities), such as the current one, Grantham cited that such market periods have always resulted in devastating losses for investors. In fact, since 1900, not including the current bubble, in 27 out of 27 “bubbles,” losses exceeded 100% of the gains previously earned. Furthermore, valuations based upon ten (10)-year normalized (earnings are averaged over years) P/E levels dropped not only below historical median valuations, they went far below the median. This would imply a Dow Jones Industrial Average to be near a 4,000 level (see Bill Gross’ article entitled, “Dow 5,000” in September of 2002 at www.pimco.com). You may also recall that in 1996, when the stock market was skyrocketing and had reached the 6,000 level, present Federal Reserve Chairman, Alan Greenspan stated this was due to irrational exuberance. Please keep in mind that we are discussing the valuations of one asset class, U.S. large stocks, and not all asset classes. As a result of these unarguable facts, we believe we have positioned our portfolios to take advantage of these trends and to avoid the inevitable.

    


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