Grantham says only these stocks are attractive
It's official: Buying the cheapest assets you can find is where you make the biggest, safest, easiest money as an investor.
What made it "official" to me was a just-completed study by one of the greatest living investors. The investor is Jeremy Grantham. His firm Grantham, Mayo, Van Otterloo, manages over $100 billion.
Grantham recently published the results of a 10-year forecast he made for the period from December 31, 1999, to December 31, 2009. In 1999, Grantham predicted the rank and return for 11 different asset classes. The actual rankings wound up correlating 93% with Grantham's forecast. The probability of equaling or besting such a performance is about one in 550,000.
How did he do it? As he wrote in his latest investor letter, "We forecast [back in 1999] that the egregiously overpriced S&P would under-perform cash and everything else – what should you expect starting at 33 times earnings? – and we assumed that emerging equities would do extremely well despite a 0.7 correlation with the S&P, because they were cheap." (Italics added.)
Grantham's forecasting feat confirms a thesis I've believed in for a long time: If you wait for asset prices to reach extremes of valuation, you have an excellent chance of outperforming most investors. It's difficult to wait for these extremes to come around, but it's crucial to your success as an investor.
Grantham's track record for spotting valuation extremes goes beyond a single 10-year period. He and his clients successfully avoided every bubble of the last two decades (Japan in the '80s, tech stocks in the '90s, financials and housing in the '00s). He was bearish at the top of the most recent bubble, in 2007, and super bullish at the bottom, in late 2008/early 2009.
Again, Grantham's secret is being bullish on cheap, unpopular assets and avoiding expensive, popular assets.
Today, Grantham says only the higher-quality large-cap stocks are attractive. I say the same and recommend World Dominator stocks like ExxonMobil, Microsoft, and Procter & Gamble. You can read more about this idea here and here.
As for the broader market, Grantham says the S&P 500's fair value is around 850, 20% below its current level.
Grantham expects seven years of "below-average GDP growth" and "more than our share of below-average profit margins and P/E ratios." Falling average price-to-earnings ratios are an important aspect of the sideways market I've been telling people about since November 2009.
Grantham's lessons are powerful and easy to understand. Avoid what's expensive. Buy what's cheap.
Stocks were incredibly popular in 1999, when Grantham made his prediction. They crashed three months later. Emerging markets were very cheap. They produced excellent returns. In both cases, extremes of valuation trumped all else.
If you're buying and selling businesses without knowing how to value them, and how to spot extremes of valuation in them, you can't possibly hope to make a dime in the stock market. If you fancy yourself a "trend follower," be careful you don't follow your beloved trend straight off a cliff.
Grantham's forecasting success proves waiting for extremes of value to arrive makes long-term investing success much, much easier to achieve.
And while I normally don't pay a bit of attention to predictions, it's great to see such a common sense forecast prove the case for value investing once again.
