Tag Archives: Jeremy Grantham

You Can’t Get Blood Out Of A Stone

My title comes from Jeremy Grantham’s recent CNBC interview. This remark occurs in a discussion about likely returns from the U.S. stock market. Everyone at Grantham’s firm, Grantham, Mayo, van Otterloo (GMO), agrees that over the next two decades stocks will deliver around 2% after-inflation or “real” returns, says Grantham himself. Traditionally, the market has delivered 6%-7% annualized real returns, but trying to achieve that now will be like trying to draw blood out of a stone. Investors hoping for the historical 6%-7% are bound to be disappointed.

The reason for Grantham’s pessimism is simple — P/E ratios are high. Grantham uses the Shiller PE (current price of the S&P 500 Index relative to the underlying constituents’ past 10-year average real earnings). The long term average of that metric is around 16, but over the past quarter century is has been over 20. But Grantham doesn’t think the average will return to 16 soon or in a way that value investors want. It will likely take around two decades instead of a more typical 7-year cycle. And, in a way, that’s more painful than having a market crash. A crash amounts to a valuation re-set; prices get cheap, and the opportunity to invest presents itself to those with courage. But a slow movement from a Shiller PE of 30 (where it sits now) to 16 is a real problem for long term investors who won’t get a good opportunity for returns for a generation.

Besides expensive valuations, the economic cycle will not be in investors’ favor. Grantham thinks recent growth numbers reflect a one-time bump of sidelined workers getting back into the labor market from the time of the financial crisis. That increase has produced an aritificial percentage point of growth in recent years, Grantham estimates, which means the U.S. isn’t growing at, say, 2.5%. Instead it’s growing at more like 1.5%. That will be apparent, in Grantham’s opinion, as the last workers who were frightened out the labor market after the crisis re-enter. Perhaps that game of re-entry can persist for a few more years, Grantham speculates, but it’s not a permanent feature of the economy. When it ceases, growth will suffer.

Moreover, population growth in the U.S. is declining. We need a 2.1 fertility rate to keep growing, and the U.S. has a 1.76 fertility rate. Also, the fertility rate is below that in every other developed country. The population growth rate in the developed world “has gone to hell,” says Grantham. Only emerging markets countries present the prospect of stronger population growth. Besides a growing population in emerging markets, Grantham is also impressed with China’s emphasis on engineering and science education. China is beginning to dominate Artificial Intelligence and green energy, for example. India isn’t far behind, and, when pressed to single out a country that might be the single best investment in the emerging markets space, Grantham singled out India. Even if Grantham is uncomfortable making a specific country call, all of this means he thinks emerging markets are the future for equity investors. It’s a given, however, that emerging markets investors will have to endure volatility.

Grantham is less keen on Europe. Population growth is worse there than in the U.S., and the recent problems with immigration will only worsen, stressing the EU considerably. And a weakened EU grants more opportunity to China and Russia to misbehave. It also increases uncertainty. Brexit looks like it might be delayed, and when it’s delayed it looks like the odds of overturning it might increase somewhat. Still, Grantham provides no guarantees regarding the country of his birth.

While population growth — or lack thereof — present problems for the economy, at least it’s beneficial for the planet. Grantham has devoted time and resources to combat global warming and harm to the environment. Grantham proudly drives a Tesla, but noted that, as a value investor, he wasn’t interested in the company’s stock. He did allow that the stock could be successful, as Amazon’s has been.

The message investors should take from Grantham’s remarks is that stock returns in the developed world will be low for the next decade and possibly longer. That means you must increase your savings rate to meet your retirement and other goals. The market probably won’t do the heavy lifting that it’s done in the past.

Stocks Vs. Bonds & What To Own Over The Next Decade

Imagine a world with two investment options, apples and oranges. Investors are best served to reduce their holdings of apples and to replace them with oranges when demand for apples drives the price too high. The simple logic in this example is applicable across the full spectrum of economics, and it holds every bit as true in today’s complex world of investing. The question every investor should have is, “When does the price of “apples” make “oranges” the preferred holding”? Most of the time, answering that question is not easy. Occasionally however, the evidence becomes too obvious to ignore.

Replace apples and oranges with stocks and bonds and you have defined the majority of investors’ asset allocation schematic. Unlike our fruit example, the allocation decision between stocks and bonds, is based on many factors other than the price of those two assets relative to each other. Among them, recent performance and momentum tend to be a big influence in both raging bull markets and gut-wrenching bear markets. In both extremes, valuations tend to take a back seat despite historical data providing ample evidence that equity valuations alone should drive allocation decision.

Current equity valuations and nearly 150 years of data leave no doubt that investors are best served to ignore yesterday’s stock market momentum and gains and should be shifting to bonds, as we will demonstrate.


How often do you hear someone touting a stock because its share price is low, or advising you to sell because the price is too high? This nonsense does not come from just Uber drivers and novice investors; it is the primary programming line-up of the main-stream business media.  The share price on its own is meaningless. However, the stock price times the number of shares outstanding provides the market capitalization (market cap) or the dollar value of the company. Inexplicably, market cap is a number you rarely hear from those giving stock tips.

Market cap allows investors to take the aforementioned corporate worth and compare it to earnings, cash flow, revenues and a host of other fundamental data to provide a logical valuation platform for comparison to other investment options.

While we use a slew of different valuation techniques, we tend to prefer the Cyclically-Adjusted Price-to-Earnings (CAPE) Ratio as devised by Nobel Prize winning economist and Yale professor Robert Shiller. The ratio adjusts for inflation and as importantly, uses ten years of earnings data to derive a price to earnings ratio that encompasses business cycles. Shiller’s approach eliminates short-term noise that tends to make the more popular one-year trailing price-to-earnings ratio erratic and potentially misleading.

Currently, the CAPE on the S&P 500 is 33.41. Looking back as far as 1871, today’s valuation has only been exceeded by a brief period in the late 1990’s. To help link return expectations and CAPE valuations we plot below every historical monthly instance of CAPE to the respective forward ten-year returns. Each of the 1,525 dots represents the intersection of CAPE and the ten year total return that followed since 1871.

Data Courtesy: Robert Shiller

Apples or Oranges

While the analysis is telling, investors should compare the returns versus those from a ten-year U.S. Treasury note to determine whether the returns on stocks adequately compensated investors for the additional risk.

The graph below shows the returns above minus the prevailing ten-year U.S. Treasury note.  Essentially, the graph shows the excess or shortfall of the returns provided by stocks versus those of ten-year Treasury Notes in the ten years following each monthly CAPE instance. Negative returns indicate the 10-year Treasury yield exceeded the 10-year total return on stocks.

Data Courtesy: Robert Shiller

To better highlight the data and put a finer point on current prospects, consider the bar chart below.

Data Courtesy: Robert Shiller

The chart above aggregates the data from the prior chart into ranges of CAPE as shown on the x-axis. It also displays the mean, maximum and minimum of the excess ten year returns of stocks at the various CAPE ranges. This information can be used to create expectations for future performance given a stated CAPE.

With the current CAPE at 33.41 as circled, investors should expect an annualized excess return for ten years of -2.04%. Based on historical data which includes 32 full business cycles dating back to 1871, the best excess return experienced for all instances of CAPE over 30 is 0.39%. Over this 147 year period, there have been 57 monthly instances in which the CAPE was above 30. Only four of these instances provided an excess return over Treasuries and the average was a paltry twenty basis points or 0.20%.

Call us cynical, but the prospect of equity market excess returns  for the next ten years measuring in the fractions of a percent is not nearly enough compensation for the distinct possibility of underperforming a risk-free asset for ten years.


History, analytical rigor and logic all argue in favor of shifting one’s allocations away from stocks. Investors have no doubt become accustomed to the easy gains provided by equity markets over the past ten years, and old habits are hard to break but we know valuations to be mean-reverting. Given current extremes, this comparison offers compelling evidence that compounding wealth most effectively depends on breaking that habit.

Deficits Do Matter

The Federal Reserve (Fed) has increased the Fed Funds rate by 125 basis points or 1.25% since 2015, which had little effect on bonds until recently. Of late, however, yields on longer-maturity bonds have begun to rise, contributing to anxiety in the equity markets.

The current narrative from Wall Street and the media is that higher wages, better economic growth and a weaker dollar are stoking inflation. These forces are producing higher interest rates, which negatively affects corporate earnings and economic growth and thus causes concern for equity investors. We think there is a thick irony that, in our over-leveraged economy, economic growth is harming economic growth.

Despite the obvious irony of the conclusion, the popular narrative has some merits. Fortunately, the financial markets provide a simple way to isolate how much of the recent increase in longer-term bond yields is due to growth-induced inflation expectations. Once inflation is accounted for, we shine a light on other factors that are playing a role in making bond and equity investors nervous.

Given the importance of interest rates on economic growth and stock prices, understanding the supply and demand for interest rates, as laid out in this article, will provide benefits for those willing to explore beyond the headlines.

Nominal vs. Real

Since September of 2017, the yield on the five-year U.S. Treasury note has risen 90 basis points while the ten-year U.S. Treasury note has increased 75 basis points. At the same time, inflation, as measured by annual changes in CPI, declined slightly from 2.20% to 2.10%. Recent inflation data, while important in understanding potential trends, is by definition historical. As such, forecasts and expectations for inflation over the remaining life of any bond are much more relevant.

Treasury Inflation Protected Securities (TIPS) are a unique type of bond that compensates investors for changes in inflation. In addition to paying a stated coupon, TIPS also pay holders an incremental coupon equal to the rate of inflation for a given period. In technical parlance, TIPS provide a guaranteed real (after inflation) return. Non-TIPS, on the other hand, provide a nominal (before inflation) return. The real returns on bonds without the inflation protection component are subject to erosion by future rates of inflation. To gauge the market’s expectations for inflation, we can simply subtract the yield of TIPS from that of a comparable maturity nominal bond.

During the same six month period mentioned above, yields on five and ten-year TIPS increased 30 basis points. As shown below, this means that 60 basis points of the 90 basis point increase in the five-year note and 45 basis points of the 75 basis point increase in the ten-year note are a result of non-inflationary factors. The graphs below highlights the recent period in which five and ten-year yields rose at a faster pace than inflation expectations.

Data Courtesy: St. Louis Federal Reserve

Data Courtesy: St. Louis Federal Reserve

By isolating the widening gap between nominal and real yields on Treasury notes of similar maturities, we establish that there are other factors besides inflation that account for about two-thirds of the recent march higher in yields. Below, we summarize the potential culprits affecting both the supply and demand for U.S. Treasury debt offerings, which should help uncover the factors other than inflation that are driving yields higher.

Supply Factors

The most obvious influence driving yields higher, in our opinion, is the prospect of larger Federal deficits in the coming years. The tax reform package boosts the deficit over the next ten years by an estimated $1.5 trillion, and the recent two-year continuing resolution (CR) for government spending adds an additional $300 billion of debt to the U.S. Treasury’s ledger. We remind you these are in addition to Congressional Budget Office (CBO) forecasts for sharply increasing deficits due to social security and other previously promised entitlements.

As if deficit spending approaching that of the financial crisis of 2008 is not shameful enough, the administration’s latest budget proposal is even more daunting. Based on the proposed budget, if we optimistically assume that the current economic expansion can last for ten more years without a recession and that GDP can grow by about 1.50% more than that of the last decade, then the deficit will grow by “only” approximately $8 trillion by 2027. Keep in mind; debt outstanding tends to grow by a larger amount than stated deficits due to accounting gimmicks used by the Treasury. Before including Trump’s budget proposal, the trajectory of Federal debt outstanding is forecast by the Office of Management and Budget (OMB) to increase by $1.1 trillion on average in each of the next five years.

To put that into context with the nation’s ability to pay off the debt, the economy has grown by approximately $500 billion a year on average over the last three years. Federal tax receipts as a percentage of GDP over the last three years have declined from 11.5% to 11.1%. If the economy grows $500 billion, we should expect an additional $55 billion of tax revenue. These numbers emphasize the extent to which elected officials from both parties have radicalized the budget process and the acute state of fiscal irresponsibility now in play.

Don’t dismiss the magnitude of $20 Trillion in U.S. debt and it projected growth rate. It is larger than the debts of the next four largest debtor nations combined. 

Demand Factors

“Deficits don’t matter.” This frequently quoted statement leads many to believe that our nation’s debts will always be funded by willing and able creditors. To their point, rapidly increasing federal debt levels of the last thirty years have been easily funded and at increasingly lower interest rates.

To better gauge whether we can expect said support to fund the increase in projected debt issuance, we analyze the two largest holders of publically traded Treasury securities, foreign investors and the Federal Reserve.

Foreign investors hold 43% of all publically held Treasury securities outstanding, commonly referred to as “marketable debt held by the public.” China and Japan top the list, with each holding over $1 trillion of Treasury debt. The graph below compares foreign holdings of U.S. Treasury debt and the entire stock of public U.S. Treasury debt.

Data Courtesy: St. Louis Federal Reserve

Will foreign buyers continue to grow their holdings by over $400 billion each year?

To help answer that question, consider:

  • Over the last year, foreign holders have purchased approximately 5% of new debt compared to a range of 40-60% since the recession of 2008.
  • Since 2015, foreign holders have increased their Treasury security holdings by $151 billion while $1.591 trillion of new Treasury debt has been issued.
  • Since 2015, Japan has reduced holdings of US. Treasuries by 12% or $141 billion.
  • Since 2015 China has reduced holdings of US. Treasuries by 4% or $52 billion.

The second largest holder of U.S. Treasuries is the Federal Reserve. Quantitative Easing (QE) was a major part of the Feds economic stimulus and bailout program of the 2008/09 financial crisis and continues to this day. QE is essentially the act of printing money to purchase debt securities from the market. According to the Federal Reserve Bank of St. Louis, Fed holdings of U.S. Treasury securities rose from $474 billion in March 2009 to a peak of $2.40 trillion in December 2014, an increase of 416%. That balance was held stable through the end of 2017. To put that into context, as of September 2017, mutual funds, pension funds, and insurance companies held a combined $2.47 trillion of Treasury debt.

As we discussed in the Fed Giveth (LINK), the Fed has recently begun reducing the size of their balance sheet, and therefore its holdings of Treasury securities are slowly shrinking. They began in late 2017 by reducing the amount of Treasuries held by $6 billion per month and will increase the pace by $6 billion every three months until they reach $30 billion per month. This schedule, if reliable, implies that the Fed will reduce their Treasury holdings by $225 billion in 2018 and $351 billion in 2019. In this way, the reduction in Federal Reserve holdings is an incremental supply of Treasury securities to the market. And when the supply of bonds increases, yields should rise.

The absence of the Fed as large Treasury holders and the reductions in holdings and new purchases of Treasuries by China and Japan should have similar effects on yields, although the magnitudes may be different. So, rising yields are not just about inflation, whether realized or expected, it is also about the changes taking place in supply and demand simultaneously.


Vice President Dick Cheney was quoted in 2002 as saying “deficits don’t matter.” With the staggering accumulated deficits of the past few years, we are about to test Cheney’s theory. The powerful economic environment of the 1980’s and 1990’s allowed for the accumulation of federal, corporate and personal debt. In this millennium, the growth of debt accelerated, but the tailwinds supporting economic growth have weakened substantially.

Just because we were easily able to fund deficits of years past does not mean we should be so naïve as to think it will be easy going forward. As described above, the circumstances we face today are far more challenging than those of past years. The confluence of these events argues that investors should prepare for a new paradigm and not get caught flatfooted trusting in outdated narratives.

We leave you with a bit of wisdom from investment guru Bob Farrell, Former Chief Stock Market Analyst Merrill Lynch

“In the early stages of a new secular paradigm, therefore, most are conditioned to hear only the short-term noise they have been conditioned to respond to by the prior existing condition.  Moreover, in a shift of long-term significance, the markets will be adapting to a new set of rules while most market participants will be still playing by the old rules.”

Strategies for Tomorrow

Most investors, knowingly or not, rely on long-only, passive strategies. They may shift holdings between stocks, bonds, and cash at various intervals, but generally, their portfolio returns mimic those of well-known stock and bond indices.

A recent graph from Goldman Sachs, as shown below, serves as a prescient reminder that this popular portfolio strategy may be worth reconsidering in the current environment.

The graph shows bull and bear market periods based on a portfolio comprised of 60% equities and 40% bonds. This graph uniquely allows the reader to simultaneously visualize both returns and the duration of the respective bullish or bearish periods.  Focusing on the current bullish period, here are two important takeaways that investors must consider:

  • The current bull market in stocks and bonds is 8.7 years old and only about five months shorter than the longest bullish period since at least 1900. That period, the “roaring twenties” preceded the Great Depression.
  • Total returns for the current recovery are the third highest over the past 118 years, eclipsing both 2008 and 1999, which both resulted in significant (over 50%) drawdowns.

This chart should give investors pause. While it does not necessarily imply the bottom will fall out as it did in the 1930’s, or even 1999 and 2008, it does suggest that asset markets are historically stretched when measured in both return and the duration. Over the coming years, it is highly likely that a sizeable portion of those returns will be lost.

The graph above fails to factor in one consideration that may make the next correction different from the last four. During the last four recessions and related equity market corrections, a balanced portfolio (60/40) benefited greatly from gains in fixed income assets. The graph below compares total returns during those periods of a portfolio that is 100% invested in the S&P 500 versus one that is allocated to the S&P 500 and U.S. 10 year Treasury notes in a 60:40 ratio.

As shown, the addition of bonds and reduction of equities resulted in positive returns during the recessions of 1981 and 1991. During the last two recessions, bonds helped to cut the portfolio’s losses in half.

Looking forward, an important question we must consider is will bonds help minimize losses as they have done in the past. In the prior two recessions, the ten year U.S. Treasury note yields were greater than 4% and nearly double those of today. The significance is that a higher yield provides more room for yields to decline and thus bond prices to increase. Further, the higher yield provides more coupon income to help offset equity losses.

Investors relying on gains on bond holdings to offset losses on stock holdings should consider that while bonds may produce gains, said gains are likely more limited than at any time in the past.

What’s an Investor to do?

Given the historical precedence, we think it is appropriate for investors to consider alternative wealth management strategies. Below, we describe a few strategies that are not dependent upon positive stock and bond market direction to generate positive returns.

Global macro – By far the most complex and difficult of strategies, managers use a fundamental assessment of global economic dynamics to establish long or short positions in every asset class available to them.

Deep value – This strategy seeks to limit investments to those securities that are heavily discounted and/or extremely out of favor and thus appear to have very limited downside risk. This strategy tends to have longer holding periods than most.

Option strategy – Managers employing this strategy predominately engage in the exchange-traded options market (put/calls) and/or over-the-counter options (swaptions). At times, options are combined with long or short positions in the underlying securities to create the desired profile.

Event-drivenThis is a strategy focused on identifying specific catalysts related to a company, a sector or an economy and positioning for the ultimate realization of that event.

Arbitrage – In this approach, managers look for pricing anomalies among related instruments and seek to extract risk-free profits by being long or short those instruments at the same time.

Volatility –  Now viewed as an asset class like stocks, bonds and commodities, this strategy uses long or short positions and options to produce returns through low (and rising) or high (and falling) price swings in those instruments.

Long/Short – Predominantly used by managers in the equity markets to pair a long position in one stock against a short position in another with the intent of limiting market risk while taking advantage of perceived richness and cheapness in selected securities.

Trend Following – This strategy is generally a technical approach which relies upon the momentum of price action in a security or an index to generate profits. Managers use long or short positions as a trend establishes itself, then take profits and reverse positions as the trend weakens or reverses.

Fund of Funds – Firms with expertise in identifying talented investment managers look to diversify investment dollars among many managers and strategies, including some of the strategies listed above.

The strategies listed above represent a subset of strategies commonly used by those seeking returns that are not highly correlated with market returns. Like any strategy, those summarized above tend to cycle through periods where they are effective and times when they are less so. Thus, like any strategy, timing is important.

The overly simplistic approach of buy-and-hold fails to acknowledge that given a deep enough correction, most investors will eventually react by selling to stop the mental anguish. This usually occurs very near the worst possible time – at the bottom. To continually build wealth through good and bad markets, investors require a diverse, alternative set of strategic tools. Further, traditional bond/stock strategies of yesterday had the benefit of a cushion provided by fixed income assets. Given the low level of rates, we must question the validity of relying on bonds to hedge a portfolio in the next turndown.

By ignoring history and shunning alternative strategies, investors will, in time, lose much of the wealth they have accumulated over the prior years. Compounding wealth does not require keeping up with high-flying markets in good times, it demands prudent decision-making to avoid large losses when markets sour.

It is important to stress that the strategies detailed above are typically beyond the scope of amateurs and do contain substantial risks of loss. We highly recommend speaking with a knowledgeable investment manager, and conducting extensive due diligence, before investing in such strategies.

Will The “Real” Real GDP Please Stand Up?

Last Friday, Gross Domestic Product (GDP or the domestic economic growth rate) for the fourth quarter of 2017 was released. Despite being 0.3% short of expectations at 2.6% annual growth, it nonetheless produced enthusiasm as witnessed by the S&P 500 which jumped 25 points.  One of the reasons for the optimism following the release was a strong showing of the consumer which notched 2.80% growth in real personal consumption. The consumer, representing about 70% of GDP, is the single most important factor driving economic growth and therefore we owe it to ourselves to better understand what drove that growth. This knowledge, in turn, allows us to better assess its durability.

There are three core means which govern the ability of individuals to spend. The most obvious is income and wages earned. To help gauge the effect of changes in income we rely on disposable income, or the amount of money left to spend after accounting for required expenses. Real disposable personal income in the fourth quarter, the same quarter for which GDP data was released, grew at a 1.80% year over year rate. While other indicators of wage growth are slightly higher, we must consider that payroll gains are not evenly distributed throughout the economy. In fact as shown below 80% of workers continue to see flat to declining growth in their wages.

While this may have accounted for some of the growth in consumption we need to consider the two other means of spending over which consumers have control, savings and credit card debt.

Savings: Last month the savings rate in the United States registered one of the lowest levels ever recorded in the past 70 years. In fact, the only time it was lower was in a brief period occurring right before the 2008/09 recession. At a rate of 2.6%, consumers are spending 97.4% of disposable income. The graph below shows how this compares historically.

As shown above, the savings rate is less than half of that which occurred since the 2008/09 recession and well below prior periods.

There are two ways to think about the record low level of savings. Optimistically, we can claim that consumers are confident about future job prospects and wage growth and therefore feel as though they do not need to save. More realistically, we can assume that consumers are in a bind and are reducing their savings to make ends meet. More recently, the higher price of education and health coverage are likely culprits for pushing consumers to skimp on savings.

Credit Card Debt: In addition to reducing savings to meet basic needs or even splurge for extra goods, one can also use credit card debt. Confirming our suspicion about savings, a recent sharp increase in revolving credit (credit card debt) is likely another sign consumers are having trouble maintaining their standard of living. Over the last four quarters revolving credit growth has increased at just under 6% annually which is almost twice as fast as disposable income. Further, the 6% credit card growth rate is about three times faster than that of the years following the recession of 2008/09.

Adjusted GDP

While the GDP data represents actual consumption, we again ask if it is sustainable. In the case of the last few quarters, in particular, we must answer that question based on the ability for savings to decline further and credit card usage to remain high. As such, we normalized GDP based on the savings rates and credit card usage growth of the post-recession era. In our opinion, this gives us a realistic reading of what GDP would be like without the benefits of sharply reduced savings rates and unsustainable usage of credit cards.

Savings: If we recalculate the amount of consumption that would have occurred had the savings rate remained at the post-recession savings rate of 5.50%, we compute that $281 billion of savings was sacrificed over the last four quarters.

Credit Cards: The amount of revolving debt has been increasing at 6% annually over the last four quarters which is double the rate of income, or the ability to pay for the debt. If we assume instead a more normal 3% usage growth rate, which is in line with income growth, we estimate that additional credit accounted for $20 billion of spending above and beyond what is sustainable.

Over the last four quarters, real GDP rose by $421 billion, resulting in a 2.60% annual increase. If we adjust consumption to more normal levels of spending and credit usage, the increase in GDP is a mere 0.71%, hardly robust.


Can savings decline further and credit increase more? The answer is yes, but to do so savings would hit all-time lows and the rate of credit growth would greatly exceed the rate of income growth. Despite the hype of post-tax reform corporate bonuses, wages and salaries continue to muddle along at a very uninspiring rate.  This data further tells the story of an indebted consumer that is being forced to spend more income on non-discretionary items such as rent, education, healthcare and energy and in response is using credit and savings to fund those purchases.

This story will get interesting when the first-quarter 2018 GDP is released and the hangover from the holiday season reveals itself. The revisions to growth are likely to be confounding and broadly rationalized away by stock-friendly analysts. While monthly data has yet to give us any meaningful indications, we suspect personal consumption for the current quarter, and likely many ahead, will be weak.

Peak Hubris

In the past month, two well-known and highly respected money managers have made confident assertions about the markets. Their comments would lead one to believe that the future path of the market in the coming months is known. Sadly, many investors put blind faith in the words of high-profile, accomplished professionals and do little homework of their own. While we certainly respect the background, knowledge, and success of these and many other professionals, we take exception with their latest bit of advice.

Before the election In November 2016, were there investment professionals that claimed a Donald Trump victory would drive equity prices significantly higher? Although we are certain there were a (very) few, they certainly were not publicly discussing it, and the broad consensus was overwhelmingly negative.  In March of 2009, which professional investors were pounding the table claiming that the next decade would produce some of the greatest market returns in history? Again, while some may have thought valuations were fair at the time, few if any were raging bulls.

The two instances are not unique. More often than not, investor expectations fail to accurately anticipate the future reality. This is not solely about amateur individual investors, as it equally applies to the best and brightest. Despite the urge to heed the sage advice of the “pros”, we must always remain objective, especially when everyone seems so certain about what will happen next.

The Known Future

The current message from Wall Street analysts, media gurus and most investors is that stock prices will undoubtedly go up for the foreseeable future.  Unbridled optimism about corporate earnings offer one point of fundamental justification for such views, but in large part these forecasts are predominantly based on the simple extrapolation of prior price trends. In late January 2018, a few esteemed Wall Street analysists actually raised their year-end S&P 500 price forecast from what it was only weeks prior. Although rationalized by stronger estimates of earnings expectations and an improving economic prognosis, the fact that January’s market rally has the S&P 500 already approaching their year-end forecast also played a meaningful role.

Basing future expectations on the most recent price activity is a great method of forecasting returns, until the trend changes. Wall Street analysts are not the only ones convinced the recent trend will continue in the months ahead. The graph below shows that expectations for stock price increases are now higher than at any time since at least 1987.

This second table from Ronnie Stoeferle at Incrementum provides a broad gauge of the excessive bullishness in the markets.

While there are a slew of technical reasons to suspect the recent market dip may be a speed bump on the way to higher prices, there are some serious fundamental warnings along with geopolitical concerns that argue downside risks are being grossly ignored. We would avoid using the word certainty to describe a market or economic forecast, and given the juxtaposition of risks and excessive valuations, relying on the certainty of others is not a prudent way to build wealth.

Ray Dalio

The following quotes came from a recent interview with Ray Dalio:

  • “We are in this Goldilocks period right now. Inflation isn’t a problem. Growth is good, everything is pretty good with a big jolt of stimulation coming from changes in tax ”
  • “There is a lot of cash on the sidelines. … We’re going to be inundated with cash,” … “If you’re holding cash, you’re going to feel pretty stupid.”
  • Finally, he said he expects to see “a market blow-off” despite the economy being in the last legs of the economic growth cycle.

What could go wrong? Ray Dalio, the billionaire founder of the world’s largest hedge fund, warns us that taking a conservative posture will make you “feel pretty stupid.”

There are four problems with these comments. First of all, does Ray Dalio really believes there is “cash on the sidelines”?  For every buyer there is a seller. The concept of “money on the sidelines” does not hold in a free market economy. This is one of Lance Robert’s 7 Myths of Investing.

7-Myths Of Investing

Second, neither he nor anyone else knows what the future holds and for every buyer there is a seller. Third, even if we presume him to be correct concerning the market, will he let you know when it’s time to sell stocks and hold cash?  Keep in mind that wealth is compounded most effectively by not chasing markets higher but by avoiding large losses. Finally, Mr. Dalio almost certainly has hedges in place so that, even if he is wrong, his portfolio will have some cushion. Again, although we respect his insight and he may well be correct, it is concerning to hear a person of such influence potentially mislead investors into thinking the future is certain and worse mocking those taking precautionary measures.

Jeremy Grantham

Mr. Grantham, also a very successful investment manager, has made similar comments as to how this bull market ends.

  • “I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull ”
  • “A melt-up or end-phase of a bubble within the next six months to two years is likely, i.e., over 50%.”

Mr. Grantham has a perfect track record this millennium of calling out the equity bubbles of 2000 and 2008 well in advance. Further, he has stated unequivocally that equity valuations are excessive and investors should expect flat to negative returns over the longer term. Currently, his firm GMO is forecasting annualized inflation-adjusted returns of -4.4% for U.S. large-cap stocks over the next seven years. Despite the prospects of negative returns and wealth losses, he feels confident influencing others to chase a “melt-up” bubble that may last from six months to two years.

Dalio/Grantham Wisdom

Both highly successful investors and thought leaders are telling the story of tenable market risks but then tempting investors with the possibility of a grand finale worth chasing.

No one knows how this current bull market will end. Dalio and Grantham may be correct, and it may end with a melt-up, blow-off rally for the ages.  On the other hand, it may have ended last week with the blow-off rally having occurred over the last year.

To put a historical perspective on how this market may top, the following charts compare the death of the NASDAQ 100 bull market in 2000 and the end to the S&P 500 bull market in 2007.

As shown, the topping of the last two bull markets took vastly different paths. Whether a blow-off rally as seen in the late 1990s, the one advocated by Grantham and Dalio, is the right call or a more frustrating rounded top of 2008 is the answer, we do not know. Left for consideration is whether the 37% rally since Trump’s election was the blow-off top and, if so, has it reached its apex?


While market geniuses in their right, Dalio and Grantham’s ideas about how this ends have zero certitude. If their minds change, we will almost assuredly be the last to know. Although a cynical premise, could they be propping the market up with talk of a magnificent rally so they can reduce their own risk? There is abundant evidence this occurred in 2007 as the mortgage meltdown progressed, albeit with different protagonists.  So, we think it is a fair question to ask in this instance.

Given current valuations, the risks are significant, and if history is any indication, we can be assured that this bull-run will end sooner rather than later. This is not a message encouraging you to ignore the thoughts of Dalio, Grantham or other successful investors. Rather we remind you that you are solely responsible for the risks you take. Being a good fiduciary and worthy steward of wealth mandates that we understand the risks as highlighted by Dalio and Grantham and avoid being influenced by the consensus groupthink that often has an ulterior motive. We all know how that ends.

We leave you with the S&P 500 price projections from Wall Street’s best and brightest in 2008.