Most global assets are now “brutally overpriced”, says Jeremy Grantham in his latest quarterly letter, as investors are bullied by the Federal Reserve’s loose monetary policy into taking more risk. This has been the pattern in markets since 1994, says Grantham.
The successive regimes of Alan Greenspan and Ben Bernanke have cut interest rates “to badger us into riskier investments in order to push up equity prices and grab a short-term wealth effect”. Despite his doubts about the efficacy of the approach, Grantham acknowledges that it creates opportunities for investors.
British-born Grantham co-founded GMO, one of America’s largest money managers, which means the 74-year-old investor has had a front-row seat as the Fed has “engineered rates” – and he’s observed a pattern. The first assets to benefit from low rates are US Treasuries.
“Next, the most obviously competitive type of equities – high-yield stocks – begin to be bid up ahead of the rest of the market.” As low rates continue, investors chase other high-yielding asset classes, such as forestry and real estate. As prices rise across all assets, yields drop and eventually they become extremely overvalued. Eventually, when everything gets too expensive, “a good healthy market crunch” arrives to reset prices.
The difficulty, says Grantham, is knowing when that’s going to happen. “These overpricings can go much further and the Fed can win another round or two.” So what should investors do in the meantime?
One sure tactic is to “own the cheaper assets”. That’s not easy when everything is expensive. But Grantham likes the look of some multinationals, while he thinks that Japanese and European stocks are “only moderately overpriced”.
As for government bonds “fugetaboutit!”. Most offer negative real returns and are exposed to the slight – but “horrific if it occurs” – risk of accelerating inflation.