GMO’s James Montier likens the U.S. stock market rally to the “hapless Wile E. Coyote, running off the edge of a cliff in pursuit of the pesky Roadrunner but not yet realizing the ground beneath his feet had run out some time ago.”
The stock market is too optimistic about an economic recovery from a recession whose shape and timing remain unknown and ultimately depend “on a large number of frankly unknowable things,” including the trajectory of the COVID-19 virus, writes Montier in a recent paper called Reasons (Not) to be Cheerful. “What happens if there is a second wave in the fall?” he wonders.
“I don’t know the answers to these questions … but I do know that these questions and many others exist,” writes Montier, who’s a member of GMO’s asset allocation team.
Montier also doesn’t buy into the idea that the Federal Reserve’s liquidity creation programs can explain the the rally in U.S. stocks, whose major indexes tumbled 30% between late February and late March only to come back and reach record highs this week.
The proponents of the Fed narrative “didn’t speak up when the S&P soared during the four years from 2016 to 2020 when the Fed’s balance sheet was either flat or shrinking,” writes Montier. “It is tricky to argue for any direct linkage from the Fed’s balance sheet to equity.”
In addition, Montier doesn’t believe that U.S. stock market valuations make sense in an environment of near-zero interest rates, which many have argued. ”Japan and Europe both have exceptionally low interest rates … but they aren’t witnessing stock market valuations at nosebleed-inducing levels.”