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GMO’s Montier Doesn’t Buy This Stock Rally

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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.” 

“Sadly, we humans are prone to love a story … When we see a correlation (even a spurious one) it is tempting to make up a story to explain the relationship.”

Missing from that story is the idea of risk, writes Montier, who also wonders “if the world has forgotten” about that concept as well. “It appears to be as if the U.S. equity market in particular has priced in a truly Panglossian future where everything is for the best in the best of all possible worlds.”

Howard Silverblatt, senior index analyst at S&P Dow Jones Indices who has been following the US. stock market for over 43 years, explains the rally as the market is looking far, far ahead, discounting this year and not expecting big improvement in earnings until the second half of 2021.

It’s not normal for market to look that far ahead but it’s also not normal to get such a massive and sudden decline and rebound, according to Silverblatt. 

“The Street is looking for getting past COVID,” with treatments and/or vaccines, expecting record earnings in the fourth quarter of 2021, Silverblatt said.   

In the meantime the S&P 500 is up 4.38% year to date, led by tech stocks, a sector that has rallied 21% through July 31 and keeps on going, and consumer discretionary — think Amazon and Netflix — up 16.9% through July, according to Silverblatt’s data. Financials, in comparison, are off 21% during the same time frame.


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