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GMO’s Inker: 2 Predictions for How the Stock Bubble Could End

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“The U.S. stock market looks like a pretty poor risk-reward trade-off, and bonds have a very low expected return — the familiar assets stink. Now is one of those times when you might as well be taking as much risk with the non-familiar assets as you and the client can be comfortable with.”

That’s the recommendation to financial advisors from Ben Inker, head of GMO’s asset allocation team, in an interview with ThinkAdvisor, in which he offers some “non-familiar” suggestions.

At the same time, and as demonstrated by the selloff earlier this week, Inker sees a “loss of fervor on the part of the momentum/retail players at the highest valuations end” of the market. “The crazy end of the market is starting to deflate,” he says.

Indeed, “The speculative end of the market has been doing poorly for at least the last couple of months”; and, Inker says, “truly loony prices have started to come down.”

But the chartered financial analyst points to a different scenario as well, one painted this past January by Grantham Mayo Van Otterloo co-founder Jeremy Grantham, who detected a “late-stage major bubble [in growth stocks]” that, he wrote, “will be recorded as one of the great bubbles of financial history.”

As of a few days ago, he hasn’t changed his stance, Inker reports. The GMO chief investment strategist forecasts that once the speculative bubble bursts, the entire market will collapse.

In the interview, Inker, a member of the GMO board of directors who joined the firm in 1992 fresh from earning a B.A. in economics at Yale University, argues that the surprisingly big rise in month-over-month inflation — the trigger that chiefly sent the market plummeting this week — is only a temporary condition, not the start of a pattern.

Meanwhile, the market rotation to value stocks from growth equities, which began late last year, continues as the business of companies hit hard by the coronavirus pandemic is starting to pick up, with consumers’ pent-up demand turning into spending.

Over the years, Inker has served at GMO as an analyst, portfolio manager, co-head of International Quantitative Equities and CIO of Quantitative Developed Equities.

ThinkAdvisor interviewed Inker by phone on Wednesday. He was speaking from Boston, where GMO is headquartered. The value investor is more than pleased with the performance of value stocks thus far this year.

“We’re seeing the rotation continue — and it deserves to continue,” he says. “The economy is really opening up. That’s good for these companies.”

Here are highlights of our interview:

THINKADVISOR: In view of this week’s selloff, should financial advisors be rebalancing their clients’ portfolios?

BEN INKER: Financial advisors should be having real conversations with their clients about what matters more: risk or return. The U.S. stock market looks like a pretty poor risk-reward trade-off, and bonds obviously have a very low expected return.

U.S. stocks are probably the wrong place to sit, but there’s a limit to how aggressively most advisors are going to want to push their clients out of the familiar assets and into the unfamiliar. But now is one of those times when you might at least be taking as much risk with the non-familiar as the client can be comfortable with because the familiar assets stink.

What non-familiar assets do you suggest investing in?

We warmly recommend non-U.S. stocks, and we quite like a variety of liquid alternatives instead of stocks and bonds.

Our long value/short growth strategy is our favorite for these times. It’s been working pretty well the last few months, and we think it has plenty more room to run.

Many investors seem to be waiting for the other shoe to drop; that is, a big correction. What validity is there to that?

Certainly if you look at investor behavior right now, people aren’t investing as if they think it [will happen]. Portfolios are positioned on the very bullish end of things.

There are those of us who have been saying for a while, “This market looks pretty expensive. That doesn’t seem like a great investment.” But if people have started listening to us, it’s news to me!

Where do you stand now in terms of the “late-stage major bubble” Jeremy Grantham [GMO co-founder] pointed out this past January?

I can see two scenarios. One is: There’s a speculative bubble — a bunch of speculative growth stocks that have been trading at truly loony prices. Those stocks have started to come down.

Some of the stocks that were, kind of, poster children for the go-go time have gotten hit. If the bubble is confined to the crazy end of the market, it does look like that’s starting to deflate, though it has plenty more room to go.

The overall market is up this year very close to all-time records. But the most speculative end has been doing poorly, at least for a couple of months now.

What’s the other scenario that you see?

The possibility that Jeremy Grantham suggested: The market looks like [pre-crash] 1929 and 2000. We’re seeing the speculative end of things peeling off.

But at the overall market level, you don’t notice that because the S&P is continuing to move higher. We’ve got a market that’s very expensive relative to history.

There’s very broad speculation. When this eventually goes, the whole market will come down. 

Has Mr. Grantham revised what he described in January?

When I was talking to him a few days ago — the S&P and the Dow were at highs despite the fact the speculative stocks had started to wobble — he said that at the end of all the great bubbles, it’s been the blue chips that were leading the way.

Before we get to the end, the market hangs on for a little while by having the blue chips continue to march higher. He says the market is now being led by the blue chips — and that’s a sign that the end is near.

Which scenario do you agree with more? 

Even though the broad market is clearly extremely expensive relative to history, the ultra-low interest rates are a more coherent justification for that than is standardly the case.

However, on a day like today, with the market falling on the back of that inflation surprise, it does mean the market is very vulnerable should something change, which makes today’s ultra-low interest rates no longer sustainable.

Wasn’t inflation expected to rise given the economy’s gradual reopening?

We knew that the year-over-year number was going to be big, and it was. What was a surprise was how big the month-over-month number was. The market reacted with a certain amount of concern over the fact that there has been more of a near-term acceleration of inflation than people were expecting.

But some of what’s driving inflation numbers higher is clearly temporary. For example, right now the cost of lumber is at an all-time high. That will eventually go away — we’re not suffering from a lack of trees.

To what extent were this week’s big sellers retail investors?

There has probably been some loss of fervor on the part of the momentum/retail players of the highest evaluation end of things.

When we talked in January, you said a rotation to value stocks was occurring. Has it continued?

Yes. March was a great month for value. April was a not-great month for value — growth won again. But May has been in favor of value.

If we look at what’s been happening with the inflation number, a big part of it is that the U.S. economy really is opening up, and that’s good for those companies that were hit when the economy shut down [because of the pandemic]. They were disproportionately value companies. The simple way to get to be a value company is that you underperform. 

So what’s your assessment of how value is doing at this juncture?

I’m very happy with the performance of value so far this year. We don’t need things to be great for value to look cheap. We just need them to not be disastrous.

Pictured: Ben Inker, head of GMO’s asset allocation team.

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