I’m not sure how I’d feel about inviting Jeremy Grantham to my Christmas party.
On the one hand, I could see him being a font of fascinating cocktail chatter. After more than a half century of navigating the markets, the man no doubt has stories to tell.
But on the other hand, at the first mention of U.S. stocks, I could see him being a real wet blanket. His forecast for the next seven years isn’t exactly rosy.
If case you’re not familiar with him, Grantham is co-founder of Grantham, Mayo, & van Otterloo (GMO), a Boston-based money manager with about $70 billion under management. He’s one of the best in the business, and he successfully called the last two market bubbles, in 2000 and 2008.
Grantham’s firm regularly publishes a seven-year forecast for the returns of various asset classes, and, while not gospel truth, it’s proven to be pretty accurate over the years.
Why seven years and why not one, five or 20?
In Grantham’s experience, seven years is roughly how long it takes for profits and stock prices to revert to their long-term averages. In any single year, guessing the direction of the market is a crapshoot, and over the very long term, stocks have historically returned about 7% per year after inflation. But seven years is that sweet spot where Grantham’s mean reversion models add value.
Just for grins, let’s see what Grantham & Co. see going forward.
There’s a lot of red on the chart.
Based on GMO’s mean reversion models, U.S. large-cap stocks are priced to lose 5.2% per year over the next seven years, and U.S. small-caps are priced to lose 2.1%. Essentially, Grantham is forecasting a major bear market in the coming years and what is likely to be a slow recovery.
Overseas, the story isn’t quite so bad… but it’s not exactly stellar. Developed international stocks are projected to lose about half a percent per year over the next seven years.
Even bonds look nasty. Adjusted for inflation, U.S. bonds are projected to earn exactly nothing over the next seven years, and develop international bonds (i.e. Europe, Canada, Australia and Japan) are projected to actually lose 1.8% per year.
If there’s one bright spot, it’s in emerging markets.
Emerging markets have been beaten and left for dead over the past decade. As a case in point, the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) is still sitting at prices first reached in 2007. In an 11-year period that has seen the S&P 500 rise over 80% even after taking the 2008 meltdown into account, emerging markets have gone nowhere.
Now, I agree with Grantham that emerging markets look like an attractive place to park some of your savings over the next seven years or so, and I plan to seek out opportunities in that space.
But you can’t put your entire portfolio in emerging market stocks. That would be madness.
After all, emerging markets started 2018 attractively priced and yet still managed to drop nearly 30% from peak to trough.
You can, however, take a more active approach to investing.
Buy-and-hold investing works over the long-term. I believe that, and history has proven it. But the “long-term” can be a lot longer than you’re willing to wait. The S&P 500 went nowhere between 1968 and 1982, leaving investors to tread water for 14 long years.
More recently, the S&P 500 went nowhere between 2000 and 2013, again making buy-and-hold a tough proposition.
None of this means that another 13- to 14-year drought starts today. But if you’re in or approaching retirement, you really shouldn’t take that risk. You should move at least a portion of your portfolio into active strategies that tend to zig when the market zags.
As an example, consider my Peak Profits strategy. It combines the best aspects of value investing and momentum investing, holding a concentrated portfolio of stocks that are trending higher.
And importantly, the system hedges. When the market started to get beaten up back in October, the model responded by selling half of our current positions and converting the portfolio into a long/short strategy.
Just as you shouldn’t put all of your cash into a buy-and-hold index fund, you shouldn’t put all of your cash into a single active strategy like Peak Profits either. You should choose a handful of strategies you like, divide your nest egg among them, and then rebalance along the way.
That’s the essence of true diversification.
Stay tuned to The Rich Investor for more details on my Peak Profits system. I’ll be sharing them over the next few weeks.