GMO has shifted its stance on equities since mid-March, when the firm was willing to wade into plunging markets to buy stocks globally amid the coronavirus tumult.
U.S. and developed-market stocks have rallied too far from their 2020 low, according to Ben Inker, the head of GMO’s asset allocation team. The firm has reduced its equity exposure by shorting equity futures against the stocks it holds in those regions, while continuing to like its long bets in emerging markets, Inker said by phone.
“Stocks in the U.S. and most of the developed markets look to us to be a pretty bad risk-reward tradeoff,” he said. “They’re already priced for the best outcome you could reasonably expect.”
That’s a change from late March, when stocks globally, apart from U.S. large cap, appeared cheap or priced at fair value, according to Inker. The equities market went on to produce in two months the types of returns GMO would expect to see over five to seven years, he said, all while the prospects of the economy remain uncertain.
“We are in the midst of the worst economic crisis the world has seen really since the Great Depression,” said Inker. “We’d love to see stocks priced for more potential pain.”
The Standard & Poor’s 500 Index has soared 38 percent from March 23 through June 2. The rally hasn’t completely wiped out U.S. stock losses in the first quarter, with the index down about five percent this year through the same date.
As investors were “pretty freaked out” in March, “we were buying primarily non-U.S. equities, although we did buy some of the more cyclical” U.S. stocks as well, said Inker. “The only thing that has really changed since then, in our minds, is the price.”
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Government intervention has helped fuel the rise in stock prices, according to Inker.
He said the measures taken by the Federal Reserve have been a “big help” to credit markets, making the potential for another Great Depression much less likely. That, along with large fiscal support, has benefited stocks, he said.
Still, government support won’t stop a fall in gross domestic product that’s expected to be “significantly larger” than the decline during the financial crisis, according to Inker.
“The market has an extraordinarily optimistic read on how the world is going to come out of this,” Inker said of economic damage from the pandemic. He said the market is assuming “this will all be well behind us” by the fourth quarter.
While GMO views developed market equities as a “lousy risk-reward trade-off,” the firm has maintained the bulk of its holdings in emerging market stocks, according to Inker. Those holdings also have seen a strong rally, he said, but at least “they’re still priced for a really bad outcome.”
Amid the pandemic, value stocks globally remain cheap relative to broader markets and should outperform in an economic recovery, according to Inker. GMO is pricing in a U-shaped recovery, with “an economic event about twice as bad as the financial crisis,” he said. That’s a world in which value stocks deserve to win over the next three to five years, estimates Inker.
With economies beginning to open up from their “deep freeze” prompted by Covid-19, he said they won’t get back to normal without a vaccine or some “extremely effective medical treatment that makes this a less scary disease.” The prospect of a vaccine by the end of this year or in 2021 remains far from certain, he said, while the pandemic takes an “extreme” toll on small businesses.
That makes a V-shaped recovery very unlikely, according to Inker.
“We can hope for a miracle because the world could use one,” he said. “But I wouldn’t want to price stocks on the basis of a miracle.”
