The U.S. stock market looks like “Wile E. Coyote, running off the edge of a cliff,” according to asset manager GMO’s James Montier.
According to Montier, the U.S. stock market has priced in all the good news it possibly can, which suggests little upside for value investors right now. This is a reversal from his and colleagues’ previously bullish position on the markets in March.
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“There is no margin of safety in the pricing of U.S. stocks today,” Montier, who works in asset allocation at GMO, wrote in a new white paper, adding that the U.S. stock market “appears to be absurd.”
The rally narrative is that investors are linking the Federal Reserve’s balance sheet expansion and the equity markets, Montier wrote. By performing quantitative easing, the Federal Reserve would lower the bond yield, and as a result, drive up the stock market, as the thinking goes.
Montier is skeptical, however, of a “clear link” between bond yields and equity valuations. Quantitative easing hasn’t previously lowered bond yields. He pointed to 10-year bond yields during three recent quantitative easing programs: January 2009 to August 2010, November 2010 to June 2011, and September 2012 through October 2014. During each of those time frames, yields rose.
Because of this, Montier sees rising equity markets and balance sheet expansion as a case of correlation, rather than causation.
With this in mind, investors’ belief that a V-shaped recovery — in which the stock market drops, reaches a trough, and immediately recovers — is certain “reflects a potentially dangerous level of overconfidence,” according to Montier.
“When I look at a very sharp recovery like the one we have all just observed, I can’t help but wonder if the world has forgotten about risk,” he wrote.
Montier’s take on the market is that its future is much less certain than investors seem to believe. Because of this, he’s approaching with caution, rather than going all in.
For GMO, this position is familiar. The company took a bearish approach to the markets back in June, when Ben Inker, the head of GMO’s asset allocation team, told Institutional Investor that the stock market rally had gone too far.