Jeremy Grantham’s firm GMO has released its 7-year asset class forecasts based on prices at the end of October.
Like some other long-term forecasts, GMO’s are based on an expected reversion to the mean for 1) prices relative to earnings, and 2) profit margins.
Today’s corporate profit margins are abnormally high–extremely high, actually–which makes stocks look much cheaper than they actually are on a PE basis. (Temporarily high earnings produce a temporarily low P/E ratio). Assuming profit margins revert to their means, this will act as a drag on earnings growth over the next several years.
The key points of GMO’s forecasts:
- The US stock market as a whole will deliver lousy returns of ~0% per year for the next 7 years, after adjusting for inflation. This is true for both big stocks and small stocks.
- US “high quality” stocks–companies with no or low debt and high cash flow–are priced to deliver a below-average but perfectly acceptable return of ~5% after inflation.
- International stocks are forecast to deliver ~5% per year.
- Emerging markets stocks will deliver an almost-average ~6% per year.
With the exception of the overall US market forecast, those are fine returns. With cash yielding nothing and bonds producing a below-inflation return, a projected return of ~5% per year is compelling.
But then come bonds and cash.
With the exception of emerging market debt, bonds are priced to deliver truly lousy returns over the next 7 years–losses of 1% to 3% per year after inflation. And cash is priced to break even.
So, what’s the best asset class, according to GMO’s chart?
Timber is priced to return 6.5% per year, after inflation.
Unfortunately, to buy “timber” as an asset class, you have to have the resources and wherewithal to acquire forests and manage them. (Or, to have a big ole pile of money and hire GMO to do it for you.)
Here are the forecasts (click for larger):
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