“Never underestimate the value of doing nothing.”
GMO Capital’s James Montier Montier is channeling Winnie the Pooh on how to be be careful given the current market environment: do nothing.
“There Is Nowhere To Hide”
In an interview posted earlier this week with German-language publication “Finanz und Wirtschaft” (which we were alerted to by Meb Faber), Montier talks more broadly about the state of the global markets, where sees value, and how to stay protected amid enormous uncertainty about what the future holds for markets.
Montier said, “This is the first central bank sponsored near bubble. There is nowhere to hide.”
For Montier, a bubble is roughly defined as a market that has seen a two standard deviation move from its long-term trend. “But let’s say it in simple terms: For all purposes, this is a hideously expensive market,” Montier said. “I don’t care if it’s a bubble or not. It’s too expensive, and I don’t need to own it. But because this is a central bank sponsored near bubble, it hurts to stay away.”
Montier notes that GMO has sold down its equity holdings from about 54% of its portfolio last year to 36% today, adding that they have been selling out of blue-chip US stocks like Johnson & Johnson, Procter & Gamble, and Microsoft.
“Fundamentally we still think they are very low risk businesses; they offer high profitability and low leverage,” Montier said. But the valuations on these stocks — which implies a 6% real return against GMO’s expectations for a 2% real return — is simply too high.
But the frustration Montier seems to have with what he calls the “central bank sponsored near bubble,” is that value across almost all financial assets has been completely eroded.
“In Cash, I Know My Downside”
In 2000, Montier says that investors could keep their holdings in cash or buy low-risk securities like Treasury Inflation-Protected Securities, or TIPS, and still get some return. Now, cash is negative in real terms — meaning when adjusting for inflation, keeping your holdings in cash will see the value of that holding fall year-over-year — which is forcing investors to make unorthodox investment decisions or face losses.
“The question for every investor is how much do you let this negative cash rate influence your behaviour,” Montier said. “Some of us are willing to own more equities, because the alternatives are just appalling. Others like me are saying cash is negative, but the danger of owning equities that are way too expensive is just much worse.
“In cash, I know my downside, but equities can fall precipitously from a wildly overvalued level. I am not being compensated for that risk. The path for equities will not be nice and smooth and linear over the next seven years.”
“The Kind Of Mentality That Will Lead To A Bubble.”
A major feature of the US stock market’s run over the last two years has been what people have referred to as the “buy the dip” mentality. Basically, when the stock market falls by 4%, 6%, 8%, investors have been quick to simply throw money at the market and buy the small sell off, or the dip.
And Montier says that it is this mentality that leads to greed, making investors no longer fear losses, but fear that they will miss out on future gains. “That kind of mentality will lead to a bubble,” Montier said. “The narrative is simple: We are all protected, underwritten by central banks. That’s a very tempting thought in the short term, but incredibly dangerous. The central banks will protect us up until they don’t anymore. And you don’t know when that will be.”
Amid this uncertainty and the unconventional state of the global market, we can even see Montier taking risks himself. Montier said that he is currently short Japanese government bonds, which is famously known as the “widowmaker” trade.
Montier said he is well aware of this moniker, adding that in 1997 he wrote a paper saying that at a yield of 3%, JGBs couldn’t possible go any lower, “And I watched them halve and halve again,” Montier said.
But going short JGBs, Montier said, isn’t expected be a “hugely positive” investment this time around. “[T]he view of our fixed income guys is [that JGB yields] just can’t go that much lower. And unlike in 1997, they are probably right. What’s the worst that can happen? The yields won’t go to zero, so the loss is limited.”
“Take It From Winnie The Pooh”
And so overall, Montier said the best posture for investors is to be patient.
“Don’t take it from me, take it from Winnie the Pooh: Never underestimate the value of doing nothing,” Montier said.
“Never forget: You can’t know the future. Hold a lot of dry powder now. 50% of our portfolio today is in cash or some form of short term bond holdings. If we do get a dislocation in equity markets, we will have the ability to deploy that dry powder. That’s the time to buy.”
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