The market will become increasingly tougher for value investors with profitability, interest rates and pricing set to remain way beyond pre-1997 levels for the foreseeable future.
That is according to GMO founder Jeremy Grantham who made the comments in his latest update, entitled ‘This time seems very, very different’.
Focusing on current levels of profitability, Grantham pinpointed 1997 as the last year figures mean reverted to rational levels and profits have jumped higher every year since.
Grantham said this has already made the job of value investors harder and does not look like stopping. He added that only an increase in real interest rates would arrest the trend.
‘What does this mean for value investing? What it does not mean is cheaper is not better. But price to book was never a measure of cheapness. The low price of book ratios reflect the market’s vote as to which companies have the least useful assets,’ he said.
‘Only if the market gets carried away with pessimism or feels uncomfortable with the career risk of owning companies in temporary trouble will such ratios work. Sometimes they do and sometimes they don’t.’
Grantham said S&P 500 has been selling at a much higher P/E level for 20 years now and the chances of a sudden reversion to its 1997 levels are increasingly slim.
‘You should at least be prepared to be frustrated for some considerable further time: until you can feel the process of the real interest rate structure moving back up toward its old level.
‘I prefer my suggestion of a 20-year limping regression that takes us back to the good old days pre-1997. What I fear is that if I am wrong, it is less likely to be because regression is more dramatic as some die-hard value managers believe (and I would dearly, dearly love to see) than it is to be even slower.’
However, Grantham added that the market is trading as if profitability levels are now permanent and, while a bear market could happen, there is no obvious catalyst at this stage.
‘What I am interested in here is quite different: a more or less permanent move back to, or at least close to, the pre-1997 trends of profitability, interest rates and pricing. And for that is seems likely that we will have to a longer wait than any value manager would like – including me.’