As world share market indices push into record territory, the big, unspoken fear is that the world climate of sustained, very low interest rates – necessary to give time for the long, slow economic recovery from massive deleveraging – could contain the seeds of another investment bubble.
This is why some of the best investment thinkers continue to worry about the future of interest rates to try to anchor their long-term investment policies. On this subject, two influential US investment gurus have been reassuring investors – and cautioning them against jumping off the rising market too soon.
The Gross outlook
PIMCO managing director Bill Gross, who coined the “new normal” tag for markets several years ago, now has a new tag – “new neutral”. Writing in his group’s May Investment Outlook, he says PIMCO thinks the new neutral policy rate of the Federal Reserve is nearer to 2%, rather than the 4% being assumed by the markets. If so, he says “then bonds, instead of being artificially priced would be attractively priced.”
This would suggest that assets like stocks and real estate must be assumed to be more fairly priced and current fears of an asset bubble would be unfounded. But this reassurance would come at a price – the low rates reduce the returns on cash and all other financial assets.
For investors such as pension funds seeking returns above 7%, this means they need to take greater risks, investing in alternative assets or higher percentages of shares in a portfolio.
The Grantham take
Meanwhile, Jeremy Grantham at GMO, which looks after $US117 billion, has taken a historical look at asset bubbles, which his group has now been studying for more than a decade. Using two standard deviations as the measure of an asset bubble, GMO has now aggregated 40 world equity markets to find that, unlike the 2007-08 period, the world markets in March were up only about 1.4 standard deviations. To reach two standard deviations, the S&P 500 would need to hit around 2250 points – almost 15% above the high reached on May 30.
While Grantham is a devout value manager, who believes all booms revert back to the mean, he thinks that, despite the fears of diehard value managers, this boom might have a lot further to run. The reason: GMO believes long-term value managers are heavily outnumbered by the momentum managers, who have no qualms about pursing the market’s rising trend – perhaps beyond 2250 points on the S&P.
So the usually cautious Grantham thinks that, after perhaps a possible down period to October this year, the stock market could be strong for the next one and a half or two years.
While warning that the market run could be derailed at any time by various global factors, he thinks there is more than a 50% chance the boom might continue for up to two years and go above 2250 points on the S&P.
“I am not saying that this time it is different,” he says. “I am sure it will end badly. But given this regime of the Federal Reserve and the levels of excess at other market peaks,” he thinks what would be different is if this bull market ended just yet.
While PIMCO’s Gross doesn’t provide detailed numbers, his conclusion on the asset bubble is very similar to Grantham. Gross says if the neutral policy rate is 4%, that could make current forecasts of a bear market almost 100% certain. But if 2% is closer to the mark, then, Gross says, “asset markets are not bubbly – just low returning.”
Since US share and bond markets largely determine the mood of local markets, the views of Grantham and Gross (who are normally more cautious than bullish) seem to provide reasons for investors to hang on longer for the ride rather than jump off the bandwagon too soon.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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