Tommy Garvey, a member of the asset allocation team at GMO.
Tommy Garvey, a member of the asset allocation team at GMO, details his vision for this year in terms of asset classes. He highlights that “the valuation of the asset class is too high” and points out that many Growth stocks “are priced for unrealistically optimistic expectations”.
What is your outlook for asset classes this year?
We are a long-term valuation-driven investor and are reluctant to make relatively short, one-year predictions on asset class returns. Simply, although valuation is an excellent indicator of long-term outcomes, we understand that investor sentiment can drive returns for short, or indeed, medium periods.
However, looking at valuations, we are very happy to own Value equities outside the U.S. as following the price falls in 2022, they offer very solid prospective returns. Many currencies also look cheap relative to the US dollar, and this offers a terrific tailwind for investing in those non-US equities.
Inside the US, the cheapest 20% of the market is trading at a fairly extreme relative valuation to the rest of the US market. We have invested in these unloved stocks although our enthusiasm is tempered slightly by the overall valuation of the US market.
What is the difference between Emerging Stocks and Emerging Value stocks and what is the reason for the difference in their returns?
At the end of January 2023, our 7-Year asset class forecast for broad emerging market stocks, in our ‘full mean reversion’ scenario was 4.2% while our forecast for Emerging Market Value stocks was 8.2%. The broad emerging market universe includes Emerging Market Value stocks and Emerging Market Growth Stocks. The difference in the forecasts reflects our belief that the valuations of Emerging Market Growth stocks, and indeed of many Growth stocks around the world, are too high. Essentially, we believe that many Growth stocks are priced for unrealistically optimistic expectations as to how long and how fast they can continue to grow, as well as maintain profitability while doing so.
In bonds, the performance of emerging debt stands out, why is that?
The forecast for emerging debt is significantly larger than the return forecast for other government bonds, but that mostly just reflects the potentially higher credit risk of owning these bonds. We currently see the pricing of emerging debt as fair, or perhaps just a little bit better than fair, compared to US government bonds.
For what reasons do you see negative performance for US Large, US Small, and Intl Bonds Hedged?
Where we portray a negative return for an asset class, it is not based on any macroeconomic predictions or anything like that, it is just expressing our belief that the valuation of the asset class is too high. We believe that investor sentiment can support asset class prices for some time, but that, ultimately, ‘fair value’ acts as an anchor. In the case of US Large, for example, we believe that the incredibly high profitability will revert towards historic norms through time and, similarly, that the multiple (or P/E ratio) that investors are currently paying will also move down towards historic norms. Contractions in these metrics would have a meaningful impact on the valuation of US equities, and hence our unfavorable forecast.