US equity ‘exceptionalism’ is an over-rated concept, according to a new analysis by Boston-based fund manager, GMO,
In the GMO quarterly newsletter published last week, GMO head of asset allocation, Ben Inker, argues the US stock market hasn’t “proved itself particularly extraordinary” by long-term measures.
Inker says the recent good run of US stocks has been buoyed by higher corporate profitability compared to the rest of the world but investors should treat any claims of ‘specialness’ with caution.
“Certainly there is no strong evidence that would cause us to believe the US is truly deserving of trading at a higher P/E than the rest of the world,” he says in the GMO paper. “On the profitability front, there seems little doubt US corporate profitability is better than normal, but the question is how much better?”
By GMO’s “best estimate” US corporate profit margins are currently about 24 per cent above the long-term norm but Inker says there is a “wider than normal range of possibilities” of between 5-40 per cent above normal.
“The impact on our forecast [US equity returns] is a range as high as +2% real to a disastrous -4% real for the next seven years, depending on which measure of profitability was the ‘true’ one,” the paper says.
Conversely, Inker says investors have unfairly discounted emerging markets as a “value trap” while ignoring long-term fundamental evidence.
“The data on emerging also provides evidence that emerging equities are just equities – neither meaningfully better or worse than those in the developed world over the period for which we have reasonable quality data,” he says.
“Profitability measures all seem to be saying that today’s [emerging market equities] earnings are about normal, suggesting a range around our forecast of +4.6% real of as much as +5.7% and as little as +3.4% – and even the worst of these is better than the best of our range for the S&P 500.”
GMO has forecast a seven-year after-inflation return from US stocks of -0.6 per cent.
In spite of the upbeat expectations for future returns, Inker acknowledges emerging market investors have taken a hammering over the last five years at least.
“Losing to the rest of the world by 14.7% in a year is bad enough, but losing by 12.2% per year for five years is a lot worse,” he says. “A dollar invested in MSCI Emerging has turned into $0.83 over that period, while a dollar invested in MSCI EAFE has grown to $1.21 and a dollar in the S&P 500 to $1.87.”
Inker says while the ongoing poor performance has prompted many investors to step back from emerging markets, others were asking whether “holding non-US stocks is at all necessary”.
“As market historians we can say that the timing of such sentiments tends to be bad – no one seems to ever decide to give up on an asset class after it has just had good performance, and the last burst of ‘why bother with non-US stocks’ occurred just before the top for the S&P 500 in 2000,” he says.
However, Inker stands by the GMO analysis that points to brighter times for emerging markets.
“None of this is to say that emerging doesn’t have its share of problems or that the US may not pull a rabbit out of its hat, but we do not currently see any reason to assume the worst from emerging or the best for the US,” he says.
The GMO newsletter also includes a statistical rebuttal by the firm’s founder, Jeremy Grantham of various US superiority myths.
Grantham argues the US has performed poorly in the global context across a range of metrics including income growth, unemployment, health care, education, foreign aid and even democratic representation.
He says the US predilection for ‘good news’ has lowered the quality of public debate.
“We are ready to be manipulated by vested interests in finance, economics, and climate change, whose interests might be better served by our believing optimistic stuff ‘that just ain’t so’,” Grantham says. “We are dealing today with important issues, one so important that it may affect the long-term viability of our global society and perhaps our species. It may well be necessary to our survival that we become more realistic, more willing to process the unpleasant, and, above all, less easily manipulated through our need for good news.”