Grantham on Small Cap Stocks

I don't often find forecasts to be all that useful but Jeremy Grantham's 7-Year Asset Class Forecast is (and has reliably been) an easy way to gauge which assets might be generally overvalued/undervalued. Ultimately, at least for myself, it still comes down to finding good individual businesses that are cheap.

Grantham's latest warning?

Watch out for small caps.

In this MarketWatch article he makes the following points:

- Small-cap stocks will do poorly. They'll likely lose something like a fifth their value in real terms over the next seven years.
- Buying assets when they are expensive in the hope of selling them at a higher price is basically just gambling.

Here is Grantham's latest 7-year Asset Class Forecast:

US Large Caps: -0.1% per year
US Small Caps: -2.8% per year
US High Quality: 4.6% per year
International Large caps: 3.2% per year
International Small caps: 0.2% per year
Emerging Markets: 4.3% per year
Managed Timber: 6% per year

The GMO forecast (monthly) and quarterly newsletter is free by registering at http://www.gmo.com.

So Grantham's not exactly bullish on anything but remains favorable toward U.S. High Quality (Pepsi: PEP, Johnson & Johnson: JNJ, Walmart: WMT etc). The favorite seems to be managed timber. I know of no easy way (nor do I have the expertise) to gain direct investing exposure to timber. I am familiar with several  businesses (Plum Creek: PCL, Potlach: PCH, Rayonier: RYN, Wayerhaueser: WY) that all have, give or take, significant timberland assets. To me, the valuations of these look stretched. So timber itself may, in fact, be cheap but the equities themselves seem expensive.

It's worth noting that Grantham's forecasts are always made on a real basis. The above estimates are adjusted lower to account for 2.5% inflation. So the 4.3% estimated real returns for emerging markets would be 6.8% on a nominal basis using his inflation assumption. If you assume more than modest inflation going forward then nominal returns would (all things being equal) be a bit higher. That's where high quality comes in.  Businesses with during pricing power and/or sustainable cost advantages are the best protection.

Adam
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Grantham on Small Cap Stocks
Grantham on Small Cap Stocks
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