Go West, Young Investor…But Go Wisely: Intelligent Investing in an Unintelligent Landscape
“Go West, young man” was advice popularized in the late 1800s by the American author and newspaper editor Horace Greeley in regards to America’s Westward Expansion.1 Greeley “saw the fertile farmland of the west as an ideal place for people willing to work hard for the opportunity to succeed.”2 Potential success, measured in terms of productive land to farm, luxurious furs to trap, and of course shiny gold to pan, enticed many Western settlers to take significant risks.
Investing requires bearing risk to reap rewards, but there is no definitive causal relationship here. Just because you might be willing to pack up your wagon and head off into the sunset doesn’t ensure you’ll be rewarded with wealth. Today investors should be particularly diligent in assessing risk before setting off on any journey.
On the one hand, the road out of town looks inviting: global economies are growing synchronously, many leading indicators including global Purchasing Managers Indices remain robust, earnings have been strong with expectations anchored around continued growth, and inflation generally remains contained. Looking toward the horizon, however, we can see dark storm clouds building: labor conditions in the U.S. have been tightening while more fiscal spending is on tap (all being a potential precursor to higher inflation levels), and the Fed has pivoted from quantitative easing to tightening and is hiking rates. The scariest storm, chock-full of lightning strikes and cacophonous thunder, for the adventurous traveler though, is the elevated valuation levels of assets across the board.
This is not the time to pack a knapsack with limited provisions, straddle a horse, and gallop off. It is a time to be well prepared for the harsh conditions of a long westward journey. To be clear, we are not counseling investors to avoid all risks right now. We are simply pointing out that it is more important than ever to do so in an intelligent manner.
What does intelligent investing look like to us? It means investing where you have a fighting chance to make decent returns and harbor a margin of safety. As valuations have continued to climb higher and prospective returns lower, our Benchmark-Free Allocation Strategy (“BFAS”) has become more provocatively positioned: we are lighter in equities with an even heavier concentration in emerging markets; we have more weight in alternative strategies; and we are still carrying meaningful cash/ cash plus exposure.
In equities, we think emerging market value stocks are the only asset priced near fair value, offering up mid-single-digit forecasted real returns. While that sort of absolute forecast is good, though certainly not great, the wide spread of GMO’s emerging markets value forecast relative to the next best asset class is impressively wide today (see Exhibit 1). Combining this attractive spread opportunity with an otherwise paltry opportunity set and low exposure to equities in general is leading us to significantly concentrate our 37% equity weight. After Quality stocks continued to rally through January, our forecasts for the group fell, leading us to sell down our remaining long Quality equity position (though we retain exposure to a beta-neutral expression of Quality, per below). BFAS presently holds only non-U.S. equities, with 25% in emerging value and 11% in developed ex-U.S.