By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) — Early to sell and later to buy makes an investor wealthy and wise.
With apologies to Benjamin Franklin, that’s the warning veteran market observer Jeremy Grantham is giving investors to handle the heightened risk he sees in the market.
Back to 1987
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In a quarterly letter Tuesday to institutional clients of Boston-based money manager GMO, the firm’s chief investment strategist said shareholders should take risk off the table now, rather than by October as he had advised earlier this year.
“The environment has simply become too risky to justify prudent investors hanging around, hoping to get lucky,” Grantham said. “Investors should take a hard-nosed value approach, which at GMO means having substantial cash reserves around a base of high-quality blue chips and emerging-market equities.” Read Grantham's letter to clients.
Grantham acknowledged that he is probably too early with the call to lighten up on risk and bet against the broad U.S. stock market. In the past, he admitted, such definitive moves have come months, sometimes years, before a market actually turned, and investors who followed his advice would have missed the last, highly lucrative parts of a rally. Read more about threats to commodities prices.
“The market may still get to, say, 1,500 before October, but I doubt it,” Grantham said, in reference to the Standard & Poor’s 500-stock index /zigman2/quotes/210599714/realtime SPX +0.01% .
High-quality blue chips and emerging-market equities share what Grantham called “semi-respectable real imputed returns of over 4% real on our 7-year forecast.”
Timing is everything
Exiting or entering a market early -- well-before a trend is done — is a risk of being a cost-conscious value investor, Grantham said. He recalled betting against Japan three years too early in 1986, sidestepping technology stocks two-and-a-half years before the tech bubble burst in 2000, and moving away from the “housing and risk-taking bubble” two years before the credit crisis broke the market in 2008.
Grantham’s call now for investors to back away from the broad U.S. stock market may also be another “two years too early” trade, he said. But he added that he can no longer “go with the flow,” as he has been doing in this third year of the so-called Presidential Cycle — an October-to-October period that historically has been the most lucrative for U.S. stocks out of the cycle’s four years.
The money manager’s change of heart also respects the old Wall Street adage to “Sell in May and go away.” Combining that directive with the Presidential Cycle history, Grantham found that in the first seven months of Year 3 since 1960, U.S. stocks returned an average of 2.5% per month for a total gain of 20% after factoring for inflation.
In contrast, the second five months of Year 3 returned 0.5% per month, or 2.5%, which also happens to be the average total return for Year 4 of the cycle.
Put those numbers up against what Grantham calculates as a 21% average cumulative real return for the entire 48-month Presidential Cycle and the strategist’s thinking becomes clear.
The 20% average gain for the first seven months of Year 3 -- October 2010 through May — reflects most of the Cycle’s return. So an investor who has been in U.S. stocks for the past seven months has likely captured the best of the Presidential Cycle, Grantham said. Using history as a guide, he added, an investor could “go away” from U.S. stocks until October 2014 when the next Year 3 begins and then plow into the U.S. market for seven months.
That’s the theory. The reality, Grantham points out, is that the S&P 500 rose 21% from October 2010 through April -- mirroring the historical average gain. Further, the S&P at 1360 (where the index stood at the time of Grantham’s writing) is just 3% below his five-month target of 1400, he noted.
Rising commodities prices is also a factor in Grantham’s cautious view. While oil and precious metals in particular have given up ground lately, the general trend toward higher prices disturbs Grantham. Read Grantham's views about investing in commodities.
“The relentless rise in resource prices is beginning to act as an economic drag as a primary effect, and as a secondary effect, it is causing inflation pressures to increase, particularly in developing countries,” Grantham wrote.
Higher inflation leads to interest-rate hikes, which could negatively affect business confidence in the developed world, Grantham said.
Other factors weighing against U.S. stocks include the end of the Federal Reserve’s fiscal stimulus spigot, largesse known as quantitative easing or QE2, which is supposed to shut down on June 30.
“We must now face what might be called “the Bill Gross effect,” Grantham said, in reference to Pimco bond-fund manager Gross, who famously has not only bailed out of U.S. government bonds but reportedly has been actively shorting them. Read more: Pimco's Bill Gross on Treasurys.
So which investments are attractive now, in Grantham’s view?
“Forestry and good agricultural land, ‘stuff in the ground,’ and resource efficiency plays” top his list, he wrote.
“Should commodities crash in the near term because of good weather, problems in China, or both,” Grantham added, “I think it will create another ‘investment opportunity of a lifetime,’ much like the several we have had in recent years.”