That’s the latest warning from legendary fund manager Jeremy Grantham, chairman of fund shop GMO and one of the few people who successfully called the 2008 crash in advance.
His firm’s latest calculations predict that investors in U.S. small-cap stocks will actually lose about a fifth of their money in real terms over the next seven or so years. That’s an annualized loss of about 2.8% after inflation.
As always when it comes to predictions, there are no guarantees. But GMO’s forecasts have a good track record.
Risky assets are supposed to make you money over the medium term, as compensation for owning them. Actually paying money to take risk makes no financial sense whatsoever.
The last time Grantham’s firm warned that people were actually paying for the privilege of owning risky assets was back in 2007, just before the wheels started to come off. Grantham himself, on a recent trip to London, warned about the valuations of U.S. small-cap stocks.
You can see something similar if you just take a step back from the day-to-day action of the market and take a longer view. The Russell 2000 Index RUT +0.91% of small cap stocks has recently skyrocketed against the broader market. According to FactSet, it is now by far the highest it has been against the Standard & Poor’s 500 Index SPX +0.39% in at least a quarter century.
It isn’t hard to work out why. Since the Federal Reserve decided to flood the world with free money, under the program known as “QE2” (like the ship) or Quantitative Easing 2, money has been chasing risk and action. Small caps give you a lot of action for the money.
It’s a reckless game. Some people say it’s going to end in tears, and QE2 might be better known as Titanic 2. The Federal Reserve is due to cease QE2 in the second quarter.
The latest surge in small caps is yet another sign that animal spirits are getting overheated on the markets, yet again. According to the latest Bank of America/Merrill Lynch survey of fund managers, institutions are now loading up on risk. The brief panic following the tsunami is now long since forgotten.
They are heavily overweight boom-and-bust stocks such as industrial and energy companies. They are loaded up on emerging markets and commodities.
Cash levels are low. Nobody much wants boring things like utilities or telecom stocks. Nobody wants boring old Japan, which enjoyed a short, bizarre investment vogue following the tsunami. (Aside: Fund managers also say gold is overvalued. They have said this for years…all the way up!)
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