The stock picks from a value-investing stickler

Jeremy Grantham, founder of investing house GMO, is always on the lookout for potential threats to markets and the economy. So, when things are feeling pretty rosy, that’s a good time to check in with him.

Right now, not surprisingly, Grantham’s a bit nervous about the high stock valuations in the US, highlighting in particular the state of the cyclically adjusted price-to-earnings (P/E) ratio (also known as the “CAPE” or “Shiller P/E ratio”). The widely trusted gauge, which is often used to weigh up the S&P 500, it’s calculated by taking the index price and dividing it by the moving average of ten years of earnings, adjusted for inflation.

Needless to say, it’s way high.

The CAPE or Shiller price-to-earnings ratio, from 1871 to 2024. Source: Finimize.

The CAPE or Shiller price-to-earnings ratio, from 1871 to 2024. Source: Finimize.

And with profit margins also at record highs, Grantham worries that the US market is priced for perfection. (And no one ever achieves that.)

Now, Grantham is a value investor at his core, and that’s the focus of his $60 billion firm. So, he’s not one to rush into assets that look frothy. Right now, he says there are just two areas of the S&P 500 that look attractive from a value perspective: quality stocks and resource firms.

Quality stocks usually outperform handsomely in a bear market, as their strong balance sheets, high profitability, and robust business models protect them from an economic downturn. In a bull market, they usually underperform slightly, but that’s not been the case lately: quality stocks have led the market recently, leaving the rest of the market in their dust. Now, almost a third of the money GMO manages is in its Quality Strategy Fund. And its top ten holdings are obviously a quality group – Microsoft, UnitedHealth Group, Meta, Alphabet, Safran SA, Amazon, Johnson & Johnson, SAP, Apple, and Accenture. Notably absent from the top ten: the Magnificent Seven’s Nvidia and Tesla.

Resource stocks – think: energy and metals – are currently trading at cheap valuations. What’s more, they’re the shares that have historically moved in the opposite direction from the broader US market (meaning, they’re inversely correlated). That makes them a good portfolio diversifier. The SPDR S&P Metals & Mining ETF (ticker: XME; expense ratio: 0.35%) and the Energy Select Sector SPDR Fund (XLE; 0.09%) may make good resource investing plays. (It’s also worth remembering that some of Warren Buffett’s biggest holdings are in oil companies and the metals space.)

GMO’s $1.6 billion US Opportunistic Value fund, unsurprisingly, owns some of the cheap energy companies like ExxonMobil and Chevron, but it also invests in Alphabet and Meta – with the two tech giants interestingly popping up in both the Value and Quality funds.

But, hey, there’s a whole big world out there where you can invest. Grantham sees opportunities in other advanced economies’ stocks, including Japan. In fact, he sees the Japanese yen eventually gaining at least 20% against the US dollar, making this a nice time to use the strong greenback to buy up assets priced in yen. He also sees opportunities at the value and the low-growth end of emerging market stocks, which are currently trading at fair-to-cheaper levels, compared to their usual range.


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