GMO’s December letter The Late Cycle Lament is a must read for anyone with savings they would like to keep and grow going forward. There are many excellent charts and clear-eyed insights on the present state of equity valuations, probable price paths and the capital-destructive myopia of most financial advisors and managers. You can read the whole thing here, the closing quote offers a summation:
“…most black swans in finance/investing are really “predictable surprises” to borrow Max Bazerman’s term (yes, I know that sounds like an oxymoron). Predictable surprises are characterised by three features: 1) at least some people are aware of them; 2) they get worse over time; and 3) they eventually explode into a crisis.
You might ponder why people are so bad at spotting predictable surprises. It turns out there is a plethora of psychological and institutional impediments. Two we have already met at the outset of this essay, overoptimism and overconfidence. They are aided by myopia – an overt focus on the short term – born of the institutional imperative to perform at all-time horizons; or its cousin, the relative performance derby; or simply a function of the human brain. Motivated reasoning plays a part as well. As Warren Buffett put it, “Never ask a barber if you need a haircut.” It is hard to get many finance professionals to think about the possibility of a crash when their employment and income depends upon that event not happening. Also noteworthy is inattention blindness…put simply, we just don’t expect to see the things we aren’t looking for…
Having read this entire essay, perhaps you believe one of the conditions I laid out earlier (in terms of P/E, ROC, or growth). If not, you are probably skeptical about the ability of the U.S. market to continue its outstanding performance. Ask yourself how much exposure you have to the U.S. stock market. Then ask yourself what is the minimum amount you could own. We at GMO own essentially zero in our unconstrained portfolios, but then again we are used to career risk and would rather run it than allocate to such an expensive asset.
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