GMO’s Chancellor: Stable US Firms Bright Spots

July 26, 2010

In an environment fraught with uncertainty, equities your 'grandmother had in her portfolio' might just be what the doctor ordered.

Edward Chancellor, a member of the asset allocation team at GMO, is the quintessence of cautionary. He focuses on capital market research at the firm Jeremy Grantham co-founded in 1977, and has written papers on the current sovereign debt crisis and on what he worries is an investment bubble in China. Overall, he’s loath to venture a guess as to how long it will take the developed world to work its way out of its indebtedness. But Chancellor did tell IndexUniverse.com Managing Editor Olivier Ludwig that among the few bright spots in the current turmoil are good old-fashioned and stable equities that pay a dividend.

 

Ludwig: What's an investor to turn to with uncertainty in the U.S., crisis in Europe and China in a bubble, as you say?

Chancellor: For purposes of our account, U.S. equities are moderately overvalued, but not at the extreme level of over-valuation that we saw in 1999 and leading up to the bust of 2008. What we mean by that is that their expected returns will be lower than what the average returns have been in the past from investing in equities, but they’re not negative. So that’s a good piece of news.

Ludwig: So what are the most prospective equities?

Chancellor: When we look through the various classes of equities, we find in the U.S. that companies that are so-called quality have high expected returns relative to the market; in other words, companies that tend not to go bust, and tend to maintain their positions—the sorts of businesses that Warren Buffett made his fortune investing in and are trading at a P/E of about 14. Johnson & Johnson and Pfizer are key companies—the sort that your grandmother had in her portfolio or are typically owned by trust companies. Normally they trade at premiums to market, but right now they’re not.

Ludwig: What’s the fate of the euro in the near term? Is it more of the same downward pressure?

Chancellor: I don’t really have a view. There are these problems, some of which I outlined in the paper on sovereign debt: this question of uncertainty related to China, excessive household debt in many Western countries, fiscal problems in many countries, and you’ve got this question of inflation or deflation. And the market’s partly depending on the actions of the politicians and central bankers and markets moving from these sort of periods of inflation and reflation and then sort of losing competence and falling back into deflation. It’s not a fantastically nice investment environment.

Ludwig: What are some of the European equivalents to the U.S. equities examples you’ve just laid out?

Chancellor: Companies like Nestle and Novartis, and there are more, like Unilever.

Given the uncertainty, these are companies that, in the worst case, we don’t think are going to go bust. Yes, of course they can go down in valuation, but what happens when equities go down in valuation? If you are not cashing it in and you’re just reinvesting your dividends, you’re buying more at an even cheaper price. So your actual returns will rise relative to expected returns.

So given the low current yields on government bonds, what’s nicer than to own a portfolio of equities that your grandparents might have owned and yet not have to pay a premium for them?

 

 

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