Behind the Markets: Going around the World with a Member of GMO’s Asset Allocation Team
On a recent episode of Behind the Markets, I had the opportunity to speak with Catherine LeGraw, a partner at GMO and member of the firm’s asset allocation team.
We had a fantastic discussion about GMO’s investment philosophy and her team’s high-conviction trades. The GMO process can be summed up as a unifying philosophy focused on valuation and the price you pay for an asset as a strong predictor of long-term returns.
Many of the views we discussed stem from the GMO forecast for real, after-inflation returns over the coming seven years, and Catherine graciously shared the February analysis with us here for our discussion recap.
Stocks versus Bonds or Both:
GMO’s asset allocation team is more constructive across asset classes than a year ago after the sell-off. Then, bonds looked expensive, near historic lows on interest rates. Today, there is more income to be had. While GMO was leaning more heavily into liquid alternatives last year, recently they are taking more equity beta and duration risk.
Forced to choose, Catherine would pick stocks over bonds, but GMO likes both stocks and bonds more than they did last year.
The GMO Model Inputs
Catherine discussed how valuation is a huge driver of these forecasts. Each forecast has two components:
2. The other component is expected return from valuation. GMO assumes all assets will return to a long-term fair valuation and builds expected repricing toward fair value.
“We Still Love Value”
GMO’s work shows value is still quite cheap and is the team’s highest conviction active view right now. Catherine believes the value-versus-growth cycle could be just halfway through a four-year or so estimated cycle.
In Catherine’s work, value still needs to outperform growth by about 40% to get to their team’s fair value.
Their team has so much conviction in the long-term idea here, GMO launched a long value, short growth strategy back in 2020, signaling this would be a mega trend.
International Stocks Offer a ‘Trifecta’
Catherine sees a trifecta supporting overseas ideas:
1. Broad equities have a forecasted real return in the range of 5%–7% for Europe, Japan and non-U.S. developed markets.
2. If you're willing to tilt into the value half of these markets, the value spreads are particularly wide, and you can capture another 2%–4%.
3. GMO sees the currencies as attractive, offering another 1%–2% in currency appreciation potential against the U.S. dollar.
0% Real Return for the S&P 500?
Contrasted with a nearly double-digit forecasted real return for international value, GMO sees the S&P 500 Index with zero real return. By contrast, GMO sees the deep value part of the U.S. market in the 5%–7% range—similar to the longer-term equity premium for U.S. stocks as a whole. So this is saying the dominating growth segment is really dragging down the GMO forecasts.
GMO is tilting toward small-cap value, particularly Japan small-cap value. In the U.S., small-cap quality is their favorite factor at the moment.
Listen to the full conversation below:
Jeremy Schwartz has served as our Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Jeremy is a member of the CFA Society of Philadelphia.