"Taste great! Less filling!" was one of the great advertising campaigns to come out of Madison Avenue. While debating that great question of the time, the two sides could agree that this light beer was the one to quaff in great quantities.
That ad is brought to mind by two prominent investors, one a bull, the other a bear, actually agreeing on one thing while disagreeing on just about everything else. To wit, Legg Mason's Bill Miller and GMO's Jeremy Grantham part company on most questions regarding the economy and the stock market.
But they both think high-quality U.S. stocks provide the best prospective long-term returns of any major asset class over the next decade. That said, Miller thinks the U.S. equity market, as defined by the Standard & Poor's 500 Index ($INX), currently is roughly 10% undervalued, while Grantham reckons it's 30% overvalued.
Bull's view: Big stocks are cheap
Bonds are attracting floods of money into fixed-income mutual funds after having crushed stocks in the decade that ended in 2009.Treasurys returned 6% per year, while stocks lost money each year on average during that span, Miller observes in his latest quarterly commentary. A decade ago, stocks were expensive, which no longer is the case.
Long term, he thinks the 10-year Treasury ought to yield 4.5% to 5.5%, which would lead to substantial losses for Treasurys and investment-grade corporate bonds, Miller says. Junk bonds ought to do better, but they already had a 50% run last year. Miller's scenario assumes "benign" inflation of 2% to 3%.
"If the inflation bears are right, bonds will be a disaster," Miller commented in January (.pdf file).
"Stocks have historically provide inflation protection that bonds cannot," Miller asserts. "Like Poe's purloined letter, these values are hiding in plain sight."
Bear's view: They'll hold up best
As for Grantham, he sees "high-quality" U.S. stocks providing a 6.8% annual return over inflation during the next 10 years, slightly more than the overall market's historical real return of 6.5%. But overall, large-cap U.S. equities should provide a real return of just 1.3% annually, while small caps should see 0.5% in real terms. (Writing in his quarterly letter, Grantham agrees with Miller that fixed-income investments are "badly overpriced.")Given the equity market's overvaluation, "value purists will have to struggle increasingly with the Fed's continued juicing of the markets," Grantham continues. To control the risk of losing money, these managers will have to take "the career and business risk of lagging a rising market."
