Ben Inker: What Looks Cheap and Dear in Today’s Market

Episode Summary

Executive Summary: GMO asset-allocation head Ben Inker explains why GMO sees a better investment landscape than two years ago: higher cash and bond yields and cheaper stocks improve prospective returns. He favors quality and value for different reasons, with especially strong opportunities in deep-value U.S. stocks, Japanese small-cap value, and non-U.S. equities. He cautions that U.S. mega-cap concentration, growth-stock expectations, geopolitical risks, and simplistic ESG return claims require careful analysis.

Main Topics: Quality investing and its persistent anomaly: Inker says high-quality companies should theoretically earn lower returns because they are more resilient in downturns, yet they have historically outperformed. GMO’s first ETF, QLTY, applies this quality focus; Inker emphasizes that quality can support durable ownership and lower turnover. A more attractive investment environment: GMO sees improved prospective returns across stocks, bonds, and cash compared with two years earlier. Higher yields offer investors alternatives to equities, while inflation and economic growth have raised stocks’ estimated fair value; selected U.S. deep-value shares appear cheap in absolute terms. U.S. mega-cap concentration and growth-versus-value: The Magnificent Seven drove much of U.S. market performance. Inker compares their concentration and sustained growth to the Nifty 50 era, while warning that market power, valuation, and possible future growth disappointments matter. He argues that simplistic interest-rate explanations of growth-stock returns overlook growth shortfalls and portfolio turnover. Value investing and rebalancing: GMO’s case for value rests on the large valuation gap between value and growth. Returns are driven substantially by value companies that improve and graduate into the growth universe, as well as by growth companies that disappoint and become value stocks. International opportunities: Japan and China: Inker is particularly positive on Japanese small-cap value, citing more reasonable valuations, improved profitability, potential balance-sheet reforms, and a very weak yen. China is not considered uninvestable, but GMO prefers other emerging markets because they offer a wider value discount and more balanced geopolitical exposure. ESG as risk, quality, and investor preference: GMO treats weak ESG characteristics as potential risks that may warrant a lower price, rather than promising automatic outperformance. Inker distinguishes climate-transition investing and values-based exclusions, and warns that excluding essential industries such as copper mining can conflict with the goal of a cleaner-energy transition.

Key Arguments: Investment analysis should examine how returns were generated, not just the returns themselves; asset characteristics, valuation changes, and fundamentals can lead to very different conclusions. High-quality companies are less exposed to severe economic downturns and should rationally offer lower long-run returns, yet quality has persistently outperformed across equity markets and even in bonds, suggesting investors may underprice it. Higher long-term risk-free rates can support lower equity valuations, but today’s interest rate is not enough to assess stocks: the relevant consideration is the average rate investors expect over decades. Growth stocks are not automatically longer-duration winners when rates fall. Growth forecasts are uncertain, and companies priced for high growth can suffer large losses when they disappoint. The recent strength of U.S. equities is unusually concentrated. The Magnificent Seven have delivered strong fundamentals as well as higher valuations, so their performance cannot be reduced solely to passive flows or a short-term fad. Value’s potential comes largely from rebalancing: companies moving from value to growth can generate substantial gains, while disappointing growth stocks can fall into value. A wider starting valuation gap can magnify these effects. Japan’s investment case has improved because its old valuation premium has disappeared while operating margins have risen and companies are beginning to use excess cash more productively. Small-cap companies may also benefit more directly from a cheap yen and often carry little net debt. China has meaningful political and geopolitical risks, but a diversified investor need not treat it as uninvestable. GMO prefers other emerging markets because of their larger value discount and the importance of limiting concentration in any one country’s risks. ESG characteristics can inform risk assessment or reflect personal values, but excluding companies does not guarantee higher returns. Climate-transition goals may require investment in industries, including copper mining, that also have environmental costs.

Data Points: Inker’s tenure at GMO: Joined in 1992; more than 30 years at the firm - He described working directly for co-founder Jeremy Grantham for roughly the first 15 years of his career. Interest-rate outlook horizon: 20 to 50 years - Inker said long-run expected rates over this horizon matter more to equity valuation than the rate prevailing today. Cash yields: About 5% - Inker said cash was yielding around 5% again, a level he said had not been seen in the U.S. for roughly 20 years; he contrasted this with cash rates averaging close to zero in the prior period. Magnificent Seven versus the rest of the U.S. market in 2023: About 100% average return versus about 3% - Inker cited this approximate contrast to illustrate the extraordinary concentration of U.S. stock returns. Magnificent Seven share of the S&P 500: About 29% - Inker said the top seven U.S. stocks represented roughly 29% of the S&P 500, unusually concentrated compared with the past 50 years. Japanese equities in 2023: Nearly 30% in yen terms - The hosts cited the Japanese market’s rise while asking whether the improvement was durable. Japanese operating margins: Approximately doubled since 2013 - Inker attributed the improvement to Japanese companies’ increased focus on profitability after Prime Minister Abe returned to power. Japan’s past relative valuation: About 3 to 4 times the rest of the world in the 1980s - Inker said Japan’s prior valuation premium later disappeared, contributing to its long period of disappointing relative returns. China’s historical share of emerging-market equities: Close to 40% - Inker said China’s large index weight made geopolitical concentration a significant portfolio risk. U.S. deep-value universe: Cheapest 20% of the U.S. stock market - GMO’s term for this group; Inker said it may be cheap in absolute terms. GMO forecast scenarios: Normal, low, and ultra-low interest-rate scenarios - Inker said GMO blends scenario-based return forecasts according to its assessment of their likelihood.

Pivotal Quotes: "It is never enough to look at the returns of an asset, you need to understand how those returns were generated." — Ben Inker: A lesson from Jeremy Grantham that Inker applies to evaluating markets and investment strategies. "When we're getting paid well for taking risk, we're excited about taking risk." — Ben Inker: His explanation of why GMO’s improved outlook depends more on prospective compensation for risk than on whether recession risks exist. "The only way you can have a group of stocks outperform in the long run, is if they are permanently mispriced." — Ben Inker: Inker’s argument against promises that ESG investing, or any stock grouping, will automatically and sustainably outperform.

Implications: Investors may find better prospective returns in both risky assets and cash or bonds, but should avoid extrapolating narrow mega-cap leadership or relying on simplistic style and ESG narratives. Valuation, quality, diversification, and the sources of returns remain central; the discussion is not individualized investment advice.