GMO's Catherine LeGraw - Capitalizing on Global Asset Allocation in 2024 | #531

Episode Summary

Executive Summary: Catherine LeGraw argues GMO sees the most attractive relative asset allocation opportunity in 35 years because many assets are cheap outside the U.S., value—especially deep value—is dislocated, and U.S. mega-cap growth is extremely expensive and concentrated. She recommends rotating away from cap-weighted U.S. indexes toward non-U.S. stocks, deep value, quality, select fixed income, and commodity/resources equities.

Main Topics: Why GMO sees the best relative opportunity in 35 years: LeGraw explains that GMO’s claim refers to outperforming a passive 60/40 portfolio through valuation-driven asset allocation across equities, bonds, credit, and currencies, where they see attractive opportunities in multiple areas simultaneously. U.S. mega-cap concentration and expensive growth: The conversation centers on why investors should not extrapolate recent U.S. index returns. She argues the S&P 500 and Nasdaq are expensive, concentrated, and heavily dominated by a small number of large tech names. Deep value versus shallow value: LeGraw draws a sharp distinction between the cheapest 20% of stocks (deep value) and the rest of the value universe, arguing deep value is where the real dislocation exists in both U.S. and non-U.S. markets. Non-U.S. equities, Japan, and currency tailwinds: She makes the case for international and emerging markets, emphasizing that valuations are more attractive abroad and that cheap currencies like the yen and euro can provide additional return potential. Fixed income beyond the Bloomberg Aggregate: LeGraw says Treasuries are now ownable again, but corporate credit is tight and less appealing. She favors broader structured credit and emerging-market debt over vanilla aggregate exposure. Real assets, commodities, and liquid alternatives: She prefers TIPS and commodity/resource equities, is cautious on REITs and gold at current levels, and highlights long deep value/short expensive growth as a favored market-neutral opportunity.

Key Arguments: Past performance is a poor guide to future allocations; today’s decision should be based on current valuation and fundamentals, not the last decade’s winners. The S&P 500’s CAPE near all-time highs and the Nasdaq’s elevated levels make broad U.S. cap-weighted exposure expensive and vulnerable. Market-cap indices have become dangerously concentrated, so investors are implicitly making big bets on the Magnificent Seven. Deep value is materially cheaper than shallow value; the cheapest 20% of stocks are the real opportunity, while many shallow-value names are not cheap enough. Non-U.S. equities are cheaper than U.S. equities, and value is dislocated across developed international markets, especially Japan and parts of Europe. Currency valuation matters at extremes; the U.S. dollar is expensive while many foreign currencies are cheap, which can add meaningful long-term return. Treasuries are now attractive again because yields are high enough to provide income and diversification, unlike the ZERP era. Corporate credit spreads are too tight to be especially compelling, while structured credit and emerging-market debt offer more opportunity. Commodity/resource equities provide diversification plus equity-like return potential; clean energy is especially cheap and looks like deep value despite growth-like characteristics. The best current portfolio takeaway for traditional 60/40 investors is to be willing to own something other than the S&P 500.

Data Points: Relative asset allocation opportunity: Best in 35 years - GMO’s view on the current cross-asset valuation setup versus a passive 60/40 portfolio S&P 500 CAPE ratio: About 34 - LeGraw cites this as near all-time highs and top 1% of history Top 10 stocks vs. other 490: Underperformance of almost 2.5% per year over the long term - Referenced from GMO’s research on equal-weighting the non-top-10 stocks Top 10 stocks in recent decade: Outperformed by about 5% per year - Illustrates the recent concentration-driven anomaly in U.S. equities Value-growth spread in 2022: Value up 17% while equities down 17% - Used to show long-short deep value versus expensive growth can diversify equity risk Deep value cheapness: Top decile cheap - Deep value in the U.S. is described as near the cheapest it has ever been Corporate credit spreads: Bottom decile relative to history - Investment grade and high yield spreads are described as very tight Treasury yield example: Around 1% pre-2022; now about 5% on T-bills - Illustrates why Treasuries were previously unattractive and are now ownable again Currency tailwind: About 2 to 4 percentage points additional return - Potential benefit from cheap foreign currencies for U.S.-based investors Japan currency level: Yen around 155 - Used as an example of a very cheap foreign currency at the time of discussion Gold behavior: All-time highs - LeGraw says gold is too expensive to be attractive as a valuation-based investment REIT yields: Higher than all-time lows but still not attractive - Explains why GMO remains cautious on REITs today Cocoa prices: More than doubled year-to-date - Example of a commodity market that has become extremely hot and dislocated

Pivotal Quotes: "This is the best relative asset allocation opportunity we've seen in 35 years." — Mett Faber / GMO framing: Introduces GMO’s current cross-asset opportunity set "You don't have to accept asset classes pre-packaged." — Catherine LeGraw: Argument that investors can and should move beyond standard cap-weighted U.S. index exposure "Be willing to buy something other than SP 500." — Catherine LeGraw: Her condensed takeaway for traditional 60/40 investors

Implications: Listeners should expect a stronger case for diversification away from expensive U.S. mega-cap growth toward deep value, international equities, selected fixed income, and commodity-linked assets. The broader message is that current valuations favor active, valuation-aware asset allocation over passive index concentration.