The perils of long-term forecasts — GMO edition

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GMO’s latest seven-year forecasts are out. This might shock you to your very core, but the asset manager thinks emerging-markets value stocks have the best potential over the next seven years.

In contrast, US stocks will be a big fat loser after adjusting for inflation.

The obvious pitfall with most long-term forecasts is that they are simple and mechanistic: you look at the long-term average returns and valuations multiples of various asset classes, take what they’re trading at now and adjust for that, and then subtract a 2 (ish) per cent inflation rate. Or you just extrapolate the current trend into the next 5-20 years.

But GMO cannot help but insert its own value prejudices into the process. You could argue that this is at least better than the facile approach described above (at least it shows some extra work), but it leads to some perennial very GMO-esque patterns — US stocks are pretty much always overvalued and doomed, emerging markets look better, and EM value is the bee’s knees.

In case you think this is an exaggeration, we went through GMO’s online library of seven-year forecasts and scoured our inbox for a few older ones. You can see a few of them below:

June 2022:

September 2020:

September 2018:

October 2015:

So how did these forecasts pan out? Well ..

This is just looking at the equity forecasts, but the actual performance of the major asset classes over the past decade has been almost perfectly inverse to GMO’s predictions.

US large-cap stocks have smashed everything, international equities and US small-caps have been fine, international large-caps and emerging markets has been a mess, and EM value has been an absolute disaster zone.

These are admittedly price indices rather than total returns, and the relative awfulness of value stocks would probably look a smidgen less awful if dividends were included. But over the past decade you would have been better served doing the opposite of whatever GMO forecast.

By the way, the insertion of a timber forecast is a fun legacy of founder Jeremy Grantham being extremely hot on the investment theme for a bit. It didn’t pan out any better than the EM value forecast.