Grantham's 3Q Market Letter

Jeremy Grantham is about the best at providing accurate long-run returns expectations for asset classes. His 3Q investor letter is here.

Reading it, we realize that our 40% equity weighting may be right for someone with a several year time horizon. But it's likely too low for someone with a 10-year (or more) time horizon and a strong stomach such as we think we have, despite the systemic risks we highlighted in recent posts. Equity valuations based on dividend yields may be too reasonable, and too much of the global crisis may be "in the market" for someone with a 10-year horizon to be only 40% in equities. (Register for and log into www.gmo.com to see Grantham's long-run return forecasts, which are based on dividend discount models and the expectation for mean reversion.) To quote from Grantham's October letter:

• "Rounds I and II – the asset bubbles breaking and the credit crisis – will soon be mostly behind us, but the effect on the real world of economic output lies, unfortunately for all of us, almost entirely ahead." [The question for us is, how deep & long will the economic recession be, and will it lead to other asset and credit crises?]

We're cognizant that you pay a terrible price for being underweight equities, if you're wrong. Putting it all together, we'll be keen to raise our 40% equity weighting further if sentiment worsens or we gain conviction when the market isn't. Also, how could anyone with a long-term horizon ignore the Warren Buffet op-ed piece this week? There's more math behind his thinking than the article tells.