4 'Reasonable' Choices, If You Must Own U.S. Stocks: Grantham

"The paradox that worries me here for the U.S. market is that we start from a Shiller P/E and corporate profit margins that are near record levels and therefore predicting near perfection, yet we face in reality not just a very risky disturbed geopolitical world, with growing concerns about democracy, equality, and capitalism, but also an unprecedented list of long-term negatives beginning to bite," Grantham said.

"The stark contrast between apparent embedded enthusiasm and these likely problems seems extreme, illogical, and dangerous," he explained.

Most institutions must own U.S. stocks, however, and "there is a reasonable choice of relatively attractive investments — relative, that is, to the broad U.S. market," he wrote.

Grantham outlined several areas that investors seeking U.S. stocks might consider, especially for portfolio diversification.

1. Quality Stocks

U.S. quality stocks, with high stable return on equity and a pristine balance sheet, aren't particularly cheap now, Grantham noted. Plus, they "have a long history of slightly underperforming in bull markets.

But they also have a long track record of "substantially outperforming in bear markets," explained Grantham, adding that these stock did perform "unusually well in the recent run-up."

"In addition, their long-term performance is remarkable. AAA bonds return about 1% a year less than low-grade bonds — everybody gets it, and always has. In bizarre contrast, the equivalent AAA stocks, with their lower bankruptcy risk, lower volatility, and just plain less risk, historically have delivered an extra 0.5% to 1.0% a year over the S&P 500," Grantham noted.

"Even holding their own should be inconceivable. It is the greatest aberration of all time in the market, and one I'm happy to say we at GMO realized 45 years ago," he added.

2. Natural Resource Stocks

"Not only are raw materials finite — believe it or not! — getting scarcer, and therefore certain to rise in price, but at longer horizons, 10 years, resources are the only sector of the stock market to be negatively correlated with the broad stock market.," Grantham said.

"They are far and away the most diversifying sector. … They are also particularly cheap today, having been whacked recently," he noted.

3. Climate-Focused Equities

As climate damage grows and givernments become more willing to take action, Grantham wrote, "I believe climate investments will have top-line revenue growth that is guaranteed to be above average for the next many decades, although with no guarantees as to the smoothness of that growth."

With solar and wind costs more up front than operational, "climate investments are exceptionally discount rate-sensitive, which has hammered them over the past two and a half years. And in its usual way, the market has overreacted to the trend of rising rates, making these investments real bargains today," Grantham said.

"Today, solar stocks are priced at over a 50% discount to the broad equity market, and some of the best clean energy companies in the world trade at levels that imply negative real growth."

4. Deep Value Holdings

Deep value stocks, with low valuations compared with their inherent worth, "look cheap enough to be worth some investment, as the comparison with the total market is about as wide as it ever gets," Grantham wrote.

 Photo: Bloomberg