We must keep in mind that when the price of any asset rises faster than its long-term return, its expected future return necessarily tumbles. If a price doubles from its fair value, its future return is halved. Under the theory of regression to the mean, this inefficiency is usually corrected via a price change.
Efficient market theorists also miss the boat, according to Grantham, when they assume that high risk (especially when defined as high volatility) is rewarded by high returns. He displayed a chart dividing stocks into deciles according to their beta since 1965; the three highest beta deciles had the three worst returns relative to the market. Grantham concludes that you are rewarded for paying attention to value, and that high volatility actually penalizes performance.
Always on the lookout for opportunities to profit from market inefficiencies, Grantham currently sees relative value in international stocks, particularly the small-value category. In the United States, "small value" seems a much better buy than the large-cap universe. His GMO Global Balanced Fund is 20% underweighted in U.S. equities. In fixed income, they are 11% underweighted in traditional bonds and overweighted in "Other Fixed Income" instruments, such as Treasury Inflation Protected Securities (TIPS) and currency-hedged foreign bonds. In true "mean reversion" portfolios that permit it, they are short Japanese government bonds and the S&P 500.
John Brynjolfsson heads Pimco's Real Return Bond Fund. His presentation was titled, "Are We Sitting On The Dock Of A Deflationary Cliff?" In commenting on the state of the markets, he pointed out a number of realities that will weigh on economic growth and diminish vendors' ability to raise prices:
Rising taxes to support increased government activity, especially the rising cost of the social safety net.
Excess productive capacity all over the industrial world.
The need for companies to increase funding for pensions. (Their current return expectations of more than 9% are unrealistically high.)
Relentless incursion of China into developed countries' markets.
Aging populations, with their increased need and propensity to save.
Very heavy debt burdens of businesses, governments and consumers.