- GMO says investor excitement in AI has inflated stock valuations, making future returns unattractive.
- The firm, which oversees $64 billion, says US stock valuations are in the 90th percentile compared to history.
- GMO likes international and deep value stocks as alternatives to broad US indexes.
GMO's John Pease doesn't love what the massive rally in AI stocks has done to broader market conditions.
While he stops short of calling it a full-fledged bubble, he did tell Business Insider in a recent interview that excitement around the technology has bid up broad stock-market valuations to levels that make future returns unattractive.
In GMO's quarterly letter published last week, Pease and his colleague Ben Inker pointed out that US stock valuations are in the 90th percentile compared to history. Relative to risk-free Treasurys, they're even more expensive, the duo said.
Eventually, they see this reality weighing on forward returns.
"Valuations could become more stretched, of course, but it pays to remember that higher valuations always beggar future returns," the pair wrote in the letter.
They have a particular focus on the so-called "Magnificent Six" — the moniker that Pease and Inker use for the Magnificent Seven stocks, minus Tesla — which they say trade at an average of 30 times earnings. That implies very lofty future expectations. It also increases the risk that earnings will underperform forecasts, especially as these firms spend big on a pivot from software to AI infrastructure.
"They're shifting toward physical investment, which is very different, and they're making that shift in a remarkably quick way," Pease told Business Insider.
He continued: "Maybe they'll continue to do something amazing, but historically, when we've looked at companies and we've looked at sectors that have invested a ton in physical capital expenditures over time, that's accrued to huge technological advances in society, to huge benefits to consumers, not huge benefits to shareholders."
Where else to look
With "disappointing" returns likely ahead for the S&P 500, Pease highlighted a couple of investments he's bullish on at the moment.
One is international stocks broadly. While investors haven't been high on ex-US stocks due to low growth, that could be changing, Pease said.
"We are sanguine that, much like with Japan, international equities will return to a path of normal growth," he wrote in the letter.
Plus, they're just cheap.
"The UK, Europe, Japan, and the rest of developed markets all trade at a 33% to 55% discount to American stocks," he wrote.
GMO
Another is deep value stocks, both in the US and abroad. Relative to the most expensive growth stocks they're as cheap as they were at the height of the dot-com bubble and in 2021, Pease said. S
"There is no reason for these stocks to be so discounted, which is why we expect them to outperform even if valuations don't do anything" he said.
"They're so discounted, it's very easy for them to surprise to the upside," he continued, adding: "It is an extremely compelling trade."
The post A $64 billion investment firm says AI has made stocks historically expensive. Here are its top 2 recommendations for avoiding the fallout. appeared first on Business Insider