Jeremy Grantham

The US stock market looks rather overvalued.

That’s certainly the view in the latest quarterly letter from GMO, a US asset management firm. GMO’s founder, Jeremy Grantham, has an impressive record of calling market movements successfully.

He avoided the Japanese property and stock market bubbles in the late ‘80s, as well as the US internet bubble in the late-‘90s. More importantly, he’s not a ‘stopped clock’ – in early 2009, he argued it was time to get back into the market and invest, so he pretty much called the bottom too.

GMO uses a model that looks at return on sales and the replacement costs for a company’s assets. In its latest letter, Grantham’s colleague Ben Inker suggests that fair value for the US S&P 500 index is just 1,100. That’s 40% below its current level.

What’s more, the letter predicts that US investors will receive an inflation-adjusted annual return of –1.3% over the next seven years. In other words, their money will fall in value by more than 1% a year in real terms. Not very tempting.

Grantham isn’t alone in the gloomy camp. Carl Icahn, the billionaire activist investor, has warned, “this market could easily have a big drop.” He believes that much of the recent rise in company profits has been driven by the opportunity to borrow cheaply rather than long-lasting organic growth.