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Stock Market Superbubble Suggests Investors Shift More To P2P Lending
Jeremy Grantham of GMO is making the case for investors putting more into “specialized” lending and less into shares today, because we're currently in superbubble territory.
While he's most concerned about the US stock market, he's also worried about stock markets in general, especially in many developed markets.
GMO is reducing its share holdings
GMO makes a compelling case for “reducing” share holdings right now and for holding more “specialized credit”, i.e. specialised lending.
The basic point is that, when stock markets have been this overpriced, they have always corrected.
GMO looked at 300 events where stock or other markets were this overpriced. It found that, with the exception of commodities and a handful of rare cases in developing countries, all the markets corrected back to where they were before. Plus, in 100 years, all stock markets in developed countries have always corrected.
Many stock markets are currently overpriced. Anyone who does share investing and has spread their money sensibly across lots of countries is going to be impacted.
The US is looking especially, extraordinarily overpriced, and it's the main focus of the GMO research. I've taken a look at various investments that spread your money across the globe and found that, typically, 60% of investor money in such funds is invested in US shares, reflecting the size of its stock market. That's a lot of exposure that you might have.
The starting point for your lending and share investments
In terms of how much P2P lending you should do compared to share investing, I have always taken a view I adapted from one of the most famous investors in the 20th century, Benjamin Graham. The starting point is that investors put their investing pot 50-50 between shares and P2P lending.
Graham says that when you have strong convictions that one is going to perform considerably better than the other (or perhaps it's better to say when you feel one of them will perform considerably badly) you could temporarily shift to 75-25, in one direction or the other.
There's more on why to use this split, and how it's adapted from Graham, in How Much Should You Invest in Peer-to-Peer Lending?
GMO begs the question whether it's time for a 75-25 split
Clearly, the higher the price of an investment, the greater the risks. So now is a time to consider reducing investments in shares.
GMO has taken the step of reducing its overall share holdings in general, and it's doing so in the US and many developed countries in particular.
One of the areas it's interested in at present is specialised lending. For us small investors, P2P lending doesn't just fit the bill by being “specialised”, but because interest rates after costs are still especially attractive compared to the risks.
By definition, if the rates are attractive in money lending, it means the loans are not overpriced for lenders, but more in the bargain territory.
Even if we assume another huge recession and property crash were to occur simultaneously in the near future, there's a great deal of coverage for the risks at present in P2P lending. And that's precisely what GMO is saying is missing in shares.
If you've got too many UK shares, you might be in luck
Not mentioned in GMO research, but the overall UK stock market is not actually hugely overpriced by any reasonable measure I can see. I don't care where you get your data from or how you measure it, the UK stock market has been contained for years due to Brexit, the pandemic, and perhaps other gloom.
So if you've not taken the trouble to create a diversified portfolio in different markets and you were just on the verge of getting around to doing so, you might want to shift more slowly than you originally intended for a while.
What to do if you don't know what to do?
You shouldn't feel any anguish at all over the decision, when you're thinking about putting your money more heavily into one thing and less into another. Don't obsess over it. If you don't know whether to move more into P2P lending, just make sure you're spread widely across lots of different shares and loans, and sit tight and relax. Don't try and shift a lot of money one way or the other.
The mistake that too many investors make is to keep moving money around too regularly, because they think they can see the future and act on the economic news that comes out on any given day or month. These investors end up doing worse than average, because of all the costs they incur in selling investments, moving them and then buying again.
Sitting tight is usually the best policy, and is always the best default policy. This is because the future is usually too uncertain, with different indicators pointing in different directions. Lots of people make the mistake of believing they can find the order from the chaos of signals in those conflicting patterns, but actually we can't. Having kept a database of forecasts for a long time, I know that it simply doesn't work in most cases.
However, once in a blue moon, all the economic indicators point aggressively in one direction. It doesn't happen often, but it means there are times when you can confidently make stronger calls in terms of where you put your money.
The last time I recall this happening was at the beginning of the property-market crash in 2008-9. All economic indicators were so clearly pointing to a continued collapse that it was inevitable the deep price slide would continue on for many months.
So it's only when you feel very strongly about all the evidence that you actually shift your strategy. The point of a 75-25 split or other decisive action is to take it only when you have absolutely deep convictions about it, because to you everything so clearly points that way.
The bottom line is, if you can't say that it's obviously the case, then don't take a position of deep conviction with your money! It's simple really. At all other times, don't fuss about a future you can't read.
How much can we rely on GMO research?
I've followed a lot of GMO research for a few decades, but I've never had the opportunity to see GMO's long-term record in investments and I don't believe it's ever tried to publish that complete picture for all to see.
I've only ever seen it mention individual victories in isolation. On the flip side, it mentions some of its mistakes in an anecdotal way, but that's invariably to emphasise the point that it's got experience.
Its most recent research claims its rewarded investors with its investment positions during the last four big bubbles. However, we don't know how well it has rewarded investors and we also don't know if it has always done so deliberately or through good luck.
All of that said, GMO's research is always very good and they understand very well the behaviour of investment markets. They have the correct attitude that you need if you want to beat the market and not get hammered by crashes.
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