Sign in
Become a MarketWatch member today
Brett Arends' ROI
April 15, 2011, 12:01 a.m. EDT
View all Brett Arends' ROI "º
"¹ Previous Column
The safest bonds in the world
First Take "º
Google on the spot to defend big spending
By Brett Arends
LONDON (MarketWatch) "” Watch out for small caps.
That's the latest warning from legendary fund manager Jeremy Grantham, chairman of fund shop GMO and one of the few people who successfully called the 2008 crash in advance.
His firm's latest calculations predict that investors in U.S. small-cap stocks will actually lose about a fifth of their money in real terms over the next seven or so years. That's an annualized loss of about 2.8% after inflation.
As always when it comes to predictions, there are no guarantees. But GMO's forecasts have a good track record.
Many financial advisers think they don't need a lawyer when switching firms. David Harmon, partner with Norris McLaughlin & Marcus, explains the role a lawyer can play to Dow Jones' Jennifer Hoyt Cummings.
Risky assets are supposed to make you money over the medium term, as compensation for owning them. Actually paying money to take risk makes no financial sense whatsoever.
The last time Grantham's firm warned that people were actually paying for the privilege of owning risky assets was back in 2007, just before the wheels started to come off. Grantham himself, on a recent trip to London, warned about the valuations of U.S. small-cap stocks.
You can see something similar if you just take a step back from the day-to-day action of the market and take a longer view. The Russell 2000 Index /quotes/comstock/64a!i:rut (RUT 827.47, +3.55, +0.43%) of small cap stocks has recently skyrocketed against the broader market. According to FactSet, it is now by far the highest it has been against the Standard & Poor's 500 Index /quotes/comstock/21z!i1:in\x (SPX 1,314.52, +0.11, +0.0084%) in at least a quarter century.
It isn't hard to work out why. Since the Federal Reserve decided to flood the world with free money, under the program known as "QE2" (like the ship) or Quantitative Easing 2, money has been chasing risk and action. Small caps give you a lot of action for the money.
It's a reckless game. Some people say it's going to end in tears, and QE2 might be better known as Titanic 2. The Federal Reserve is due to cease QE2 in the second quarter.
The latest surge in small caps is yet another sign that animal spirits are getting overheated on the markets, yet again. According to the latest Bank of America/Merrill Lynch survey of fund managers, institutions are now loading up on risk. The brief panic following the tsunami is now long since forgotten.
They are heavily overweight boom-and-bust stocks such as industrial and energy companies. They are loaded up on emerging markets and commodities.
Cash levels are low. Nobody much wants boring things like utilities or telecom stocks. Nobody wants boring old Japan, which enjoyed a short, bizarre investment vogue following the tsunami. (Aside: Fund managers also say gold is overvalued. They have said this for years"¦all the way up!)
So-called QE2 isn't the only reason small cap stocks have risen so far.
A lot of private investors and financial advisers believe that small-cap stocks will always outperform over the long term, albeit at the cost of greater volatility.
Admittedly this blind faith raises some awkward questions. How, for example, can any asset can possibly outperform, regardless of the price paid? And why would an asset be so volatile if it guaranteed such great long-term performance? But never mind. Many believe in small caps regardless.
So those who are behind the curve on their retirement, and who have missed out a lot of the market gains in the past two years, may be tempted to bet wildly on smaller stocks to catch up.
Good luck with that. Make sure you get out in time.
People should at least know what they are doing, and the risks they are taking. Generally speaking in this business, one makes more money over the long term buying assets when they are cheap and selling them when they are expensive. Buying them when they are expensive, in the hope of selling them when they are even more expensive to someone else, is gambling.
Brett Arends is a senior columnist for MarketWatch and a personal-finance columnist for the Wall Street Journal.
Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others. He was educated at Cambridge and Oxford Universities, and has worked as an analyst at McKinsey & Co. He is a Chartered Financial Consultant (ChFC) and Accredited Asset Management Specialist (AAMS). His latest book, "Storm Proof Your Money," has just been published by John Wiley & Co.
Investors disappointed by Google's earnings miss on Thursday pushed the stock to a six-month low as the search giant defended its heavy spending on new hires, investments.
5:56 p.m. April 14, 2011
"Small-cap investors paying too much for risk http://on.mktw.net/eY33Qt" 11:23 p.m. EDT, April 14, 2011 from MKTWArends
"The safest bonds in the world http://on.mktw.net/ftH0Ws" 11:33 p.m. EDT, April 12, 2011 from MKTWArends
"Why Europe's debt crisis isn't over http://on.mktw.net/gKcxCj" 11:08 p.m. EDT, April 11, 2011 from MKTWArends
"Is America the next Portugal? http://on.mktw.net/gf7KHk" 11:48 p.m. EDT, April 7, 2011 from MKTWArends
"The truth about hedge funds http://on.mktw.net/fdx311" 12:02 a.m. EDT, April 6, 2011 from MKTWArends
Ethics Monitor
Investing in forests could save the world
Media Web
Is the next Silicon Valley at Annenberg?
Money and Power
Ryan and Obama health plans fail
No-Nonsense Investing
Global bull market may soon face biggest test
Read Full Article »