- Investors must avoid the "superbubble" in stocks that is concentrated in the growth sector, according to GMO.
- The asset management firm co-founded by Jeremy Grantham outlined how investors can still make money in stocks despite the bubble risk.
- "There remain significant opportunities to make money and reduce risk in today's market," GMO said.
Even though there may be a "superbubble" in the stock market, there are still opportunities for investors to manage risk and make money, according to a Tuesday note from Jeremy Grantham's GMO.
The asset management firm said the first step investor can make to navigate the current stock market bubble is to avoid the frothiness of growth stocks, which is where GMO believes the bubble is concentrated, and instead invest in non-US value stocks.
"As such, the largest risk position in our flagship strategy is long a global portfolio of value stocks and short a global portfolio of growth stocks," GMO said. While this strategy led to big outperformance in 2021, GMO believes there is still room for upside in holding value stocks rather than growth stocks.
While reducing exposure to US stocks, investors can find value in emerging market stocks, as well as in Japan, according to the report. "To us, these stocks look very cheap relative to the US," GMO said. Additionally, resource stocks like energy and basic materials "also look cheap relative to the rest of the world," the note said.
This isn't the first time GMO successfully navigated a so-called "superbubble" in the stock market. The asset management firm noted that it held zero Japanese stocks during the 1989 Japan equity bubble, it reduced equity exposure and focused on value stocks during the 2000 dot-com bubble, and it reduced equity exposure and focused on quality stocks amid the 2008 Great Financial Crisis.
"Navigating bubbles is fraught with all types of risk – absolute, relative, and career. This time is no different: when mean reversion will begin is inherently unknowable," GMO said.
Perhaps the most crucial step an invest can make to profit off of the frothy stock market environment is have good investment discipline and sell winners to rebalance into losers. This practice is "incredibly difficult to do for a whole host of behavioral reasons," GMO said, before adding "that investment discipline is particularly critical given the equity superbubble we see today."