Why the Housing Market Has Remained Resilient

On this episode of The Long View, Jeremy Grantham, long-term investment strategist at his namesake firm, Grantham, Mayo, Van Otterloo, or GMO, discusses market bubbles, climate and environmental issues, artificial intelligence, and what his outlook is for US and international markets.

Here are a few highlights from Grantham’s conversation with Morningstar’s Christine Benz and Dan Lefkovitz.

Why the Housing Market Has Remained Resilient

Dan Lefkovitz: When you last joined us in 2022 on the podcast, you talked about the US housing market as overpriced and vulnerable to economic weakness. Somehow the housing market has remained pretty resilient even amid higher borrowing costs. Why do you think that is?

Jeremy Grantham: It is a major surprise to me. The housing market on a global basis has been somewhat similar, except in China, which is important by the way. The Chinese real estate market plays a very big role one way or the other in global economics and a very, very big role in local Chinese economics. And China, of course, has become a major player, a major cog in the global economic system. But in America, some regions were pretty good, some were not so strong. It’s been an odd market. And if you think about the nature of a mortgage, you can get some idea. You’ve seen mortgages fall to almost ludicrous low levels of 3.0% and below. And you’ve sensibly, let’s say, locked one in at 2.8%. And now they went 6.0%, how enthusiastic are you going to be putting your house on the market the way you had intended a year earlier? And the answer to that one is pretty obvious, not enthusiastic at all.

And so, you freeze the market. And the best proof that that is a major component is the actual house turnover rate, which dropped like a stone and stayed dropped. And the turnover in the UK, Canada, and Australia, it’s a uniform feature of this era. So, when you change the rate that profoundly, people feel, well, I’ve got this great asset. I’ve got this 30-year mortgage or even in the UK, a much shorter-term mortgage, it’s still financially significant. So, people hold on to see what will happen. And everyone tells them the rates will come down in the not-too-distant future. And so, they start moving. They change their plans, or they rent their house, et cetera, et cetera. And you create cross currents in that that are not typical. And that’s what we’ve seen.

It’s not so much a strong market as a weird market, very local, very odd, sometimes dips, sometimes recovers. And generally speaking, fairly bamboozling from my point of view. Because in the end, if you lower the rate for 50 years, you lower the real interest rate structure, you’re going to increase the value of almost all capital. Farms go from a 6% yield to 3%, forests do the same. The stock market does the same. Instead of yielding 5%, which it did for 80, 90 years, it yields much less. And you would think, therefore, when you move real rates back, that it would have an effect. I have no doubt it will. But I have lots of doubt as to how long it takes to flow through the system. How long does the real rate have to be considerably higher than zero, which it was, to push back on the price of assets? I don’t know. But it’s almost a mathematical certainty that eventually they relate.

And any long-lived asset is not worth the same with a real rate of 2% than it is at zero. And yet, that is not the immediate response for some of the reasons we’re talking about. I have a family member involved in farms and forests. And that has kind of become a strange, weird market like the commercial real estate market, like the real estate market itself. They’re just strange. They lose volume and they act oddly. This is like a little interim, like the phony war at the beginning of World War II, where nothing seems to be happening in quite the predicted way. But in the end, basic relationships tend to exert themselves and higher real rates mean lower asset prices sooner or later.

Will There Be a Rotation in the Stock Market?

Christine Benz: US equity returns have been so concentrated in a handful of largely technology names. There’s been this widespread anticipation that there will be a rotation away from those names into other parts of the market—value, smaller stocks, non-US stocks. Can you talk about that, whether you think that there will be some rotation and what would be the catalyst for it?

Grantham: I have no particular insight, step one. Step two, however, a catalyst would be if global governments move against monopolies, and it becomes more politically acceptable, and the pendulum begins to swing back toward more consideration for labor and the ordinary worker. That would be a catalyst to watch out for the great monopolies. And they’re not ludicrously expensive, as we know, by the standards of 2000 and the tech bubble. They sold at substantially higher P/Es back then. But is the world more driven by monopoly today than 2000? Yes, it is. And if you don’t act against that, you’re likely to see huge earnings. And when you get to be that big, it is hard to sustain the 70 P/Es of the tech bubble. When you’re a trillion-dollar market cap, it just becomes implausible to have such high P/Es. And so, we haven’t. Let’s say one of the main reasons for that is the sheer colossal unprecedented size of the current group of superhero monopolies.

Will Non-US Stocks Outperform the US in the Next Decade?

Lefkovitz: When you think about future asset-class returns, are you expecting non-US stocks to outperform the US over the next, say, 10 years?

Grantham: Yes, historically, they’ve tended to rotate. There’s never been a period, never been a window like we’ve seen in the last, gosh, it’s almost 15 years now, where the US outperformed in earnings by such a wide margin. The typical measure would be 15% or 20%, and then the following decade, the rest of the world would come back. This time, it’s more like 80%, maybe 100% outperformance. And 75% or 80% of that are what used to be called the FAANGs and now the Magnificent Seven, they are the lion’s share. When I say lion’s share, they’re close to 80% of the extraordinary outperformance of the US corporate system over the rest of the world for the last, let’s say, 12 or 13 years. It’s just these couple of handfuls of stocks. Slight change between the FAANGs and the current iteration, but only two or three names.