Herro says stocks still cheap; Grantham begs to differ

Several of the successful market gurus I keep an eye on say the market remains attractively valued -- but not all of them.

By John Reese Jan 29, 2010 6:51PM

 It was another down week for the market, with the S&P 500 falling for the third straight week. The index is now about 6.5% off its recent high, and many are warning of a substantial correction. But if you listen to the investment gurus I keep an eye on, the dip may be more of a buying opportunity than a reason to flee stocks.

Take David Herro, the Oakmark fund manager who was recently named one of Morningstar's managers of the decade. Herro told Morningstar.com this week that he thinks stocks are still cheap, despite the big rally that began last March, and that his portfolios are still trading at valuations typical of other, more "normal" downturns.

 

Herro measures on a daily basis the spread in his portfolios' prices and their underlying values, allowing him to see what valuations, in terms of cents on the dollar, they're selling for. "In a typical downturn, they would maybe [fall] to the high 40 cents to the low 50s," he said. "This downturn, they went to about 35, 36 cents. ... So you saw it really go down a standard deviation or two." Today, they sit in the mid-50s, "just a little bit above of where we were in previous downturns," Herro says.

 

Charles Schwab Chief Investment Strategist Liz Ann Sonders, meanwhile, says stock valuations aren't bad -- though she thinks we are going to have a significant correction in the short term. Sonders has actually welcomed a correction, saying it will push sentiment down and set the stage for another leg up of the rally.

 

This week, Sonders told The Motley Fool web site that stocks aren't as cheap as they were last year at this time, but that they aren't too expensive either. "At best, we're reasonably valued," she said. "So now you need the denominator -- the E [in P/E] -- to do the lifting. I think it probably will -- again, not without bouts of corrective phases, but I think earnings will be a pleasant surprise this year."

 

Also sounding optimistic: Blackrock Global Chief Investment Officer of Equities Bob Doll. In an interview with WealthTrack's Consuelo Mack, Doll says he expects the government stimulus to continue to push the market up this year. “That’s a wind at our back,” he said of the stimulus plans put in place in the U.S. and abroad. “This is a powerful tailwind. … When stimulus is powerful, financial markets tend to do well.” He acknowledged that the winding down of the stimulus could cause some problems, but he thinks that the government support won’t be removed until self-sustaining mechanisms -- exports, business investment, etc. -- are providing enough support to replace the stimulus’ impact.

 

GMO's Jeremy Grantham also thinks the market will head higher -- for a while. But over the long haul, he sees a myriad of problems. In his latest client letter, Grantham says stocks have become significantly overvalued, with the S&P 500 trading about 25% above its fair value -- which according to him is about 850. Investors haven't learned from the last two market crashes, he says, however, and they are likely to  push the index higher. "Now it seems likely to go through 1200 and possibly higher," Grantham writes. … Any advance from here will make it once again seriously overpriced." On the bright side, Grantham says the quality portion of the market is still relatively cheap.

 

Hedge fund guru Barton Biggs has a different take. Biggs tells Bloomberg that the U.S. economy is in a “strong recovery”, and that he thinks it will grow in the 5% to 5.5% range in the next couple quarters. He also says valuations on stocks remain attractive. Among the areas he’s high on: large, high-quality technology stocks, large, multi-national growth plays, and high-quality drug firms.

 

Finally, another top hedge fund manager, George Soros, had two big pronouncements this week. He told Bloomberg that the Chinese market is "overheating", and said the country must slow it down. And, he said that gold is becoming the "ultimate asset bubble", according to the London's Telegraph.

 

John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".

 

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