- According to GMO, the best way for investors to prepare for a potential market decline is to buy cheap, unpopular stocks.
- The investment firm finds the extreme discounts on deep value stocks attractive.
- Once the optimistic sentiment fades, these valuations should correct, GMO wrote.
It’s time to turn to the cheapest stocks on the market as the value sector is on the verge of a comeback, GMO wrote in a new research note.
The investment firm, led by legendary investor Jeremy Grantham, expressed its strong confidence in “deep value” stocks – that is, stocks that are cheap relative to their actual fundamental value.
Based on these criteria, the investment firm began targeting the cheapest 20% of stocks in May 2023 to avoid “deceptively cheap” value traps.
“In a world where many stocks are being driven ever higher by positive sentiment and investor optimism, many of the least popular and least traded stocks are trading at extraordinary discounts,” the company wrote.
Last year, U.S. investment was heavily focused on large-cap technology companies, helping benchmark indices hit a series of all-time highs.
Against this backdrop, deep value stocks have become extremely cheap – not only compared to the overall market, but also in historical comparison.
“Outside the US, everything is cheap, but deep value is in the 2nd percentile of its history,” the note said. “In the US, deep value is similarly in the 10th percentile of its history, while the rest of the value should be largely negligible at current valuations.”
Therefore, according to GMO, deep value stocks are well positioned to deliver strong returns once investor sentiment toward mega-caps fades. Earlier this year, GMO forecast a 1% decline in U.S. large caps over the next seven years and predicted deep value stocks to gain 7.6%.
“The S&P 500 is technology and growth-heavy, so investing in international stocks from more than just a regional perspective is the perfect complement,” GMO wrote.
