Jeremy Grantham’s Latest Quarterly Letter
It’s here. Jeremy Grantham, chairman of GMO LLC of Boston and a well-known money manager whose clients have included U.S. Vice President Dick Cheney and 2004 presidential candidate John Kerry, has finally released his latest quarterly letter, along with a “special topic” letter to boot. The following are some notable excerpts:
U.S. Stock & Housing Markets
Where does this leave me? Believing that asset prices will come down to fair price and below by about 2010, a belief I have held since 1999. This means about a 10% to 15% decline in the S&P by then (to about 1100) and a similar percentage decline for EAFE; about another 10% decline in U.S. housing and perhaps a 40% decline in U.K. housing, which is likely to take quite a while longer than 2010 to bottom out. Critically, overruns on the downside for all asset prices after a bubble breaks are much more the rule than the exception!
Commodities
The prices of commodities are likely to crack short term (see first section of this letter), but this will be just a tease. In the next decades, the prices of all future raw materials will be priced as just what they are: irreplaceable. Oil, for example, will never again be priced on the marginal cost of pumping a marginal barrel from some giant Saudi oil field, as has been the practice for most of the last 100 years of oil production. Real cost is always replacement cost and oil, a precious feedstock for chemicals and fertilizers, simply cannot be replaced. Using marginal cost as a substitute was ignorant and conducive to wasteful consumption of scarce energy resources. It also enabled us to put our collective head in the sand and ignore the growing need for an enlightened long-term energy and climate policy.
Relatively quickly, in 100 years or so, we will run out of oil, underground water, and most non-fully-renewable resources. At current rates, we will do it very, very fast. A major complication now, though, is that we have been brainwashed by repetition to reject this whole idea as irretrievably pessimistic and defeatist, and just well… thoroughly un-American.
Summary & Recommendations
Due to a combination of spectacular mismanagement by the authorities that resulted in very excessive and dangerous speculation and very bad luck in the timing of commodity problems and over-rapid expansion of China, the fundamental global outlook is substantially worse than expected. These problems lower long-term asset values by a little and increase the chances of deeper overruns and perhaps a faster trip to the lows. Our advice until now was very simple: take as little risk as possible except for emerging markets. Now it is even simpler: take as little risk as possible.
The more complex issues, as always, involve timing. Both emerging markets and commodities (especially oil) have a creative tension between the negative and risky short term (1-2 years) and the attractive long-term (5-10 years) prospects. In the short term, slowing world economic growth combines with credit, currency, and inflation problems to dominate the outlook and offer poor prospects for emerging markets and commodities. Longer term, the reverse is true and they look like the assets to own. But for those who can keep some of their powder dry, there are likely to be much better investment opportunities in a year or two (or three) than we have seen for 20 years. Our motto should be:
Don’t be brave, run away.
Live to fight another day.
You can access both Grantham letters via the GMO site here.
Sources:
“Meltdown! The Global Competence Crisis”
GMO Quarterly Letter, July 2008
Jeremy Grantham
GMO, August, 2008
“Living Beyond Our Means: Entering the Age of Limitations”
Letters to the Investment Committee XV
Special Topic, July 2008
Jeremy Grantham
GMO, August, 2008
