Investor Letters: Jeremy Grantham
Jeremy Grantham, chief investment analyst for the global investment firm he founded, Grantham, Mayo, Van Otterloo & Co. (GMO), has just released his latest quarterly letter. Here are some notable excerpts from the piece:
The good news is that we have not fallen off into another Great Depression. With the degree of stimulus there seemed little chance of that, and we have consistently expected a global economic recovery by late this year or early next year… In short, the normal tendency of an economy to recover is nearly irresistible and needs coordinated incompetence to offset it – like the 1930 Smoot-Hawley Tariff Act, which helped to precipitate a global trade war. But this does not mean that everything is fine longer term. It still seems a safe bet that seven lean years await us…
To repeat my earlier forecast, I expect developed markets to grow moderately less fast – about 2.25% – for the next chunk of time, and to look pretty anemic compared to emerging countries growing at twice that rate. We are nervous about the possibility of a major shock to Chinese growth. (My personal view of a major China stumble in the next three years or so is that it is maybe only a one in three chance, but is still the most likely important unpleasant surprise of the fundamental economic variety.) Notwithstanding this concern, I believe we are well on the way to my “emerging emerging bubble” described 18 months ago (1Q 2008 Quarterly Letter). I would recommend to institutional investors, including my colleagues, to give emerging equities the benefit of value doubts when you can…
On a longer horizon of 2 to 10 years, I believe that resource limitations will also have a negative effect (see 2Q 2009 Quarterly Letter). I argued that increasingly scarce resources will give us tougher times but that we are collectively in denial. The response to this startling revelation, for the first time since I started writing, was nil. It disappeared into an absolutely black hole. No one even bothered to say it was idiotic, which they quite often do. Given my thesis of a world in denial, though, I must say it’s a delicious irony.
So, back to timing. It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1100. It can certainly happen.
Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at -15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19).
Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.
NEW VIDEO! Has the S&P Index Topped Out for the Year?
The British investor offered a “Forecast Summary,” which said:
Bonds, except emerging, have very low seven-year return forecasts: on our numbers, they are below 1.25% real. The forecast for the S&P 500 is well below 3%, but the high-quality subset is still handsome. We score international developed stocks as close to fair value, and emerging equities as expensive, although just within range of normal if I am allowed to give them a seven-year bonus of 2% a year (15% in total).
In addition, the investment adviser whose clients have included Dick Cheney and John Kerry offered “Portfolio Recommendations”:
Having reinvested back in March to be almost neutral in equities, we have recently taken just a few chips off the table and recommend that anyone who was neutral weighted in equities or even overweighted (lucky you!) do the same.
For investors who still want to get in the game, Grantham suggested quality U.S. stocks. He wrote:
Our main argument is quantitative. Quality stocks (high, stable return and low debt) simply look cheap and have gotten painfully cheaper as the Fed beats investors into buying junk and other risky assets, a hair-of-the-dog strategy if ever there was one. In our seven-year forecast the quality segment has a full seven-percentage-point lead over the whole S&P 500, or 9% over the balance ex-quality. This is now at genuine outlier levels.
In addition, there are qualitative arguments. We like owning high-quality blue chips if we are indeed going into a more difficult seven years than any we have faced since the 1970s. The problems of reducing debt and the potential share dilution that can go with it as it did in Japan for a decade, particularly play to the strength of the largely debt-free high-quality companies. And for nervous investors there is yet another reason for favoring quality stocks: their more than 50% foreign earnings component, which is higher than the balance of the S&P500 with its heavy financial component. In the long run, quality stocks have proven to be the one free lunch: you simply have not had to pay for the privilege of owning the great safe companies, as plain logic and established theory would both suggest. Exhibit 2 shows that quality stocks have slightly outperformed the market for the last 40 years. Not bad.
You can read the entire quarterly letter here (.pdf format).
Source:
“Just Desserts and Markets Being Silly Again”
Jeremy Grantham
GMO, October 2009
