MarketWatch’s Jonathan Burton wrote about well-known money manager Jeremy Grantham back on August 29. Burton had this to say about the chairman of GMO LLC:

Jeremy Grantham is not given to false alarms. The chief investment strategist at GMO, the highly regarded Boston-based manager of institutional and high-net-worth accounts, makes buy and sell decisions with a combination of computerized technical analysis and old-fashioned spadework. But nowadays, his digging for attractively valued stocks is mostly hitting rocks, and that has Grantham deeply concerned.

“The fundamentals have turned out to be worse than I had thought,” Grantham said. “My advice would be, don’t take any risk.”

Burton explained what the famous investor was getting at:

What he means is that in this market, don’t be a hero; live to fight another day. Here’s why: Global economic growth is slowing under the weight of increasingly illiquid credit markets and inflationary pressures. Weaker growth slashes corporate earnings, and since stock prices are tied to earnings, the outlook for equities worldwide, as Grantham sees it, is poor to middling…

One of his biggest fears, he added in an interview, is that “the whole global economy will be weaker than the market expects for quite a considerable time.” How long? “I would guess at least two years of sustained disappointment.”

Did Grantham see any bright spots on the investment landscape? The MarketWatch reporter wrote:

Don’t hide under the mattress just yet. Grantham points out that many of the world’s strongest companies are based in the U.S., which could help the U.S. market’s relative performance. Moreover, he said, the weaker global picture will benefit the U.S. dollar, so the American market could turn out to be “a safe haven.”

Source:

“The four horsemen of the market”
Jonathan Burton
MarketWatch, August 29, 2008

Reuters’ Jennifer Ablan reported yesterday that legendary money manager Jeremy Grantham recently acquired distressed debt for his personal portfolio. Ablan wrote:

The allure of moribund mortgage bonds and corporate debt has grown so strong that Wall Street’s biggest money managers are picking over their carcasses…

Even influential investor Jeremy Grantham said he has doled out money to three such funds for his personal account. “A well-managed distressed fund will no doubt do very well and will have great opportunities,” Grantham, chairman of global investment management firm GMO, said in an interview.

Source:

“Big money managers bet big on distressed debt”
Jennifer Ablan
Reuters, August 7, 2008

On Tuesday, Reuters interviewed Jeremy Grantham, chairman of GMO LLC, about his latest economic and investment outlook. Reuters’ Jennifer Ablan and Herbert Lash wrote:

The credit crisis that has ravaged world markets since last summer will fester for years and result in anemic economic growth in Japan, the United States and most of Europe through 2009, according to an influential Wall Street investor.

Grantham said:

We are in a recessionary phase that will last perhaps two and two and a half years. It will be, interestingly, unlike anything else we’ve seen.

Alban and Lash added:

His outlook for the environment now is grim, if not dire… a more prolonged and painful recession than anyone has imagined will occur, an economic downturn that will come closer in global reach to anything the world has seen since the Great Depression, Grantham said.

As for where to invest, Grantham, whose clients have included U.S. Vice President Dick Cheney and former U.S. presidential candidate John Kerry, suggested cash is king. From the Reuters piece:

He recommends investors hold cash, and if they must be invested, he favors large-cap U.S. equities…

Where should investors hide? Grantham said large-cap U.S. stocks provide “an absolute guaranteed no-brainer.”

“Their profit margins are the only profit margins in any group we look at anywhere that aren’t measurably above average at all,” he explained. “Everything else, the profit margins are way over average globally, including emerging markets — very vulnerable, hugely mean-reverting,” he warned.

Grantham said they have lagged other asset classes over the past six years:
“They’ve been left behind, exactly the time you would need them.”

Source:

“GMO’s Grantham sees prolonged credit crisis”
Jennifer Ablan, Herbert Lash
Reuters, August 6, 2008

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

Yesterday, a piece appeared on The Economist (UK) website which showed that the American global investment management firm Grantham, Mayo, Van Otterloo & Co., or GMO, made some terrific long-term calls regarding levels of returns from ten separate asset classes. Then again, what else would you expect when the firm is headed by legendary investor Jeremy Grantham? According to the well-known financial publication, Grantham and his cohorts are not so keen on the U.S. stock market and the housing markets of both the United States and United Kingdom. From the piece:

GMO has a very gloomy outlook for the American and British housing markets at the moment. By using the ratio of the median house price to the median family income, GMO reckons that prices in America need to fall by 17% instantly or stay flat for four years to return value. In Britain, prices need to fall by 38% or stay flat for seven years. And of course, there is no guarantee they will stay at fair value; in the mid-1990s, they dropped well below it.

More generally, Jeremy Grantham, GMO’s chairman, thinks that the equity bear market will continue for another couple of years, with the S&P 500 dropping by around 10-15% from here. But he warns that the chance of a meltdown—a drop well below fair value—has increased.

Source:

“The long and short of it”
The Economist (UK), August 3, 2008

Money managers from around the world gathered in Chicago last week for the CFA Institute’s annual investment seminar. Yesterday, the Chicago Tribune’s Gail MarksJarvis talked about two of the speakers- Jeremy Grantham and Marc Faber. The personal finance columnist wrote:

“I am officially scared,” GMO investment manager Jeremy Grantham told professionals from as far away as Abu Dhabi and Malaysia. “In 2000, we had a technology bubble. But this is massive, a massive credit crisis and a bubble in global housing, global equity and global land.”

Grantham, whose clients have included Vice President Dick Cheney and 2004 presidential candidate John Kerry, warned that the world is working its way through the “first truly global bubble.”

The British money manager shared his investment outlook with seminar participants. MarksJarvis wrote:

When asked by a money manager what he would buy now, Grantham said, “long mattresses” — jesting about the stereotypical nervous behavior of hoarding cash. He seriously suggested: “Put money into something incredibly safe, like a high-quality hedge fund.”

Grantham said rather than buying stocks for the long run now, he would only “short” them, or bet that they will decline in price. He sees “nothing interesting in quality corporate bonds,” and he has been shorting oil. “Commodities had a good run, but that’s over,” he said.

Although downtrodden mortgage-related bonds might be a good deal now because some are selling for 59 cents on the dollar, he said he wonders if the price will seem compelling if home prices fall another 20 percent or 25 percent.

He confessed to the group that “I bought my first gold last week, and I hate gold. It doesn’t pay a dividend. I would only do it if I was desperate.”

MarksJarvis noted:

Generally, when bubbles burst, the asset prices stay down for lengthy periods. Grantham isn’t expecting the stock market to hit its low until 2010.

The Tribune columnist also talked about Marc Faber, who publishes the monthly investment newsletter The Gloom Boom & Doom Report. She quoted the Swiss-born investor as saying:

The Fed has created a bubble in everything — stocks in emerging market, real estate everywhere in the world, commodities, art. The only asset class that is down is the U.S. dollar…

It is quite likely that the current synchronized global economic boom and the universal, all-encompassing asset bubble will lead to a colossal bust.

MarksJarvis also noted:

And with commodity prices so inflated, he expects an “increase in international tensions” over resources.

Source:

“Even the pros may be stuffing the mattresses”
Gail MarksJarvis
Chicago Tribune, July 29, 2008

Yesterday, the financial publication InvestmentNews ran a piece about a roundtable that took place in June that focused on the prospects for markets and opportunities for institutional investors. Jeremy Grantham, chairman of GMO LLC of Boston, was one of those who participated. Grantham, a well-known money manager whose clients have included U.S. Vice President Dick Cheney and 2004 presidential candidate John Kerry, responded to the following questions:

IN: So is the credit crisis over?
GRANTHAM: The stock market never does lags very well. They always expect that the first impact is the whole ballgame. So you have the first impact of the credit crisis, the first round of the effects on the housing market, and then people missed the point that the longer-term effects of less credit burn through very slowly over two, three — and even longer — years. For me, that’s all part of the credit crisis.

Step one is, you recognize you have a problem in housing. Step two, in consumer debt. Step three, that the whole debt structure was much too high. Step four, you bring the debt leverage everywhere down. The debt-to-GDP ratio in ‘82 was 125[%], one and a quarter times [gross domestic product]. The cumulative debt rose to over three times. So we had a dazzling rise, and people learned to adjust their businesses to live in a world where all kinds of debt — financial debt, consumer debt — were rising. Now they have to change all that, and the changing period is lumpy and long-winded and painful. I expect we’ll have a lot of unexpected consequences because we never had this collection of problems before.

The idea that you would solve a long-term problem of too much debt by paying people to take debt, by having a negative real rate, brings to mind the hair of the dog that bit you. The guy is a drunk and you’re offering him a kind of early morning pick-up. It may get him to the office feeling reasonably good but it doesn’t do much for his cirrhosis of the liver.

Later on, the roundtable turned its attention to the topic of fixed income and the economy:

IN: Let’s turn to the bond markets and the economy. How will they play out over the next 18 months?
GRANTHAM: The inflation versus deflation argument is the central issue for investors for the next two or three years. Whether the credit crisis cools down the economy and commodity crisis and so on, is that the central issue or is the inflation coming through — particularly in the Middle Eastern and some third-world countries — induced mainly by huge sustained demand and pressure on commodities? Which of those two is going to tilt the scale the most? I don’t know. It’s what I spend my nights waking up sweating about. The consumer polls now say they’re expecting 7% inflation, which is higher than almost the last 20 years. Whether they’re right or not, I’m not sure. In general, I think the economy over 18 months will simply play out weaker globally than expected by a little bit.

I would like to, however, back up. You mentioned before, “What have we learned?” No one addressed that, and I would like to.

We’ve learned that there aren’t too many adults around. There’s nothing but easy solutions and easy answers. I think we’ve learned that the Fed is intellectually nearly bankrupt, that it’s stretched the law in bailing out investment banks and in the process compromised, as [Mr.] Volcker said, some long-established principles, which he obviously valued.

We’ve learned that the Fed has to think about asset-class bubbles, with the problem being that we have such academic members of the Fed that they’re not sure that bubbles could exist in an efficient world. It would be a real help to have a Fed boss who lived in this real world.

I have a job description for the Fed, which is a lot simpler than the compromising combination of growth and inflation, and that is to protect the integrity of the U.S. financial system. It does seem to me entirely appropriate for the Fed to have that on the list. They have totally allowed the integrity of our financial system to erode in the last 20 years and they should be ashamed of themselves.

Source:

“The market has been battered, but some opportunities exist”
InvestmentNews, July 28, 2008

Yesterday afternoon, Brett Arends from the Wall Street Journal talked about moving from high-risk stocks to blue chips in an effort to protect one’s portfolio during this bear market. To help him get his point across, he brought up legendary investor Jeremy Grantham. Arends wrote:

Grantham has been successfully navigating markets for decades. He was among those who predicted the recent crisis before it happened, rather than after the fact. Right now, he thinks worldwide stock markets have further to fall, and at this point he is so bearish he wants to stick his money in the mattress. “I’m long the mattress,” he jokes.

That says, he still likes, at least in relative terms, high-quality U.S. stocks: big, blue-chip companies with solid balance sheets, strong franchises, and fairly stable earnings.

His top 15 picks, as of the end of May, were Wal-Mart, ExxonMobil, Johnson & Johnson, Coca-Cola, Microsoft, Pfizer, Chevron, PepsiCo, UnitedHealth Group, Merck, Procter & Gamble, Qualcomm, Cisco Systems, Oracle Corp. and 3M.

Arends also pointed out that these stocks were the biggest holdings (in order) in Grantham’s U.S. Quality Equity mutual fund.

Tokyo, Japan
Photo by Jon Butterworth, stock.xchng

Grantham also weighed in on overseas bargains. Arends wrote:

For those who are interested, Grantham also thinks the Japanese stock market is “less expensive than most other countries,” – which, for him, is high praise.

Source:

“Protect Your Portfolio With Blue Chip Stocks”
Brett Arends
Wall Street Journal, July 9, 2008

This morning, Barron’s Randall W. Forsyth and Vito Racanelli talked about the onset of a new bear market in U.S. stocks. They wrote:

IT’S OFFICIAL: THE BEAR HAS ARRIVED. The Dow Jones Industrial Average last week qualified for the widely accepted definition of a bear market of a 20% drop from the highs. The good news is that once the decline reaches that arbitrary 20% mark, based on history, the market has suffered most of its losses. The bad news is that the decline typically drags on for some time, and time may be the worst enemy.

Forsyth and Racanelli noted:

The post-1940 average bear market (as defined by the Standard & Poor’s 500 index) produced a decline of 30.4% from a peak that took 386 days to reach its trough, according to data compiled by Bespoke Investment Group. By the time the market was down the requisite 20%, the average bear market was 74% completed. Based on those averages, the bear market would have another 118 days to run and would face losses of another 14% from current levels.

The reporters spoke to Jeremy Grantham, chairman of global investment firm GMO, who indicated that this “new” bear market is really just part of a “super bear” that began in 2000. Forsyth and Racnelli wrote:

But others see the current decline as another phase in a longer-term secular bear market. “We are still in the super bear of 2000,” asserts Jeremy Grantham, chairman of money manager GMO. In a bear market, stocks fall back to, or below, their long-term trend line. But after the great bull market from 1982 to 2000, equities never flushed out their excesses “because of the Greenspan-inspired chain of bubbles, from growth stocks to real estate to commodities,” referring to former Federal Reserve Chairman Alan Greenspan.

Grantham, whose clients have included U.S. Vice President Dick Cheney and 2004 U.S. presidential candidate John Kerry, believes that this bear market has some claws, and is likely to run longer than 118 days. From the Barron’s piece:

“Great bear markets always take their time, and the most likely end is 2010,” Grantham continues. If the S&P 500 were to fall to 1100 in 2010, that would be about a 13% decline from here, about 1263, and would put the index back on its long-term trend line. He adds: “Chances are we will overshoot on the downside. We always do. We will be lucky if it is 1100.”

Source:

“The Bear’s Back”
Randall W. Forsyth, Vito Racanelli
Barron’s, July 7, 2008

This weekend Kathleen Pender of the San Francisco Chronicle talked about how horrible 2008 has been for the economy and markets. So miserable, in fact, she wrote Sunday:

You have to go back many decades - to the early 1970s at least - to find a year that started as miserably for the economy and the markets as 2008.

Pender spoke to Jeremy Grantham, the money manager who oversees $152 billion as chairman of Grantham, Mayo, Van Otterloo & Co. She wrote:

This has been a “wickedly awful year,” says Jeremy Grantham, chairman of investment firm GMO. This is “worse and much broader” than previous downturns…

Grantham says the turmoil is not nearly over. “I’m very confident the global economy, and the U.S. economy, will be weaker than people expect, for longer than people expect,” he says.

The credit crisis is global and “the Fed and Congress have much less power than people think” to fix it. “Now that the system is in retreat, it’s hard to stop,” he adds.

For Grantham, who has advised such clients as U.S. Vice President Dick Cheney and former U.S. presidential candidate John Kerry, China is the key to global economic health. Pender wrote:

Grantham says the biggest risk is China slowing. “If they stumble into the teeth of slowing growth, nervous confidence and a credit crisis, that would be extremely bad news.”

Commodity prices would fall, which would hurt developing countries that export commodities. These countries have been fueling global growth, and if they slow, it will spill over into the developed world.

Source:

“Start of 2008 is the ugliest in decades”
Kathleen Pender
San Francisco Chronicle, June 29, 2008