Grantham On The 10 Things That Really Matter

What’s on Jeremy Grantham’s mind? Ten things, and in his second quarter letter, the renowned value investor lays out the lot of them.

As usual, Grantham’s areas of interest go far beyond those of most investment managers. Here, from Barron’s, which published his letter, is his list of the 10 things that “really matter”:

  1. Pressure on gross domestic product growth in the U.S. and the balance of the developed world
  1. The age of plentiful, cheap resources is gone forever
  1. Oil
  1. Climate problems
  1. Global food shortages
  1. Income inequality
  1. Trying to understand deficiencies in democracy and capitalism
  1. Deficiencies in the Federal Reserve
  1. Investment bubbles in a world that is, this time, interestingly different
  1. Limitations of homo sapiens

Grantham talks about each one of these issues, many of which link back to #1 — struggling GDP growth. His discussion of natural resources and commodities is particularly interesting, as is his take on how the combination of misguided Federal Reserve policies and huge stock-option-heavy executive bonuses that are not linked to performance has negatively impacted GDP. “This pattern [of stock-option bonuses] has meshed very well with the policy of the current Fed regime – now internationalized – of encouraging higher stock prices so that the resulting wealth effect can help the economy,” Grantham says. “Since Greenspan’s early days, this has led to long, drawn-out six- to eight-year bull markets, interrupted with short bear markets. What could possibly be better for a stock option culture (as Andrew Smithers calls it)? In a decline, they rewrite their options. In a market advance, senior corporate officers cash in again and again, basically diluting stockholders’ value. They do this, all the time knowing that the Fed’s well-known asymmetry is on their side: Stumble and we at the Fed (and the Treasury, if necessary) will immediately help out – interest rate declines in early 2000 and 2008 and the giant 2008-09 bailouts are great examples – but succeed and we will not interfere, even in the midst of the most extreme housing or tech bubble.”

This, Grantham says, has led to companies spending most of their cash buying back their own stock rather than investing in their businesses. “And why should we be surprised?” he asks. “For how risky it is to build new factories and shake them down in a world where things can go wrong and corporate raiders lurk. How safe it is to buy your own stock and how likely that doing so will push prices higher, thus increasing option values (making it easier for CEOs to go from earning 40 times the average worker in 1965 to over 300 times today) and enlarging the Fed’s wealth effect at the same time!” The problem, he notes, is that such behavior leads to less corporate expansion; less GDP growth; lower job creation, and lower wages.

Grantham & Inker on Oil and Stocks

In GMO’s fourth-quarter letter, Ben Inker says the firm is finding better opportunities abroad than in the US, and Jeremy Grantham offers his thoughts on what’s going on with oil prices — and where they are headed.
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Grantham: It’s Not A Bubble — But It Probably Will Be

While some have been raising the notion that stocks are in a bubble, top strategist and noted bubble identifier Jeremy Grantham doesn’t seem to be seeing one — though he does think stocks are significantly overvalued.
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What Worries Jeremy Grantham Now

Given that he was one of the few to warn about both the Internet bubble and the housing and credit bubble before they burst, Jeremy Grantham’s worries and concerns about the economy and stock market carry a lot of weight. So what is GMO’s front man concerned about these days? Resources.

In an interview with The Wall Street Journal, Grantham reiterates his concern about what he says are looming shortages in food, fertilizer, and metals. “The investment implications are, of course, own stock in the ground, own great resources, reserves of phosphorous, potash, oil, copper, tin, zinc — you name it,” he says. ” I think oil, the metals and particularly the fertilizers, I would own — and the most important of all is food. The pressures on food are worse than anything else, and therefore, what is the solution? Very good farming, which can be done. The emphasis from an investor’s point of view is on very good farmland.”

Grantham says we are now living in the world in which “everything is overpriced” thanks to the “wicked plan” of the Federal Reserve. Stocks, he says, “can go a lot higher than this with the Fed pushing it. And we can have another real bubble. Based on the Fed’s history, that seems to be what they like.”

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Grantham Talks Growth, Markets, and More

GMO’s Jeremy Grantham recently sat down for a lengthy interview with Charlie Rose, and offered a number of interesting takes on the economy and stock market.

Grantham says that the great U.S. franchise company stocks are a bit expensive, but that the balance of the U.S. market is very expensive. Overseas in emerging markets, the picture is better, he says. He’s currently slightly underweight global equities, and heavily underweight U.S. equities outside of those great franchise companies. Still, he says we’re not in a terrible outlier situation for the market — he just thinks investors should be careful when buying regular U.S. stocks.

More generally, Grantham also said that, despite what efficient market theorists say, markets can be “crazily inefficient” at times, and that “economic theory doesn’t work with human beings”, who he says are far too “messy”.

Grantham reiterated his belief that the global economy is in a long-term slowdown that is being unappreciated by most economists, who aren’t interested in the long-term. He says that gross domestic product growth is a function of population growth and productivity growth. In the U.S., growth of the workforce has slowed significantly, in part because the addition of women into the workforce over the second half of last century has peaked. He thus does not think the U.S. will return to its former levels of 2.5% or 3% GDP growth per year.

Grantham also reiterates his concern about resource use. He says that we can switch pretty seamlessly to alternative energy sources, but he doubts political leaders’ willingness to do so. If we keep going in the path were going, however, he sees terrible consequences.

Despite his bearish economic views, Grantham says there is no reason to think good companies won’t be profitable. “What it’s about is value,” he says. He also says that the U.S. would be better off using direct government spending to stimulate the economy rather than creating an ultra-low interest rate environment, and he says the hyperfocus on the U.S. debt problems is distracting from real-world problems. What really matters is the quantity and quality of the people in economy, meaning things like job training and education need to be improved in America, he says.

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Grantham on a Low-Growth, Overpriced Environment

Equities and other assets have become overpriced (to varying degrees) just about everywhere you look, GMO’s Jeremy Grantham says in his latest quarterly letter.

“Courtesy of the … Fed[‘s] policy, all global assets are once again becoming overpriced,” writes Grantham. “But, as always, asset prices are not uniformly overpriced: emerging markets and, we believe, Japan are only moderately overpriced. European stocks are also only a little expensive, but in today’s world are substantially more risky than normal. The great global franchise companies also seem only moderately overpriced. Forestry and farmland, which is not super-prime Midwestern, is also only moderately overpriced.” Grantham says that U.S. stocks (ex “quality”) “now sell at a negative seven-year imputed return on our numbers and most global growth stocks are close to zero expected return.” Fixed income investments, meanwhile, mostly have negative estimated returns, he says.

Grantham says Ben Bernanke and the Federal Reserve are creating the overpricing with their loose monetary policies, which is becoming a pattern. “This strategy will be seen in future years as archetypical of the Greenspan-Bernanke era: badger and bully investors into taking more risk and eventually pushing assets — houses or stocks or both — far over replacement value, followed eventually, at long and hard-to-predict intervals, by exciting crashes,” he says. “No way to run a ship, but it does produce an environment that contrarians like us, who can take a few licks, can thrive in.” He also says the Fed is overestimating how much the U.S. will grow, which could have very bad repercussions.

But, Grantham says, markets could continue to rise for a while longer. “When one combines the apparent determination and influence of those who do the bullying with the career risk and short-termism of the bullied and the desire of the general public to believe unbelievable good news, these overpricings can go much further and the Fed can win another round or two,” he says. “That’s the problem.”

Grantham also spends a good portion of his letter talking about GMO’s meager long-term growth projections for the U.S. He offers a good deal of evidence showing that stock returns and GDP growth are not, as many assume, related, but that doesn’t mean he’s optimistic on stocks. His advice: “Prudent managers should be increasingly careful.”

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Siegel Counters Grantham on Profit Margins, Zero Growth

Wharton Professor and author Jeremy Siegel was pretty accurate with his 2012 market call, and he thinks 2013 is going to be another solid year for stocks.

“We’re going up,” Siegel tells Robert Huebscher on Advisor Perspectives. “We could get another 15 to 20%. I’m on record saying that I think there is an overwhelming probability that we’re going to get Dow 15,000 by the end of next year, so if the current level is 13,180, that’s a 14% rise. There is a possibility — if we get some good work done on the entitlements, if we set the tax rates appropriately– with the housing recovery, it’s very possible to get 25% next year. That would certainly be a very-good-case scenario.”

Siegel says he thinks the market is pricing in some very bad scenarios involving the fiscal cliff, so even if a solution does result in tax increases, he still thinks the market will rise. He did say, however, that it would be “very disappointing” if dividend taxes rise to pre-Bush-tax-cut marginal rates.

Siegel also says that we are now seeing the “biggest bond bubble in history”, and he discusses why rising interest rates wouldn’t be a danger to stocks. And he says that he doesn’t think profit margins are artificially high, as GMO’s Jeremy Grantham has argued. Siegel says that profit margins are high for some good reasons, including the fact that more and more sales are coming from foreign countries and technology firms, both of which are higher-margin areas. Siegel also rejects Grantham’s claim that the U.S. is headed for a lengthy period of little to no economic growth.