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.

 

Slow Growth Here To Stay, Says Grantham

GMO’s Jeremy Grantham says those waiting for the U.S. to return to the 3%+ growth rates it has averaged over the past hundred years are going to be disappointed.

“The U.S. GDP growth rate that we have become accustomed to for over a hundred years … is not just hiding behind temporary setbacks,” Grantham writes in his third-quarter letter. “It is gone forever. Yet most business people (and the Fed) assume that economic growth will recover to its old rates.”

Grantham estimates that GDP growth going forward will be about 1.4% per year, using conventional measures. But he says that doesn’t even tell the whole story. Current measuring techniques don’t properly account for the cost of resources. Resources costs have been rising by 7% per year, using a conservative estimate, since 2000, Grantham says, adding that that figure “might even accelerate as cheap resources diminish. If resources increase their costs at 9% a year, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system. It would take just 11 years before the economic system would be in reverse! If, on the other hand, our resource productivity increases, or demand slows, cost increases may decelerate to 5% a year, giving us 31 years to get our act together. Of course, with extraordinary, innovative breakthroughs we might do even better, but we certainly shouldn’t count on that. … Excessive optimism and doing little could be extremely dangerous.”

Accounting for the resource issue, GMO estimates U.S. growth will be about 0.9% through 2030, and then decrease to 0.4% for the next two decades. In addition to rising resource costs, Grantham says declining population growth will also inhibit growth. He offers a variety of intriguing data about population, productivity, and economic growth, as well as some insight into the impact that “fracking” to obtain natural gas could have on the economy. You can read the full letter on GMO’s website. 

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Grantham Keeping Head Down Amid Headwinds

In an interview with Charlie Rose for Bloomberg BusinessWeek, GMO’s Jeremy Grantham says he’s going to be quite cautious in 2013.

“I am going to be careful, particularly for the first half of next year,” Grantham says. “Great brands of blue chips are not so bad in the U.S. Emerging countries are about fair price. Beaten-down European stocks, particularly the so-called value stocks, are probably a little cheap, although risky. And resource stocks, once they reflect the weak economy — and we’ll get another whack-down — will be a wonderful long-term purchase. Farmland and forests, which should be the backbone of any long-term, serious portfolio. … It will also be a good time to buy in.”

Grantham says he’s a big believer in the Presidential Cycle being a driver of returns, and that the first years of the four-year cycles tend to be weak for stocks. He adds that with Republicans threatening to add fiscal constraints to an already weak U.S. economy, and Europe’s and China’s troubles lingering, 2013 should be “a really good year to keep your head down.”

Grantham also says he thinks the U.S. debt situation is “exaggerated”, and that education levels, capital spending, the quality of innovation, and technology are issues that should be focused on. And he discusses how soaring resource prices have shaved three points off global GDP in the past decade.

Grantham: Act Now, Or Food Crisis Could Be Devastating

GMO’s Jeremy Grantham says the world is well into a food crisis that isn’t likely to abate, and that it will have huge sociological, governmental, economic, and investment repercussions.

“We are five years into a severe global food crisis that is very unlikely to go away,” Grantham writes in his latest quarterly letter on GMO’s site. “It will threaten poor countries with increased malnutrition and starvation and even collapse. Resource squabbles and waves of food-induced migration will threaten global stability and global growth. This threat is badly underestimated by almost everybody and all institutions with the possible exception of some military establishments.”

Grantham says the crisis is likely to be around for decades, until the global population has “considerably declined” from the 9 billion peak it is expected to reach in 2050. If it continues, the crisis “will cause the social structure of several countries to break down, resulting in waves of immigration on a scale unknown in modern times, outside of major wars,” and create risks to global security. Part of the problem, he says, is food availability, while another part is cost — even if the world can produce enough food to feed everyone, the input costs could be so high that many are priced out.

The crisis is already having a big impact in some areas, Grantham says. Food accounts for about 10% to 12% of total budgets in developed countries, but 40% in poorer countries like Egypt. He also discusses water shortages, and risks to farming productivity like erosion and dwindling supplies of phosphate and potash fertilizer.

Grantham cites one big positive in the food situation: optimism about scientists’ abilities to engineer genes that would make some key crops more efficient. But, he says, while “strong countermeasures” could be taken to help stem the crisis, they likely won’t be taken. “This is because the price signals for the rich countries are too weak — they can afford the higher price — and there is inertia in all parts of the system,” he says. “Also, the problems of malnutrition in distant countries are not generally felt as high-order priorities in the richer countries.” He says a related energy crisis can be addressed by large investments in renewables and smart grids, and the countries that make those investments will come out ahead of those that don’t. He doesn’t think the U.S. has the will to do so, however.

Grantham says his comments are based on a horizon of 10 years and further out. As for how they impact investing, he explains: “The portfolio investment implications are that investors should expect resource stocks — those with resources in the ground — to outperform over the next several decades as real prices of the resources rise. Farming and forestry, though, are at the top of the list. Serious long-term investors should have a very substantial overweighting in a resource package. I suggest for long-term investors a resource position of at least 30%. Another relative beneficiary of resource pressure is the quality group of equities. Resources are a smaller fraction of final sales than average and higher profit margins make them more resilient to margin pressures.”

 

Grantham: U.S. Stocks Aren’t Cheap, But International Stocks Look Okay

GMO’s Jeremy Grantham says that U.S. stocks are not cheap, as many believe, but that international equities are looking more attractive.

“You’d lose a ton in U.S. small caps; but international small caps are fairly priced — right on the nose,” Grantham said at the Morningstar Investment Conference, CNBC reports. “If you put together a respectable portfolio of international stocks, you’d do much better.” In particular, he likes resource-related stocks like energy, metals, and food companies.

Grantham says abnormally high profit margins are skewing apparent U.S. equity valuations, providing an artificial prop to the market. “Think how weird profit margins are,” he said. “We’ve got high unemployment and financial crises — and world record profit margins. People think the American market is very cheap. We don’t. The market quite incorrectly gives full credit to today’s earnings.”

Grantham on Incredibly Irrational Markets

In his latest quarterly letter, GMO’s Jeremy Grantham offers some very interesting data on the disconnect between the stock market on one hand, and the economy and “fair value” of the stock market on the other.

“This difference is massive — two-thirds of the time annual GDP growth and annual change in the fair value of the market is within plus or minus a tiny 1% of its long-term trend,” Grantham writes in the letter, which is available on GMO’s web site. “The market’s actual price — brought to us by the workings of wild and wooly individuals — is within plus or minus 19% two-thirds of the time. Thus, the market moves 19 times more than is justified by the underlying engines!”

Grantham says the biggest reason for this disconnect is career risk for professional investors. Being wrong on your own can be career suicide, he says, so most of the pros “go with the flow”; that way, even if they are wrong, they can say that they weren’t alone. And that creates herding and momentum, which drive markets far out of whack with economic and corporate realities.

Grantham talks about how his firm has tried to battle that tendency, and offers some tips for how to go against the flow: “You apparently can survive betting against bull market irrationality if you meet three conditions,” he says. “First, you must allow a generous Ben Graham-like ‘margin of safety’ and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage.”

Because asset class selection packs a more deadly punch in the career and business risk game,” he adds, “the great investment opportunities are much more likely to be at the asset class level than at the stock or industry level.”

Grantham’s colleague, Ben Inker, also offers GMO’s take on the current market as part of the quarterly letter. “Today, stocks are expensive relative to our estimate of long-term fair value,” Inker says. “The trouble is, so are bonds and cash. If everything was guaranteed to revert to the mean over 7 years, we would hold equity-heavy portfolios, because the gap between stocks and either bonds or cash is wider than normal. But we don’t know that it will take 7 years. Because cash and (most) bonds have a shorter duration with regard to changes in their discount rate than stocks do, fast reversion would lead to smaller losses for them than for equities.”

With that in mind, GMO is a little lighter on stocks than their long-term projections would warrant. Inker says GMO “around 63% to 64% in equities for a portfolio managed against a 65% equities/35% bonds benchmark and 48% to 58% in equities for absolute return oriented portfolios, depending on their aggressiveness and opportunity set.” The firm sees little to like in the bond market, “leaving us with significant holdings of cash and ‘other.'”