The Jeremy Grantham Interview
Jeremy Grantham, of the esteemed Boston money management firm, GMO, LLC, is not a person who suffers fools gladly (click here for their site at http://www.gmo.com/America/About/MissionStatement.htm ).
I learned this the hard way, way back in the Jurassic Period, or some 30 years ago, when I pitched him to become a client of Morgan Stanley’s nascent international equity desk. Grantham, Mayo Van Otterloo, as it was then known, was a newly formed, very astute early player in the great international equity boom of the eighties, and we were desperate to get his business at any cost. In the end, a beautiful, and smart as a whip female associate made the connection, and our firm was more than richly rewarded.
When Jeremy made a rare appearance into the sunlight last week with a media interview, my ears perked up. The diminutive Englishman is brilliant, is one of a few who possess a truly global view, is as rich as Croesus, but keeps at it for the shear love of mastering the three dimensional chess game that is international finance. In other words, he’s a lot like me.
He also articulates my own views of all asset classes with more precision and clarity than I can myself. So I thought it wise to parse the crumbs of wisdom carefully that fell off his table.
Jeremy worries most about the Federal Reserve, which has been manipulating the economy for the last 20 years. Whenever they feel the economy needs a kick, they deploy their only weapon, the “wealth effect”. If they can drive asset prices up, people feel richer, more confident, and spend and invest more. The stock market went up 80% last year, and consumers spent about 2.8% of that gain, or some $280 billion, which adds 2% to GDP, so it is a real kicker. But you can’t see this clearly because of the enormous counter drag from the housing market.
Jeremy believes that the long term US trend growth is only 2% a year. Unless we’re really lucky, we’re going to have another crash. The recent moves in American stocks have been purely speculative. While the S&P 500 went up 20%, the junky part went up 120%.
The Fed is now using quantitative easing to trick us into buying one overpriced asset, stocks, because the alternative, bonds, is even more overpriced. The third alternative is to not play the game and hold cash. Cash gives you optionality, in that if you get a crash in the S&P 500 down to 900, which is where he sees fair value, then you have the money to do something about it. If you are fully invested, you don’t.
With interest rates at zero, the Fed has made cash so ugly that they are forcing you to speculate. Jeremy fears that the market will continue to accumulate risk. Real interest rates are negative, so it is not surprising that people are borrowing money to do this. The consequence is that you get booms and busts. Everything risky prospers. Then shear overpricing causes markets to break.
If you want to go with the flow, don’t fight the Fed, but be very nimble on your feet. You can play with a pretty good chance of winning for a few more quarters. The time to start acting conservatively is now.
The problem is that this time there is not much ammunition for the current heady market conditions to last much longer. In 2000, the Fed and the government had good balance sheets. Now they don’t. When this one breaks, we may have some real Japanese type deflationary experiences. When the wealth effect gets given back, plus interest, the markets crash. All of the employment is given back too, as jobs are lost.
As a card carrying value manager, Jeremy despises playing in a world of overpriced assets, where we are now. The Fed is driving the S&P 500 from very overpriced to dangerously overpriced. For the next seven years, he expects the US stock market to deliver only an annual 1% return, plus the inflation. If you push it up over 20% from here in the next year, it enters bubble territory, ready to inflict serious pain. He’s already started to sell for major institutional clients.
Jeremy is convinced that we are already in a currency war. Depreciating your currency is the same as raising import tariffs, which occurred in the 1930’s. This offers some miniscule short term gains, but at the price of large long term costs.
Regarding commodities, it will become devastatingly clear that we are running out of everything. Commodity prices declined for 100 years, but the fall stopped about five years ago. Maybe only oil was flat. The birth rates of China and India can’t be borne by the declining quantities of commodities. We have a chain link of crisis to look forward to, where panic buying spills from one commodity to the next.
Commodity prices could be peaking here short term. If there is a big break next year, it would be a terrific buying opportunity. If you can bring yourself to adopt a long horizon, say ten or 20 years, then locking up resources in the ground is a terrific idea. The oil industry has doubled since 2000, not because they were brilliant, but because oil prices increased four times. It has clearly broken out now to the upside.
Jeremy argues that it is the great movements between asset classes that makes you money. He over weighted emerging markets back in 2000, which have since outperformed the S&P 500 by 330%. The case for emerging markets is so crystal clear that they will continue to outperform until they command premium price earnings multiples. Their economies are growing at 6% a year, while the US is eaking out a measly 2%. The developed world is now slowing down further. Emerging markets are starting to approach that excess premium, but we still have several years to go until it is fully priced in.
If Jeremy had a gun to his head and had to do something with the $92 billion he advises, he would have a heavy overweight in big US blue chips. The old fashioned super blue chip franchises, like Coca Cola (KO), are much cheaper than the rest of the market. He also would have a modest overweight in emerging markets, which are a bit overpriced, but have plenty of potential. Beyond that, he would have higher than normal levels of cash to put to work when the major blow ups occur. He has a big allocation in patience.
That is a quality that investors and traders alike seem to find in permanently short supply.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.