When last we checked in with Jeremy Grantham, the GMO co-founder was still bubble watching [7], reiterating his outlook from November [8] that although stocks can always go higher in the "strange, manipulated world" that we call the "new paranormal", "bubble territory" probably isn’t far off given that the Yellen Fed is "bound and determined" to facilitate the inexorable rise of asset prices.
More specifically, bubble territory for Grantham is around S&P 2250, and because "the Greenspan/ Bernanke/Yellen .. Fed historically did not stop its asset price pushing until fully- fledged bubbles had occurred, as they did in U.S. growth stocks in 2000 and in U.S. housing in 2006," there’s no good reason to think we won’t reach a bubble-defining two sigma event before all is said and done, even if that means launching QE4 in the event liftoff's first 25bps baby steps result in a 1937 redux [9].
Grantham also bemoaned the lack of capex spending and the myopia exhibited by corporate management teams, noting the "current extreme reluctance to make new investments in plant and equipment (how old-fashioned that sounds these days) rather than [plowing money] into stock buybacks, which may be good for corporate officers and stockholders, but bad for GDP growth and employment."
In GMO’s latest quarterly missive, Grantham is back with another dose of inconvenient truthiness, this time in the form of "ten quick topics to ruin your summer."
In short, this is a list of what Grantham - who points out how fortunate he is to "have an ideal job [with] no routine day-to-day responsibilities [which leaves him] free to obsess about anything that seems both relevant and interesting" - thinks you should worry about going forward:
- A new era of lower trend GDP growth
- Resource scarcity
- Oil
- The environment
- Food shortages
- Income inequality
- The death of “majoritarian electoral democracy”
- The Fed
- Asset bubbles
- The limits of humankind
Here are some excerpts from Grantham’s thoughts on each topic:
* * *
From GMO
1. Pressure on GDP growth in the U.S. and the balance of the developed world: count on 1.5% U.S. growth, not the old 3%
- Factors potentially slowing long-term growth:
- Slowing growth rate of the working population
- Aging of the working population
- Resource constraints, especially the lack of cheap $20/barrel oil
- Rising income inequality
- Disappointing and sub-average capital spending, notably in the U.S.
- Loss of low-hanging fruit: Facebook is not the new steam engine
- Steadily increasing climate difficulties
Partially dysfunctional government, particularly in economic matters that fail to maximize growth opportunities, especially in the E.U. and the U.S.
Mainstream economists, with their emphasis on highly theoretical models, have been perplexed by the recent chain of disappointments in productivity and GDP growth and would disregard all or most of these factors as theoretically unsatisfactory.
2. The age of plentiful, cheap resources is gone forever
After every historical major rally in commodity prices, there has been the predictable reaction whereby capacity is increased. Given the uncertainties of guessing other firms’ expansion plans, the usual result is a period of excess capacity and weaker prices as everyone expands simultaneously.
In agriculture, we also had a global sell-off following three consecutive years in which extremely hostile grain-growing weather had driven prices to panic levels of triple and quadruple their previous lows.
All in all I am still very confident, unfortunately, that the old regime of irregularly falling commodity prices is gone forever.
3. Oil
Among commodities, oil has been king and still is. For a while longer. Oil has driven our civilization to where it is today. It created the surplus in our economic system that allowed for scientific research and rapid growth. Now, as we are running out of oil that is cheap to recover, the economic system is becoming stressed and growth is slowing.
4. Climate Problems
Both the actual climate and the associated politics seem to be changing more rapidly these days, with the seriousness of the situation becoming better appreciated. Visible changes in the climate have also been accelerating, with many more records than normal of droughts, floods, and, most particularly, heat. Last year was the hottest year ever recorded, and this year, helped by an El Nin?o, has gotten off to a dreadful start. January was the second hottest January ever. February and March were outright records. April was in third place, but both May and June were back in first place. This consistency with volatile climate is unusual and ominous. If kept up, 2015 will be the hottest by a lot.
5. Global food shortages
The world’s population continues to grow, and the increasing middle class of the emerging countries, especially China, is rapidly increasing its meat consumption. Both trends put steady pressure on our grain and soy producing capabilities at a time when productivity gains have been irregularly slowing for several decades and show every sign of continuing to slow.7 Both overland and underground water supplies are stressed. Weather for farming becomes increasingly destabilized with increased droughts and radically increased flooding events. Flooding particularly increases soil erosion, which still continues at 1% a year, close to 100 times natural replacement rates. Insects and weeds are apparently becoming resistant to chemicals faster than chemists can respond.
6. Income inequality
Over the last few years, we have been presented with data showing that the U.S. is the most unequal society (or one of the two or three worst) in both income and wealth in the developed world. It is also one of the less economically mobile ones, especially for mobility out of the poorest quintile. Neither situation applied or even nearly applied 40 years ago.
7. Trying to understand deficiencies in democracy and capitalism
Democracy
"The central point that emerges from our research is that economic elites and organized groups representing business interests have substantial independent impacts on U.S. government policy, while mass-based interest groups and average citizens have little or no independent influence." This is the killer conclusion of a paper last fall by Gilens and Page.11 Based on the study of almost 1,800 policy issues for which income breakdowns were available, and defining the “Elite” generously as those above the 90th percentile, it finds that “majoritarian electoral democracy” is largely a thing of the past.
Capitalism: a failure to be inclusive (and feathering the corporate officers’ nests)
I have previously gone on at length about the critical, perhaps even deadly, deficiency in capitalism in dealing with long-term issues of the commons – damages to our common air, water, and soil. I would now like to take a swipe at capitalism’s increasing failure to be inclusive. Capitalism has steadily dropped its baggage of stakeholders, with the exception of senior corporate officers in first place and stockholders in second. Interest in local communities, cities, states, and countries of origin has been largely put aside as has the previous jewel in the crown of responsibilities to workers, the defined benefit pension fund. At a time of provable abnormally high corporate profits as a percent of GDP, corporations have argued that defined benefit pensions are not affordable. That they are dropping them should come as no surprise, for defined contribution plans (in general less attractive to employees than defined benefit plans) are much cheaper and easier on accounting predictability. What is surprising is why they adopted defined benefit plans in the first place, when they did not have to. And why did they have, in the 1935 to 1985 window, a sense of a social contract, suggesting that other things mattered besides maximizing short-term profits? Good ethics but bad capitalism? Actually, my colleague, James Montier, argues that a single-minded emphasis on relatively short-term share value maximization is a bad business idea; and I agree. Loyalty from workers, community, and country and an image as a company with worthwhile values is very probably a better business proposition. A longer-term focus certainly is. The best strategy, as Montier argues, is probably to concentrate on the highest possible customer satisfaction at a reasonable profit.
8. Deficiencies in the Fed
A counter-productive job description, badly executed.
9. Investment bubbles in a world that is, this time, interestingly different
Two significant items seem to be different this time. First, profit margins in the U.S. seem to have stopped mean reverting in the old, normal way, and second, some real estate markets have bubbled up and then stayed there at high prices. Both seem surprising events, even against what I would call “the laws of nature,” or at least the usual laws of capitalism. What is going on?
10. Limitations of homo sapiens
After reading all of this you may think that I am particularly pessimistic. It is not true: It is all of you who are optimistic! Not only does our species have a strong predisposition to be optimistic (or bullish) – it is probably a useful survival characteristic – but we are particularly good at listening to agreeable data and avoiding unpleasant data that does not jibe with our beliefs or philosophies. Facts, whether backed by 97% of scientists as is the case with man-made climate change, or 99.9% as is the case with evolution, do not count for nearly as much as we used to believe.
For that matter, we do a terrible job of planning for the long term, particularly in postponing gratification, and we are wickedly bad at dealing with the implications of compound math. All of this makes it easy for us to forget about the previously painful market busts; facilitates our pushing stocks and markets on occasion to levels that make no mathematical sense; and allows us, regrettably, to ignore the logic of finite resources and a deteriorating climate until the consequences are pushed up our short-term noses.
