Jeremy Grantham

Yesterday we first posted Jeremy Grantham's latest letter which incidentally is a must read for everyone who still is stupid enough to think this market reflects anything remotely related to fundamentals, when instead all it is pricing in is the money printing Kommendant's daily predisposition to continuing his dollar decimation via ZIRP and shadow QE. Just like all those who are buying Apple at these stratospheric prices are in essence selling life insurance on Steve Jobs (sorry, someone had to say it), all those buying into the market here are betting the Fed is apolitical when it comes to monetary policy decisions: a proposition so naive and ludicrous, it is not surprising that only the momos continue to buy into the rally, which is driven purely by Primary Dealers recycling money they lend to the treasury which in turn is repoed back by the Fed, so that the banks can buy 100x P/E risky stocks with the same money used to keep the treasury curve diagonal. This is nothing but Fed-sponsored monetary pornography at its NC-17 best. Of course, those who grasp it are few and far between, while the rest of the population is ignorant in its hopes that S&P 1,500 is just over the horizon, without a resultant crash back to 0 on the other side of the bubble. So for all those who are still confused (this means you Kommendant Bernanke) here is a 6 minute clip in which Grantham tells it just the way it is: there is nothing more to this rally that free money and banks' last ditch attempt to lock in another year of record bonuses before it all goes to shit. And the implication - play with the big boys at your own peril. "Bubbles are when you should cash in your "career risk units" and do something brave to protect the investors. There is nothing more dangerous and damaging to the economy than a
great asset bubble that breaks, and this is something that the Fed
never seems to get. Under Greenspan's incredible leadership he managed to give us the
tech bubble, and by keeping interest rates at negative levels for three
years drove up the housing bubble, and finally the risk bubble. And
Bernanke has happily picked up the mantle, and seems totally
unconcerned about creating yet another bubble. He has interest rates so
low banks can't possible not make a fortune. Savers are being
penalized, anyone who wants to buy cash faces a painful experience, and
so we are all tempted into speculating, which is apparently what he
wants and we've just had one of the great speculative rallies in
history, second only to 1932-33."

It’s spring, and this spring a young man’s fancy lightly turns to thoughts of speculation. The Fed’s promises look good and, as long as you’re not a small business, you can borrow to invest or speculate at no cost. The market has had a near record rally, sprinting far past our estimated fair value of 875 for the S&P 500. Bernanke is, in fact, begging us to speculate, and is being mean only to conservative investors like pensioners who cannot make a penny on their cash. Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank- and speculator-benefiting socialism. - Jeremy Grantham, GMO

Everyone in Congress, and anywhere else for that matter, knows prop desk trading (banks trading their own capital like a hedge fund) is a conflict of interest. They may or may not think it important or that it caused this or that problem, but they know it’s a real conflict.  Congressmen, since when wasn’t conflict of interest and poor ethical standards reason enough to change the law? But since we bring it up, of course prop trading was indeed the rot at the heart of our financial problems (see last quarter’s Letter). Watching traders take home their $28 million bonus sent a powerful message to lowly salesmen and packagers of asset-backed securities, for example, to get out there and really take some risk. This rot spread to the very top, and pretty soon chairmen of boards were exhorting CEOs to leverage up and look more like some much more profitable rival that resembled a hedge fund rather than an investment bank. Thus encouraged – or intimidated – some CEOs just kept on dancing right off the cliff. Let’s
learn from our near disaster. Viva Volcker!

We believed from the start that this market rally and any outperformance of risk would have very little to do with any dividend discount model concept of value, so it is pointless to “ooh and ah” too much at how far and how fast it has traveled. The lessons, if any, are that low rates and generous liquidity are, if anything, a little more powerful than we thought, which is a high hurdle because we have respected their power for years. And what we thought were powerful and painful investment lessons on the dangers of taking risk too casually turned out to be less memorable than we expected. Risk-taking has come roaring back. Value, it must be admitted, is seldom a powerful force in the short term. The Fed’s weapons of low rates, plenty of money, and the promise of future help if necessary seem stronger than value over a few quarters. And the forces of herding and momentum are also helping to push prices up, with the market apparently quite unrepentant of recent crimes and willing to be silly once again. We said in July that we would sit and wait for the market to be silly again. This has been a very quick response although, as real silliness goes, I suppose it is not really trying yet. In soccer terminology, for the last six months it is Voting Machine 10, Weighing Machine nil!

Price, however, does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors. First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fi x of short-term labor cuts fades away. Second, the slow gravitational pull of value as U.S. stocks reach +30-35% overpricing in the face of an extended difficult environment.

Grantham rides the moral hazard wave to new peaks. Complete with some amusing probability scenarios