I know I am a few days late commenting on the latest from Jeremy Grantham, but this note really is a must read. Grantham is really on point here. I’ve added a few of the highlights in case you don’t feel like reading the entire thing (you can read the entire note here).
Grantham doesn’t yet think there’s a bubble in equities:
“In equities there are few signs yet of a traditional bubble. In the U.S. individuals are not yet consistent buyers of mutual funds. Over lunch I am still looking at Patriots’ highlights and not the CNBC talking heads recommending Pumatech or whatever they were in 1999. There are no wonderful and inﬂuential theories as to why the P/E structure should be much higher today as there were in Japan in 1989 or in the U.S. in 2000, with Greenspan’s theory of the internet driving away the dark clouds of ignorance and ushering in an era of permanently higher P/Es.”
He really hates EMH and Stocks for the Long Run:
“The folly of Rational Expectations resulted in ﬁve, six, or seven decades of economic mainstream work being largely thrown away. It did leave us, though, with perhaps the most laughable of all assumption-based theories, the Efﬁcient Market Hypothesis (EMH).
(There is only Jeremy Siegel doing his usual, apparently inexhaustible thing of explaining why the market is actually cheap: in 2000 we tangled over the market’s P/E of 30 to 35, which, with arcane and ingenious adjustments, for him did not portend disaster. This time it is unprecedented margins, usually the most dependably mean reverting of all ﬁnancial series, which are apparently now normal.)”
He is very clear that it’s not currently a bubble, but says the bubble is coming:
“I would think that we are probably in the slow build-up to something interesting – a badly overpriced market and bubble conditions. My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up.”
And who’s to blame? Of course, QE and the Fed Chief:
“And then we will have the third in the series of serious market busts since 1999 and presumably Greenspan, Bernanke, Yellen, et al. will rest happy, for surely they must expect something like this outcome given their experience. And we the people, of course, will get what we deserve. We acclaimed the original perpetrator of this ill-fated plan – Greenspan – to be the great Maestro, in a general orgy of boot licking. His faithful acolyte, Bernanke, was reappointed by a democratic president and generally lauded for doing (I admit) a perfectly serviceable job of rallying the troops in a crash that absolutely would not have occurred without the dangerous experiments in deregulation and no regulation (of the subprime instruments, for example) of his and his predecessor’s policy.”
And when it blows up we’ll all get a chance to praise Janet Yellen for “fixing” it all:
“At this rate, one day we will praise Yellen (or a similar successor) for helping out adequately in the wreckage of the next utterly unnecessary ﬁnancial and asset class failure. Deregulation was eventually a disappointment even to Greenspan, shocked at the bad behavior of ﬁnancial leaders who, incomprehensibly to him, were not even attempting to maximize long-term risk-adjusted proﬁts. Indeed, instead of the “price discovery” so central to modern economic theory we had “greed discovery.””
Still, Grantham says the prudent investor should realize that stocks are badly overpriced now:
“In the meantime investors should be aware that the U.S. market is already badly overpriced – indeed, we believe it is priced to deliver negative real returns over seven years – and that most foreign markets having moved up rapidly this summer are also overpriced but less so. In our view, prudent investors should already be reducing their equity bets and their risk level in general. One of the more painful lessons in investing is that the prudent investor (or “value investor” if you prefer) almost invariably must forego plenty of fun at the top end of markets. This market is already
no exception, but speculation can hurt prudence much more and probably will. Ah, that’s life. And with a Fed like ours it’s probably what we deserve. “
And what are the big risks for the market? Grantham provides a dose of economic reality and an unhappy historical point:
“What can go wrong for the market? There is a slow and for me rather sinister slowing down of economic growth, most obviously in Europe but also globally, that could at worst overwhelm even the Fed. The general lack of ﬁscal stimulus globally and the almost precipitous decline in the U.S. Federal deﬁcit in particular do not help. What are the odds in the next two years? Perhaps one in four.
Hot off the press, for a less serious moment at our client conference comes the latest update (or data mining, if you prefer) of the… ta da…Presidential Cycle. Since October 1977 when GMO started, 36 years have passed. In that time – when logic and experience say you stimulate to help the next election – the third year has been over 1½ times the other three added together and years one and two, when you should be tightening, have been commensurately weak. For the weakest ﬁve cycles, the average of years one and two was negative but for three cycles it was strong, even very strong. These three cannot be blamed totally on the Greenspan-Bernanke regime’s tendency to overstimulate, but mostly they can. Bearing in mind that for us Presidential years run October 1-September 30, these three two-year returns were 1996, +48%; 1984, +43%; and 2004, +19%. Now, this is the scary part. 1996 ended in the 2000 crash, 1984 in the crash of 1987, and 2004 in the ﬁnancial crash of 2008. In the current cycle we are already up 19% with a year to run! Of course, it may turn out to be a very strong two years and all will be well. Who knows?”
Great thoughts. Always very thought provoking. There’s a reason why I think Grantham is a must read….