Jeremy Grantham’s first quarterly letter of the year arrived and with it the usual pithy insights we’ve come to expect. Grantham starts off by sharing his opinion on the two most recent important events on the political front: the Volcker rule proposed a few days ago by Obama and the Supreme Court decision on campaign finance. I’m glad to find he shares my take on both:
In a remarkable development, a Volcker plan for Glass-Steagall-lite has been proposed by the Administration. One minute Paul Volcker, the only ﬁnancial administrator not called Brooksley Born who has shown any real backbone in the last 30 years, is so out in the cold that his toes must have frozen off, and the next – hey, Presto! – his ideas are put forward lock, stock, and barrel and Geithner and Summers are left scrambling to take some credit for the plan and pretend they hadn’t been dissing Volcker up until eight seconds ago for what they thought were his antique and unnecessary ideas that were far too harsh on our poor banking system. Wow!… Viva Volcker!
Five Supreme Court justices today announced that not only are corporations people and that their money is free speech – this is old hat and a very ugly hat at that – but now, there should be no limit to the money they spend to inﬂuence political outcomes.
He then continues into an overview of the economy and the stock market. He acknowledges the uncharted waters we find ourselves in due to the extraordinary set of circumstances we’ve just traversed: two back to back asset bubbles with a third on its way; wiping out $20 trillion in wealth; deterioration in government budget and Fed balance sheet; and the stratospheric moral hazard due to bailouts.
My view of the economy’s future is boringly unchanged: “Seven Lean Years.” I still believe that after the initial kick of the stimulus, we will move into a multi-year headwind as we sort out our extreme imbalances.
Even so, Grantham believes that high quality US equities will proffer the highest returns among major asset classes for the next 7 years. But even then at a projected 6.8% per annum, there isn’t much to celebrate (emphasis his):
The real trap here, and a very old one at that, is to be seduced into buying equities because cash is so painful. Equity markets almost always peak when rates are low, so moving in desperation away from low rates into substantially overpriced equities always ends badly.
Believe it or not, they can outperform on the upside, and these times tend to be: later in bull markets, or when they are relatively cheaper than the rest of the market, or both. (More quantitatively, high quality stocks have outperformed in more than 40% of up months and approximately 60% of the time when they were relatively very cheap, as they are now.)
So not surprisingly, GMO believes that bonds here are much too expensive and will provide very poor returns going forward. Their estimates range from -0.6% p.a. for short term T-Bills to 1.1% for long term US government bonds. While retail investors have been pouring money into fixed income as an asset class, I’ve already mentioned a few times before why I believe today’s bond buyers will be disappointed.
Finally, while acknowledging the ‘animal spirits’ that are once again running amok in the stock market - courtesy of an ever accommodating Federal Reserve - Grantham reiterates the valuation target that we’ve heard from several other reputable sources (like David Rosenberg of Gluskin & Sheff):
Whenever the Fed attempts to stimulate the economy by facilitating low rates and rapid money growth, the economy responds. But it does so reluctantly, whereas asset prices respond with enthusiasm.
…all investors should brace for the chance that speculation will continue for longer than would have seemed remotely possible six months ago. I thought last April that the market (S&P 500) would scoot up to 1000 to 1100 on atypical relief rally. Now it seems likely to go through 1200 and possibly higher. The market, however, is worth only 850 or so; thus, any advance from here will make it once again seriously overpriced, although the high quality component is still relatively cheap.
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