Jeremy Grantham is out with his much anticipated Quarterly Letter and it’s a good one. “Just Deserts and Markets Being Silly Again” is a cutting, snarling, and sarcastic rejection of the prevailing V-shaped recovery bull market view. But Grantham is far from ultra-bearish, giving a more nuanced and realistic assessment for the medium and longer-term.
He starts his letter with sarcastic allusion to Obama’s Nobel Prize, titling the section “Just Deserts.”
I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just deserts? Let’s review some of the more obvious examples.
But, he is just warming up, as he goes on to heap vitriol on 13 groups he feels are equally undeserving of rewards in a scathing condemnation of status quo ante in the economic and financial establishment.
- Ben Bernanke
- Larry Summers and Tim Geithner
- Mortgage Brokers
- Over-spenders and under-savers
- Too-big-to-fail banks
- Over-bonused financial types
- Overpaid large company CEOs
- Stock holders of overleveraged Corporations
- The U.S. Auto Industry
- Over-vehicled America
- Stock options
- And, of course, Sir Alan Greenspan
This letter is a polemic against the financial elites of a ferocity the likes of which I have never seen from a major fund manager. I see it as a must-read.
As for the markets, he is not all doom and gloom. But the point that certainly jumped out at me was this:
Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year.
Translation: the market is so overvalued now that you should expect pretty meager long-term returns in equities. Does that mean a crash is right around the corner? Not necessarily – but a brutal correction is probably in the offing. Grantham says:
I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at -15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19).
Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.
The bottom line here is this: the market is significantly overvalued at present levels because of a technical rally super-charged by stimulus. This necessarily means lower returns over a longer-term horizon. The possibility of a major correction is high.
Update: the full letter with a lot more detail, market history and asset allocation recommendations is now linked below instead of embedded due to copyright restrictions.
One other thing: a GMO representative reminded me you that can register with their site and subscribe to the letter and receive it automatically as well.
Jeremy Grantham’s 3Q 2009 letter – GMO website
(the link to the GMO splash page above will guide you to registration in order to view the letter – and to subscribe to future letters)