In his latest outlook Reaping the Whirlwind, one of my favorite and distinguished “perma” bear Mr. Jeremy Grantham (JG) of GMO, wrote some very important insights (all highlights mine/charts from Jeremy Grantham):
JG: ``Global profit margins, the second near certainty, are also declining rapidly, but have a long way to go. The estimates of future earnings that we have been sniggering at for a year are still inconceivably high. Why do they bother? To repeat our mantra: global profit margins were recently at record highs. Profit margins are the most provably mean reverting series in finance or economics. They will go back to normal. After big moves, they almost invariably overrun. With the current set of global misfortunes, they are very likely to overrun considerably this time.”
My interpretation:
The impact to the real economy of the imploding bubble and credit crunch has yet to filter into corporate profits. This means markets may overshoot to the downside as they will eventually reflect on the downscaling of profit expectations amid the unraveling recessionary environment.
JG: ``The real growth in the index has historically been only 1.8% per year for the S&P, but for technical reasons (low payout rates in particular) we have allowed for moderately more real growth in recent years. In the six years since October 2002, the trend line has risen to 975 (plus or minus a little – we are constantly fine-tuning a percent here or there). Needless to say, two weeks ago the market crashed through that level, producing Exhibit 1. So now all 28 burst bubbles are present and accounted for. Long live mean reversion!”
My interpretation:
Reversions to the Mean have always been a truism for markets. It has happened before (in 28 previous bubbles) and has reinforced its applicability again today. Serious investors have always to keep this in mind.
JG: ``Full disclosure requires that we add that, in our opinion, this is not as brilliant as it sounds, for markets have been more or less permanently overpriced since 1994 and have not been very cheap since 1982-83 and perhaps a few weeks in 1987. There is also a terrible caveat (isn’t there always?), and that is presented in Exhibit 3, which shows the three most important equity bubbles of the 20th Century: 1929, 1965, and Japan in 1989. You will notice that all three overcorrected around their price trends by more than 50%! In the interest of general happiness, we do not trot out these exhibits often and, until recently, they would have been seen as totally irrelevant and perhaps indecent. But, after all, it’s just history. Being optimistic like most humans, we draw the line at believing something so dire will happen this time.”My interpretation:
US markets today have fallen below trend line, but lessons of the past shows (see two charts above by Mr. Grantham) that there is that risk that markets can extend to the downside in as much as it has overreached to the upside. Don't forget markets are emotional than rational during major inflection points.
JG: ``On October 10th we can say that, with the S&P at 900, stocks are cheap in the U.S. and cheaper still overseas. We will therefore be steady buyers at these prices. Not necessarily rapid buyers, in fact probably not, but steady buyers. But we have no illusions. Timing is difficult and is apparently not usually our skill set, although we got desperately and atypically lucky moving rapidly to underweight in emerging equities three months ago. That aside, we play the numbers. And we recognize the real possibilities of severe and typical overruns. We also recognize that the current crisis comes with possibly unique dangers of a global meltdown. We recognize, in short, that we are very probably buying too soon. Caveat emptor.”
My interpretation:
US and global stocks have reached reasonable valuation or “cheap” levels. But since market timing is difficult, for Mr. Grantham, they will be gradual accumulators, in the understanding that markets could risk a downside overshoot.
JG: ``The global economy is likely to show the scars of this crisis for several years. In particular, the illusion of wealth created by over-inflated asset prices has been dramatically reduced and, though most of this effect is behind us, a substantial part of the housing decline in some European countries and the U.S. is still to occur. We were all spending and, in the case of the U.S., importing as if we were much richer than is in fact the case. Particularly here in the U.S., increasing household debt temporarily masked some of the pain from little or no increase in real hourly wages for 20 to 30 years. Household debt since 1982 has added over 1% a year to consumer spending. Unfortunately, this net benefit does not go on forever.”
My interpretation:
Following the bubble burst and the credit crunch, we transit o the next stage -the impact to the real economy.
The painful adjustment process will take time to heal which in the market’s vernacular translates to a cyclical shift into a “bottoming out” process.
JG: ``At under 1000 on the S&P 500, U.S. stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10th prices, but even more so. History warns, though, that new lows are more likely than not. Fixed income has wide areas of very attractive, aberrant pricing. The dollar and the yen look okay for now, but the pound does not. Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry! Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows. As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.”
My interpretation:
There are vast and select opportunities out there but an investor’s time horizon should extend to over 18 months, as bouts of volatility from the market clearing process will continue to surface intermittently until most of the required adjustments would have been attained.
Over the interim, inflation will not be much of a concern because of the deflationary impact from the ongoing debt destruction process.
Thank you, Mr. Grantham.
Thus, Mr. Grantham joins other contrarian former “bear” gurus as Warren Buffett and Dr. John Hussman to the cautious "bull" camp.
No comments:
Post a Comment