Grantham: ho hum 7 yrs

Jeremy Grantham has attracted a cultlike following to his quarterly investment letters. For good reason: The chief investment strategist at Boston asset manager GMO warned of dismal returns ahead for U.S. stocks in the 2000s and predicted the bursting of both the technology and housing bubbles.
Lest you get the impression Grantham is a permabear (a label he hates), in his March 2009 letter he advised snapping up U.S. stocks just as they were plunging to their nadir in the financial crisis. Those who bought profited from one of the most powerful market rallies ever. N

These days Grantham, 73, is downbeat about the prospects for most, but not all, stocks. A student of history, he has much to say about why markets get out of whack, and why we may be entering a period in which resource scarcity is again an issue for society -- and an opportunity for investors.


How do you go about finding the best opportunities?
The great opportunities are much more likely to come at the broader asset class level than from individual stocks.
Asset classes -- stocks, bonds, commodities -- get very badly mispriced. That's because they come with enormous career risks for institutional investors. As a professional, you can afford to pick some stocks and be wrong about a few of them. To keep your job, you cannot take the risk of being seen to be wrong about the "big picture" for very long.

How did the price/earnings ratio of the S&P 500 get to 35 in 2000, compared with the long-run average of 15?
You had a massively mispriced market, and it was talked about all over the place. But no one would step aside. Institutions couldn't bring themselves to do that because they would have been skinned alive for their conservatism.
So asset allocation is an enormous opportunity, but only if you're willing to take considerable career risks. Playing against the tech bubble was unbelievably painful for us for two years, and then eventually, of course, it paid off handsomely.

How do you avoid getting sucked into bubbles yet still get some benefit from rising prices? 
Remember that history always repeats itself. Every great bubble in history has broken. There are no exceptions.
At GMO, we have a database of 35 bubbles. Of the 33 that have ended, every one broke all the way back -- not halfway back -- to the trend before the bubble started.

Remember also that stocks are kind enough to wear a price tag. In 2000 the price tag said "Ouch!" It implied a return of negative 3% a year for 10 years. In March 2009 the price tag for the S&P 500 was 13 times earnings. That said you were going to make about 10% a year plus inflation for seven years.

Is a bubble forming in the U.S. bond market? 
Fixed income has had a big run for two reasons. One is manipulation by the Federal Reserve to keep rates artificially low. The other is the substantial degree of nervousness in the system due to the weak economy, Europe's problems, and the recency of the great crash. So you have in fixed income what I would call an anti-bubble. It's there because people are still frightened of the stock market.
The next giant move in bonds will be bad for long-term-bond holders. The normal return would be 3% plus inflation. So if inflation is around 2.5%, you'd expect 5.5% from a government bond. That's a long, long way from where we are.

What is the long-term effect of the Federal Reserve keeping interest rates low?
[Fed chairman Ben] Bernanke is making sure that we don't get a decent risk-free return. It's brutally unfair to retirees. He's doing this because if he keeps rates ugly enough for long enough, we will reluctantly filter our money into equities. A higher stock market induces more consumption and is helpful short term to the economy.
The bad news is every penny of that gets given back. It's like a pact with the devil: You make your money by pushing stocks up, but then inevitably the market must go back to fair value. When it does, it creates an anti-wealth effect, usually at the worst possible time.

What is your long-term outlook for stocks? 
Returns over the next seven years will likely be ho-hum. On a global portfolio, that means maybe 4% after inflation, compared with 6.1% historically.

What area of the world do you see as a focus for investment over the next few years?
Foreign markets are decidedly more reasonable than the U.S., so we advise a bigger than normal emphasis on developed and emerging countries. They're priced to return about 5.1% a year, above inflation, over seven years.
Within the U.S., 100% of our equities are in high-quality blue chips. If you concentrate on the great franchise companies, you should get a real return of around 3.9% over seven years. So you'll feel not too bad.
Our seven-year numbers say that you should stay away from low-quality U.S. equities completely.

If you're underweight U.S. stocks, is it because you see another bubble there?
It doesn't feel to me that we're in the late stages of a bubble. The U.S. seems overpriced -- and if you take out the blue chips, it seems substantially overpriced. But it doesn't have the usual signs of group-think.
If the S&P 500 were to build up from about 1300 today to 1500 later this year or early next, then you'd want to run for cover and keep your head down.

Are commodities the next bubble? -
We used to live in a world where the price of resources came down steadily, and now the world has changed. You have a great mismatch between finite resources and exponential population growth.
China uses 46% of all the world's coal, for heaven's sake! The global population has surged from 6 billion to 7 billion in 12 years, and is now on its way to 9 billion. You'd better expect prices to rise.

So how would you advise investing in commodities?
I wouldn't touch futures; it's complicated and too unprofitable. Buy the guys who own stuff in the ground. Metal, oil, even natural gas, which is cheap now but will eventually pick up.

Our biggest problem as a planet will be our inability to feed more than 9 billion people in 30 years' time. We have to address this. It's much more important than any stock market problems.
When it comes to portfolios, my personal advice is for anyone who can, put money into forestry or farmland. Long term, you would probably never come near their returns in the stock market. In the world that I see, land is golden.

How will the stock market react to the upcoming election? 
On one hand you've still got Bernanke promising to keep rates low. On the other hand, you've entered a new political world. The Republicans will want to show much more fiscal responsibility. And even if the Democrats are back, they will attempt to illustrate that they are also aware of the long-term problems of debt accumulation. My guess is that it's a tougher environment for the market starting next year.