October 29, 2009
For some reason, a large number of people continue to rely on the advice of stock market prognosticators, long after those pundits have proven themselves unreliable, usually due to a string of erroneous predictions. The best example of this phenomenon is Jim Cramer of CNBC. On March 4, Jon Stewart featured a number of video clips wherein Cramer wasn’t just wrong — he was wildly wrong, often when due diligence on Cramer’s part would have resulted in a different forecast. Nevertheless, some individuals still follow Cramer’s investment advice.
This summer’s stock market rally made many of us feel foolish. John Carney of The Business Insider compiled a great presentation entitled “The Idiot-Maker Rally” which focused on 15 stock market gurus “who now look like fools” because they remained in denial about the rally, while those who ignored them made loads of money.
One guy who got it right was a gentleman named Jeremy Grantham. His asset management firm, GMO, is responsible for investing over $85 billion of its clients’ funds. On May 14, I discussed Mr. Grantham’s economic forecast from his Quarterly Letter, published at the end of this year’s first quarter. At that time, he predicted that in late 2009 or early 2010, there would be a stock market rally, bringing the Standard and Poor’s 500 index near the 1100 range. As you probably know, we saw that happen last week. Unfortunately, he was not particularly optimistic about what would follow:
A large rally here is far more likely to prove a last hurrah — a codicil on the great bullishness we have had since the early 90s or, even in some respects, since the early 80s. The rally, if it occurs, will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.
Mr. Grantham’s Quarterly Letter for the third quarter of 2009 was recently published by his firm, GMO. This document is essential reading for anyone who is interested in the outlook for the stock market and our economy. Grantham is sticking with his prediction for “seven lean years” which he expects to commence at the conclusion of the current rally:
Price, however, does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors. First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away. Second, the slow gravitational pull of value as U.S. stocks reach +30-35% overpricing in the face of an extended difficult environment.
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So, back to timing. It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1100. It can certainly happen.
Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. 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).
Scary as that may sound, Mr. Grantham does not believe that the S&P 500 will reach a new low, surpassing the Hadean level of 666 reached last March. On page 4 of the report, Grantham expressed his view that the current “fair value” of the S&P 500 “is now about 860”.
What I particularly enjoyed about the latest GMO Quarterly Letter was Grantham’s discussion of the factors that brought our economy to where it is today. In doing so, he targeted some of my favorite culprits: Alan Greenspan (who was pummeled on page 3), Larry Summers, Turbo Tim Geithner (who “sat in the very engine room of the USS Disaster and helped steer her onto the rocks”), Goldman Sachs and finally: Ben Bernanke — whose nomination to a second term as Federal Reserve chairman was treated with well-deserved outrage.
The report included a supplement (beginning at page 10) wherein Mr. Grantham discussed the imperative need to redesign our financial system:
A simpler, more manageable financial system is much more than a luxury. Without it we shall surely fail again.
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I have no idea why the current administration, which came in on a promise of change, for heaven’s sake, is so determined to protect the status quo of the financial system at the expense of already weary taxpayers who are promised only somewhat better lifeboats. It is obvious to most that there was a more or less complete failure of our private financial system and its public overseers. The regulatory leaders in particular were all far too captured and cozy in their dealings with reckless and greedy financial enterprises.
Grantham’s suggested changes include forcing banks to spin off their “proprietary trading” operations, wherein a bank trades investments on behalf of its own account, usually in breach of the fiduciary duties it owes its customers. He also addressed the need to break up those financial institutions considered “too big to fail”. (As an aside, the British government has now taken steps to break up its banks that pose a systemic risk to the entire financial structure.) Grantham’s final point concerned the need for public oversight, to prevent the “regulatory capture” that has helped maintain this intolerable status quo.
Jeremy Grantham is a guy who gets it right. Our leaders need to pay more serious attention to him. If they don’t — we should vote them out of office.