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More Great Thoughts from Jeremy Grantham

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I always look forward to Jeremy Grantham’s Quarterly Letter.  Grantham is the Co-founder and Chief Investment Strategist of Grantham Mayo Van Otterloo (GMO), an investment management firm, entrusted to oversee approximately $97 billion in client assets.

Unlike many asset managers, Jeremy Grantham has a social conscience.  As a result, during the past few years we have seen him direct some sharp criticism at President Obama, Tim Geithner, Ben Bernanke and – of course – Goldman Sachs.  Grantham fell behind schedule when his Third Quarter 2011 Letter was delayed by over a month.  As a result, Grantham’s Fourth Quarter 2011 Letter was just released a few days ago.  At 15 pages, it earned the title “The Longest Quarterly Letter Ever”.  As usual, Grantham has provided us with some great investment insights – along with some pointed criticism of our ignorant legislators and mercenary corporate managers.  What follows are some selected passages.  Be sure to read the entire letter here (when you have time).

To leave it to capitalism to get us out of this fix by maximizing its short-term profits is dangerously naïve and misses the point: capitalism and corporations have absolutely no mechanism for dealing with these problems, and seen through a corporate discount rate lens, our grandchildren really do have no value.

To move from the problem of long time horizons to the short-term common good, it is quickly apparent that capitalism in general has no sense of ethics or conscience.  Whatever the Supreme Court may think, it is not a person.  Why would a company give up a penny for the common good if it is not required to by enforced regulation or unless it looked like that penny might be returned with profit in the future because having a good image might be good for business?  Ethical CEOs can drag a company along for a while, but this is an undependable and temporary fix.  Ethical humans can also impose their will on corporations singly or en masse by withholding purchases or bestowing them, and companies can anticipate this and even influence it through clever brand advertising, “clean coal” being my favorite.  But that is quite different from corporate altruism. Thus, we can roast our planet and firms may offer marvelous and profitable energy-saving equipment, but it will be for profit today, not planet saving tomorrow.

It gets worse, for what capitalism has always had is money with which to try to buy influence.  Today’s version of U.S. capitalism has died and gone to heaven on this issue. A company is now free to spend money to influence political outcomes and need tell no one, least of all its own shareholders, the technical owners.  So, rich industries can exert so much political influence that they now have a dangerous degree of influence over Congress.  And the issues they most influence are precisely the ones that matter most, the ones that are most important to society’s long-term well-being, indeed its very existence.  Thus, taking huge benefits from Nature and damaging it in return is completely free and all attempts at government control are fought with costly lobbying and advertising.  And one of the first victims in this campaign has been the truth.  If scientific evidence suggests costs and limits be imposed on industry to protect the long-term environment, then science will be opposed by clever disinformation.

*   *   *

Capitalism certainly acts as if it believes that rapid growth in physical wealth can go on forever.  It appears to be hooked on high growth and avoids any suggestion that it might be slowed down by limits.  Thus, it exhibits horror at the thought (and occasional reality) of declining population when in fact such a decline is an absolute necessity in order for us to end up gracefully, rather than painfully, at a fully sustainable world economy.  Similarly with natural resources, capitalism wants to eat into these precious, limited resources at an accelerating rate with the subtext that everyone on the planet has the right to live like the wasteful polluting developed countries do today.  You don’t have to be a PhD mathematician to work out that if the average Chinese and Indian were to catch up with (the theoretically moving target of) the average American, then our planet’s goose is cooked, along with most other things.  Indeed, scientists calculate that if they caught up, we would need at least three planets to be fully sustainable.  But few listen to scientists these days.  So, do you know how many economic theories treat resources as if they are finite?  Well, the researchers at the O.E.C.D say “none” – that no such theory exists.  Economic theory either ignores this little problem or assumes you reach out and take the needed resources given the normal workings of supply and demand and you can do it indefinitely.  This is a lack of common sense on a par with “rational expectations,” that elegant theory that encouraged the ludicrous faith in deregulation and the wisdom of free markets, which brought us our recent financial fiascos.  But this failure in economic theory – ignoring natural limits – risks far more dangerous outcomes than temporary financial crashes.

*   *   *

As described above, the current U.S. capitalist system appears to contain some potentially fatal flaws.  Therefore, we should ask what it would take for our system to evolve in time to save our bacon.  Clearly, a better balance with regulations would be a help. This requires reasonably enlightened regulations, which are unlikely to be produced until big money’s influence in Congress, and particularly in elections, decreases.  This would necessitate legal changes all the way up to the Supreme Court.  It’s a long haul, but a handful of other democratic countries in northern Europe have been successful, and with the stakes so high we have little alternative but to change our ways.

*   *   *

Capitalism, by ignoring the finite nature of resources and by neglecting the long-term well-being of the planet and its potentially crucial biodiversity, threatens our existence.  Fifty and one-hundred-year horizons are important despite the “tyranny of the discount rate,” and grandchildren do have value. My conclusion is that capitalism does admittedly do a thousand things better than other systems:  it only currently fails in two or three.  Unfortunately for us all, even a single one of these failings may bring capitalism down and us with it.

Keep in mind that the foregoing passages were just from Part II of the Quarterly Letter.  Part III is focused on “Investment Observations for the New Year”.  Be sure to check it out – it’s not as bearish as you might expect.  Enjoy!



 

Government Should Listen To These Wealth Managers

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A good deal of Mitt Romney’s appeal as a Presidential candidate is based on his experience as a private equity fund manager – despite the “vulture capitalist” moniker, favored by some of his critics.  Many voters believe that America needs someone with more “business sense” in the White House.  Listening to Mitt Romney would lead one to believe that America’s economic and unemployment problems will not be solved until “government gets out of the way”, allowing those sanctified “job creators” to bring salvation to the unemployed masses.  Those who complained about how the system has been rigged against the American middle class during the past few decades have found themselves accused of waging “class warfare”.  We are supposed to believe that Romney speaks on behalf of “business” when he lashes out against “troublesome” government regulations which hurt the corporate bottom line and therefore – all of America.

Nevertheless, the real world happens to be the home of many wealth managers – entrusted with enormous amounts of money by a good number of rich people and institutional investors – who envision quite a different role of government than the mere nuisance described by Romney and like-minded individuals.  If only our elected officials – and more of the voting public – would pay close attention to the sage advice offered by these wealth managers, we might be able to solve our nation’s economic and unemployment problems.

Last summer, bond guru Bill Gross of PIMCO  lamented the Obama administration’s obliviousness to the need for government involvement in short-term job creation:

Additionally and immediately, however, government must take a leading role in job creation.  Conservative or even liberal agendas that cede responsibility for job creation to the private sector over the next few years are simply dazed or perhaps crazed.  The private sector is the source of long-term job creation but in the short term, no rational observer can believe that global or even small businesses will invest here when the labor over there is so much cheaper.  That is why trillions of dollars of corporate cash rest impotently on balance sheets awaiting global – non-U.S. – investment opportunities.  Our labor force is too expensive and poorly educated for today’s marketplace.

*   *   *

In the near term, then, we should not rely solely on job or corporate-directed payroll tax credits because corporations may not take enough of that bait, and they’re sitting pretty as it is.  Government must step up to the plate, as it should have in early 2009.

In my last posting, I discussed a February 2 Washington Post commentary by Mohamed El-Erian (co-CEO of PIMCO).  El-Erian emphasized that – despite the slight progress achieved in reducing unemployment – the situation remains at a crisis level, demanding immediate efforts toward resolution:

Have no doubt, this is a complex, multiyear effort that involves several government agencies acting in a delicate, coordinated effort.  It will not happen unless our political leaders come together to address what constitutes America’s biggest national challenge. And sustained implementation will not be possible nor effective without much clearer personal accountability.

One would think that, given all this, it has become more than paramount for Washington to elevate – not just in rhetoric but, critically, through sustained actions – the urgency of today’s unemployment crisis to the same level that it placed the financial crisis three years ago.  But watching the actions in the nation’s capital, I and many others are worried that our politicians will wait at least until the November elections before dealing more seriously with the unemployment crisis.

On October 31, I focused on the propaganda war waged against the Occupy Wall Street movement, concluding the piece with my expectation that Jeremy Grantham’s upcoming third quarter newsletter would provide some sorely-needed, astute commentary on the situation.  Jeremy Grantham, rated by Bloomberg BusinessWeek as one of the Fifty Most Influential Money Managers, released an abbreviated edition of that newsletter one month later than usual, due to a busy schedule.  In addition to expressing some supportive comments about the OWS movement, Grantham noted that he would provide a special supplement, based specifically on that subject.  Finally, on February 5, Mr. Grantham made good on his promise with an opinion piece in the Financial Times entitled, “People now see it as a system for the rich only”:

For the time being, in the US our corporate and governmental system backed surprisingly by the Supreme Court has become a plutocracy, designed to prolong, protect and intensify the wealth and influence of those who already have the wealth and influence.  What the Occupy movement indicates is that a growing number of people have begun to recognise this in spite of the efficiency of capital’s propaganda machines.  Forty years of no pay increase in the US after inflation for the average hour worked should, after all, have that effect.  The propaganda is good but not that good.

*   *   *

In 50 years economic mobility in the US has gone from the best to one of the worst.  The benefits of the past 40 years of quite normal productivity have been abnormally divided between the very rich (and corporations) and the workers.

Indeed “divide” is not the right word, for, remarkably, the workers received no benefit at all, while the top 0.1 per cent has increased its share nearly fourfold in 35 years to a record equal to 1929 and the gilded age.

But the best propaganda of all is that the richest 400 people now have assets equal to the poorest 140m.  If that doesn’t disturb you, you have a wallet for a heart.  The Occupiers’ theme should be simple:  “More sensible assistance for the working poor, more taxes for the rich.”

I’ve complained many times about President Obama’s decision to scoff at using the so-called “Swedish solution” of putting the zombie banks through temporary receivership.  Back in November of 2010, economist John Hussman of the Hussman Funds discussed the consequences of the administration’s failure to do what was necessary:

If our policy makers had made proper decisions over the past two years to clean up banks, restructure debt, and allow irresponsible lenders to take losses on bad loans, there is no doubt in my mind that we would be quickly on the course to a sustained recovery, regardless of the extent of the downturn we have experienced.  Unfortunately, we have built our house on a ledge of ice.

*   *   *

As I’ve frequently noted, even if a bank “fails,” it doesn’t mean that depositors lose money.  It means that the stockholders and bondholders do.  So if it turns out, after all is said and done, that the bank is insolvent, the government should get its money back and the remaining entity should be taken into receivership, cut away from the stockholder liabilities, restructured as to bondholder liabilities, recapitalized, and reissued.  We did this with GM, and we can do it with banks.  I suspect that these issues will again become relevant within the next few years.

The plutocratic tools in control of our government would never allow the stockholders and bondholders of those “too-big-to-fail” banks to suffer losses as do normal people after making bad investments.  It’s hard to imagine that Mitt Romney would take a tougher stance against those zombie banks than what we have seen from the Obama administration.

Our government officials – from across the political spectrum – would be wise to follow the advice offered by these fund managers.  A political hack whose livelihood is based entirely on passive income has little to offer in the way of “business sense” when compared to a handful of fund managers, entrusted to use their business and financial acumen to preserve so many billions of dollars.  Who speaks for business?  It should be those business leaders who demonstrate concern for the welfare of all human beings in America.


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More Wisdom From Jeremy Grantham

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One of my favorite commentators, Paul Farrell of MarketWatch, recently discussed some of the prescient essays of Jeremy Grantham, who manages over $100 billion as chief executive of an asset management firm – GMO.  Paul Farrell reminded us that Grantham warned of the impending financial crisis in July of 2007, which came as a surprise to those vested with the responsibility of paying attention to such advice.  As Farrell pointed out:

Our nation’s leaders are in denial, want happy talk, bull markets, can’t even see the crash coming, even though the warnings were everywhere for years. Why the denial?  Grantham hit the nail on the head:  Our leaders are “management types who focus on what they are doing this quarter or this annual budget and are somewhat impatient.”

Paul Farrell is warning of an “inevitable crash that is coming possibly just before the Presidential election in 2012”.  He incorporated some of Grantham’s rationale in his own discussion about how and why this upcoming crash will come as another surprise to those who are supposed to help us avoid such things:

Most business, banking and financial leaders are short-term thinkers, focused on today’s trades, quarterly earnings and annual bonuses.  Long-term historical thinking is a low priority.

Paul Farrell’s article was apparently written in anticipation of the release of Jeremy Grantham’s latest Quarterly Letter at the conclusion of the first quarter of 2011.  Grantham’s newest discourse is entitled, “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever”.  The theme is best summed-up by these points from the “summary” section:

  • From now on, price pressure and shortages of resources will be a permanent feature of our lives.  This will increasingly slow down the growth rate of the developed and developing world and put a severe burden on poor countries.
  • We all need to develop serious resource plans, particularly energy policies.  There is little time to waste.

After applying some common sense and simple mathematics to the bullish expectations of immeasurable growth ahead, Grantham obviously upset many people with this sober observation:

Rapid growth is not ours by divine right; it is not even mathematically possible over a sustained period.  Our goal should be to get everyone out of abject poverty, even if it necessitates some income redistribution.  Because we have way overstepped sustainable levels, the greatest challenge will be in redesigning lifestyles to emphasize quality of life while quantitatively reducing our demand levels.

We have all experienced the rapid spike in commodity prices:  more expensive gas at the pump, higher food prices and widespread cost increases for just about every consumer item.  Many economists and other commentators have blamed the Federal Reserve’s ongoing program of quantitative easing for keeping interest rates so low that the enthusiasm for speculation on commodities has been enhanced, resulting in skyrocketing prices.  Surprisingly, Grantham is not entirely on board with that theory:

The Monetary Maniacs may ascribe the entire move to low interest rates.  Now, even I know that low rates can have a large effect, at least when combined with moral hazard, on the movement of stocks, but in the short term, there is no real world check on stock prices and they can be, and often are, psychologically flakey.  But commodities are made and bought by serious professionals for whom today’s price is life and death. Realistic supply and demand really is the main influence.

Grantham demonstrated that most of the demand pressure on commodities is being driven by China.  This brings us to his latest prediction and dire warning:

The significance here is that given China’s overwhelming influence on so many commodities, especially in terms of the percentage China represents of new growth in global demand, any general economic stutter in China can mean very big declines in some of their prices.

You can assess on your own the probabilities of a stumble in the next year or so.  At the least, I would put it at 1 in 4, while some of my colleagues think the odds are much higher.  If China stumbles or if the weather is better than expected, a probability I would put at, say, 80%, then commodity prices will decline a lot.  But if both events occur together, it will very probably break the commodity markets en masse.  Not unlike the financial collapse.  That was a once in a lifetime opportunity as most markets crashed by over 50%, some much more, and then roared back.

Modesty should prevent me from quoting from my own July 2008 Quarterly Letter, which covered the first crash.

*   *   *

In the next decade, the prices of all raw materials will be priced as just what they are, irreplaceable.  If the weather and China syndromes strike together, it will surely produce the second “once in a lifetime” event in three years.

For the near-term, we appear to be in an awful double-bind:  either we get crushed by increasing commodity prices – or – commodities will become plentiful and cheap, causing the world economy to crash once again.  It won’t bother Wall Street at all, because The Ben Bernank and “Turbo” Tim will be ready and willing to provide abundant bailouts – again, at taxpayer expense.


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A Wary Eye On The Indicators

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March 1, 2010

The past few days brought us some observations by a number of financial commentators, who expressed concern about how our economic recovery is coming along.  Although none of the following three are ready to start sounding alarms, they all seem to share a similar tone of discouragement.

Don Luskin of The Wall Street Journal ’s Smart Money blog began his February 26 piece with an explanation of how proud he used to be about the accuracy of his May, 2009 declaration that the recession had ended.  Although he still believes that he made the right call back then, the most recent economic indicators have muddied the picture:

I made my recession end call in May because of an entirely different set of statistics, designed to be predictive rather than merely to recognize what has already happened.  What worries me is that these statistics have all started to get a little worse recently.

Luskin explained that although initial unemployment claims reached their peak in early April, the four-week moving average has risen 7 percent from where it was a few weeks ago.

Over history, upticks like that have no predictive value.  There have been many of them, and very few have led to recessions.  Still, 7% is a big reversal.  In May when I got excited about the drop in claims, that drop was only about 4%!

Luskin found another disappointing trend in the fact that earnings expectations for the S&P 500 are now growing at a much slower pace than they were in April.  Two other trends concerned him as well.  The fact that the dollar has rallied ten percent in the last couple of months raises the question whether “the fear that gripped world markets in 2008 and 2009” could be returning.  Finally, the fact that the credit spread between Treasuries and “junk bonds” is now at six percent after having been below 5%, brings a little discomfort simply because of a move in the wrong direction.  Nevertheless, Luskin is still optimistic, although his perspective is tempered with realism:

So is the economic recovery over?  I don’t think so.  I think it’s just being tested.  None of the indicators I use to detect the onset of recession are giving signals.  But it’s haunting, nevertheless.  After the horrific global recession we went through, you’d think we ought to come roaring back. We’re back, but we’re not exactly roaring.

In Sunday’s Washington Post, Frank Ahrens wrote an article discussing three indicators that “spell trouble for the recovery”.  Here’s how he explained them:

— On Wednesday, the Commerce Department reported that January new-home sales dropped 11.2 percent from December, plunging to their lowest level in nearly 50 years.

— On Tuesday, the Conference Board reported that February consumer confidence fell sharply from January, driven down by the survey’s “present situation index” — how confident consumers feel right now — which hit its lowest mark since the 1983 recession.  On Friday, the Reuters/University of Michigan consumer sentiment survey also showed a falloff from January to February.

— On Thursday, the government’s report on new jobless claims filed during the previous week shot up 22,000, which was exactly opposite of what economists predicted.  Forecasters expected new jobless claims to drop by about 20,000.

Taken together, what do these reports tell us?

We’ve got a long way to go to get out of this economic mess, and we may be actually losing a little ground.

At the conclusion of that piece, Mr. Ahrens added that another factor holding back recovery is the current state of activity in the stock market.  Investors seem to be exhibiting caution, uncertainty and “a hard-to-shake sense that we haven’t hit bottom yet”.

As I frequently point out, one of my favorite financial gurus is Jeremy Grantham of GMO.  The February 26 issue of Bloomberg Business Week featured an article by Charles Stein concerning Grantham’s career.  In the section of the piece discussing Grantham’s current outlook, we see yet another view toward a very lean, slow recovery process:

Grantham’s favorite asset class today is high-quality U.S.stocks, companies defined by high, stable returns and low debt.  The allocation fund had 31 percent of its money in that category at year-end, sometimes called blue chips, according to the GMO Web site.  In the interview, he said he expects such stocks to return an average of 6.8 percent a year over the next seven years, compared with 1.3 percent for all large-cap U.S. stocks.

Emerging-market stocks may rise about 4 percent annually in the next seven years, as investor enthusiasm for economic growth in developing countries carries the stocks to unsustainable levels, Grantham said.

“Why not go along for the ride?” he said.  The MSCI Emerging Markets Index returned an average of 22 percent in the past seven years, compared with a gain of 5.5 percent by the S&P 500 index.

U.S.government bonds will return 1.1 percent a year over the seven-year period, according to the latest GMO forecast.  The Bank of America Merrill Lynch U.S. Treasury Master Index rose 4.3 percent from 2003 through 2009.

Grantham said he expects a difficult, not disastrous, period for the economy and investments.

“It will feel like the 1970s,” he said. “One step forward, one step back.”

None of the three gentlemen whom I have quoted here are seeing visions of rainbows and unicorns in our economic future — at least not for the next few years.  Be sure to keep the opinions of these experts in mind if the cheerleading by some perma-bull, TV pundit motivates you to “get in on the ground floor of the next stock market rally”.  You could save yourself a lot of money and even more pain.



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More Super Powers For Turbo Tim

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February 18, 2010

I shouldn’t have been shocked when I read about this.  It’s just that it makes no sense at all and it’s actually scary — for a number of reasons.  On Wednesday, February 17, Sewell Chan broke the story for The New York Times:

The Senate and the Obama administration are nearing agreement on forming a council of regulators, led by the Treasury secretary, to identify systemic risk to the nation’s financial system, officials said Wednesday.

They’re going to put “Turbo” Tim Geithner in charge of the council that regulates systemic risk in the banking system?  Let the pushback begin!  The first published reaction to this news (that I saw) came from Tom Lindmark at the iStockAnalyst.com website:

Only the Congress of the United States is capable of this sort of monumental stupidity.  It appears as if the responsibility for running a newly formed council of bank regulators is going to be delegated to the Treasury Secretary.

Lindmark’s beef was not based on any personal opinion about the appointment of Tim Geithner himself to such a role.  Mr. Lindmark’s opinion simply reflects his disgust at the idea of putting a political appointee at the head of such a committee:

The job of overseeing our financial system is going to be given to an individual whose primary job is implementing the political agenda of his boss — the President of the US.

Regulation of the banks and whatever else gets thrown into the mix is now going to be driven by politicians who have little or no interest in a safe and sound banking system.  As we know too well, their primary interest is the perpetuation and enhancement of their own power with no regard for the consequences.

So there you have reason number one:  Nothing personal — just bad policy.

I can’t wait to hear the responses from some of my favorite gurus from the world of finance.  How about John Hussman — president of the investment advisory firm that manages the Hussman Funds?  One day before the story broke concerning our new systemic risk regulator, this statement appeared in the Weekly Market Comment by Dr. Hussman:

If one is alert, it is evident that the Federal Reserve and the U.S. Treasury have disposed of the need for Congressional approval, and have engineered a de facto bailout of Fannie Mae and Freddie Mac, at public expense.

What better qualification could one have for sitting at the helm of the systemic risk council?  Choose one of the guys who bypassed Congressional authority to bail out Fannie Mae and Freddie Mac with the taxpayers’ money!  If Geithner is actually appointed to chair this council, you can expect an interesting response from Dr. Hussman.

Jeremy Grantham should have plenty to rant about concerning this nomination.  As chairman of GMO, Mr. Grantham is responsible for managing over $107 billion of his clients’ hard-inherited money.  Consider what he said about Geithner’s performance as president of the New York Fed during the months leading up to the financial crisis:

Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks.

Mr. Grantham should hardly be pleased to hear about our Treasury Secretary’s new role, regulating systemic risk.

The coming days should provide some entertaining diatribes along the lines of:  “You’ve got to be kidding!” in response to this news.  I’m looking forward to it!



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Getting It Right

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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.

*   *   *

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.

*   *   *

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.



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Spinning Away From The Truth

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May 14, 2009

Wednesday was a rough day on Wall Street.  The Dow Jones Industrial Average dropped 184 points (just over two percent) to 8284; the Standard and Poor’s 500 index gave up over 24 points (2.69 percent) closing at 883.92 and the NASDAQ 100 index gave up 51.73 points (3.01 percent).  One didn’t have to look very far to find the reason.  At The Daily Beast website on Wednesday evening, item number 2 on the Cheat Sheet was a link to an article from The Wall Street Journal by Peter McKay, entitled:  “Signs of Consumer Strain Hit Stocks”.  The morning’s bad news was described by Mr. McKay in these terms:

The Commerce Department reported that retail sales fell 0.4% in April from the prior month, a steeper decline than the 0.1% gain economists expected.  Sales in March were revised down, falling 1.3% instead of 1.2% as previously reported.

The Wall Street Journal also ran an article on this subject by Justin Lahart:  “Retail Sales Stall on Consumer Caution”.  Mr. Lahart’s piece underscored the message reverberating through the evening’s financial reporting:

Indeed, retail sales rose in January and February after sliding for six straight months.  But those hopes were undermined by the 1.3% drop in retail sales in March as well as April’s decline.

The data suggest that a recovery won’t come until the second half of the year, and that when it does arrive it will be sluggish, said Michael Darda, an economist at MKM Partners in Stamford, Conn.

As I scanned through a number of websites to peruse the evening’s news stories, I was quite shocked to see the following headline on the Huffington Post blog, with screaming, bright red, upper-case, oversized font:  “BLOOMBERG NEWS:  CONSUMERS FEELING ‘INSPIRED’ TO SPEND MORE”.  Huh?   Just below the headline were three large photos.  The photo on the left featured a lineup of luxurious yachts, reminiscent of what can be found along Indian Creek during the Miami Beach Boat Show.  The middle picture showed that guy from Lifestyles of the Rich and Famous, raising a silver goblet in a toast to the photographer.  The photo on the right depicted a headless woman, adorned in enough jewelry to turn Ruth Madoff green with envy.  Had someone hacked into the HuffPo website and put this up as a gag?  (Later in the evening, I checked back at the site.  Although there was a new main headline relating to a different story, the link to the “inspired consumers” story was still there, although down the page.)

Clicking on the “inspired consumers” headline brought me to a story from Bloomberg News, entitled:  “‘Good Bad’ Economy Inspires Consumers As Slump Eases”.  “Good bad economy”?  I had trouble figuring out what that meant because I lost my George Orwell Decoder Ring.  Looking at this slice from the story told me enough about what they were trying to say:

Investor Exuberance

A Bloomberg survey of users on six continents showed that confidence in the global economy rose to the highest level in 19 months.

Antarctica and what five other continents?

The Huffington Post‘s BizarroWorld headline struck me as an attempt to imbue readers with a perception of Happy Days in Obamaland.  That headline and its incorporated story reminded me of a point recently made by one of my favorite bloggers, Jr. Deputy Accountant:

You know, there are times when I wonder just how difficult it is to keep the PR machine running at full speed and keep the market propped up artificially and massage Goldman’s nuts all at once.  Somehow, the powers-that-be are pulling it off, and I imagine that a large part of the dirty work, at least when it comes to PR, is taken care of by our moronic friends in mainstream media who feed up gems like this:  Citi using most of TARP capital to make loans.

(As an aside:  the reference to “Goldman” is Goldman Sachs, the second largest contributor to President Obama’s election campaign.)

Instead of relying on “the PR machine” to feed me propaganda about the economy, I rely on some of the sources included on this website’s blogroll.  Most of the writers for those sites are credentialed professionals, regarded as experts in their field (as opposed to the dilettantes, who cheerlead for Wall Street in the mainstream media).  One of these experts is Yves Smith of Naked Capitalism.  If you want to keep up with what’s really happening in the financial world, I suggest that you read her blog.

The truth of what the economy has in store for us is not pretty.  If you are ready to have a look at it, read Jeremy Grantham’s most recent report.  His bottom line is that late this year or early next year there will be a stock market rally, bringing the Standard and Poor’s 500 index near the 1100 range.  After that, get ready for seven really lean years:

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.

Unfortunately, it’s already too late for President Obama to accept the following rationale from Mr. Grantham’s essay:

We should particularly not allow ourselves to be intimidated by the financial mafia into believing that all of the failing financial companies — or very nearly all — had to be defended at all costs.  To take the equivalent dough that was spent on propping up, say, Goldman or related entities like AIG (that were necessary to Goldman’s well being), as well as the many other incompetent banks and spending it instead on really useful, high return infrastructure and energy conservation and oil and coal replacement projects would seem like a real bargain for society.  Yes, we would certainly have had a very painful temporary economic hit from financial and other bankruptcies if we had decided to let them go, but given the proven resilience of economies, it would still have seemed a better long-term bet.

After reading Jeremy Grantham’s recent quarterly letter, ask yourself this:  Do you feel “inspired” to spend more?