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.
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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.
Running Out of Pixie Dust
On September 18 of 2008, I pointed out that exactly one year earlier, Jon Markman of MSN.com noted that the Federal Reserve had been using “duct tape and pixie dust” to hold the economy together. In fact, there were plenty of people who knew that our Titanic financial system was headed for an iceberg at full speed – long before September of 2008. In October of 2006, Ambrose Evans-Pritchard of the Telegraph wrote an article describing how Treasury Secretary Hank Paulson had re-activated the Plunge Protection Team (PPT):
Among the massive programs implemented in response to the financial crisis was the Federal Reserve’s quantitative easing program, which began in November of 2008. A second quantitative easing program (QE 2) was initiated in November of 2010. The next program was “operation twist”. Last week, Jon Hilsenrath of the Wall Street Journal discussed the Fed’s plan for another bit of magic, described by economist James Hamilton as “sterilized quantitative easing”. All of these efforts by the Fed have served no other purpose than to inflate stock prices. This process was first exposed in an August, 2009 report by Precision Capital Management entitled, A Grand Unified Theory of Market Manipulation. More recently, on March 9, Charles Biderman of TrimTabs posted this (video) rant about the ongoing efforts by the Federal Reserve to manipulate the stock market.
At this point, many economists are beginning to pose the question of whether the Federal Reserve has finally run out of “pixie dust”. On February 23, I mentioned the outlook presented by economist Nouriel Roubini (a/k/a Dr. Doom) who provided a sobering counterpoint to the recent stock market enthusiasm in a piece he wrote for the Project Syndicate website entitled, “The Uptick’s Downside”. I included a discussion of economist John Hussman’s stock market prognosis. Dr. Hussman admitted that there might still be an opportunity to make some gains, although the risks weigh heavily toward a more cautious strategy:
In December of 2010, Dr. Hussman wrote a piece, providing “An Updated Who’s Who of Awful Times to Invest ”, in which he provided us with five warning signs:
On March 10, Randall Forsyth wrote an article for Barron’s, in which he basically concurred with Dr. Hussman’s stock market prognosis. In his most recent Weekly Market Comment, Dr. Hussman expressed a bit of umbrage about Randall Forsyth’s remark that Hussman “missed out” on the stock market rally which began in March of 2009:
Nevertheless, Randall Forsyth’s article was actually supportive of Hussman’s opinion that, given the current economic conditions, discretion should mandate a more risk-averse investment strategy. The concluding statement from the Barron’s piece exemplified such support:
Beyond that, Mr. Forsyth explained how the outlook expressed by Walter J. Zimmermann concurred with John Hussman’s expectations for a stock market swoon:
Given the fact that the Federal Reserve has already expended the “heavy artillery” in its arsenal, it seems unlikely that the remaining bit of pixie dust in Ben Bernanke’s pocket – “sterilized quantitative easing” – will be of any use in the Fed’s never-ending efforts to inflate stock prices.