Jeremy Grantham: “S&P worth no more than 950”

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Jeremy Grantham has become a familiar and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, the co-founder and chairman of Boston-based GMO has just published the August edition of his popular newsletter. In the context of today’s turbulent markets, Grantham’s Letter revisits his early 2009 piece “The Last Hurrah and Seven Lean Years” wherein he asserted that it would be a rocky return to normal for the markets after the excesses of the previous decade. Presenting both positive and negative factors, he evaluates where we are two years into the period.

Here is an addendum that Grantham has added to the start of his thoughtful newsletter:

“My worst fears about the potential loss of confi ence in our leaders, institutions, “and capitalism itself” are being realized. We have been digging this hole for a long time. We really must be serious in our attempts to resuscitate the “average hour worked” and the fortunes of the average worker. Walking across the Boston Common this morning, I came to realize that the unpalatable (to me) option of some debt forgiveness on mortgages looks increasingly to be necessary as well as the tax changes I discuss here.

“To go further, if we mean to prosper long term, I am sure we need to act to make debt less attractive to everybody: it really is a snare and a delusion.”

Grantham concludes with a section on what to buy, as summarized below.

  • For those with a long horizon, I am sure well-managed forestry and farmland will outperform the average of all global assets.
  • I think it is likely that resources in the ground, hydrocarbons, metals, and fertilizer will also win on a 10-year horizon. I am not certain, though, because of the remarkable gains in so many of these in the last five years. I would put the odds at 2 to 1. As mentioned last quarter, many commodities have the potential for very sharp declines in the short term. If that occurs, then the odds would, of course, rise.
  • On a regular time horizon, I would continue to overweight quality stocks, which may well be on a roll. They are not priced to make a fortune, but they are priced to give approximately 4.5% to 5% real return, which I think is acceptable for low-risk assets. They have also delivered dependable downside – risk off – relative performance for several years, which is a characteristic generally in short supply.
  • Emerging markets are hard to evaluate because they are clearly going through many phases of development in a real hurry. So what is normal profitability? Probably not the old levels. They are moving toward developed status and probably toward our developed world’s level of profitability. (Yes, James Montier, that would be a change and, therefore, I admit, far from certain.) In a global financial crisis it is also important to remember that their cumulative foreign reserves are remarkable, twice that of the developed countries. But, all things considered, I believe they will outperform other non-high-quality equities for the next seven years and are likely to produce a semi-respectable return for a risky group of about 4% to 5% a year real.
  • We at GMO also believe that Japan is likely to “regress,” in the mathematical sense, toward levels of profitability that would be considered normal in other developed countries. We expect the progress to be very slow and uneven. If it does not happen at all, then Japanese stocks are priced like the average of all other developed equities, or a bit cheaper. If, however, by some chance margins improve quite fast, then Japanese stocks will likely be the best performing stocks around and could hit double-digit real returns for seven years. Japan’s remarkable resilience in the face of electricity shortages gives some inkling of what they are capable of. How quickly we have forgotten their obvious talents of 20 years ago. Can all of those talents really be lost forever?
  • As for the rest of global equities, they range from unattractive (August 2) to very unattractive. The S&P 500, for example, is worth no more than 950 on our estimates.
  • In general, risk avoidance looks like a good idea. Cash – despite its manipulated low rate, deliberately designed to make us reach for risk – should be seen as a safe haven replete with important optionality: dry powder to take advantage of possible opportunities.
  • As mentioned in previous quarterlies, the main long-term risk is that after two massive bubbles and two equally massive resurrection programs, the Fed may be out of ammunition. Should more building blocks fall (government bond downgrade and further market declines have missed my deadline) and a serious global double-dip develop, then the pattern of market behavior this time may be more historically typical. That is, instead of quickly recovering, markets will become cheap and stay below long-term averages for several years as was the case pre-Greenspan. Twenty years is a long time, so most investors think that dipping to fair value for a minute and bouncing is normal. It is, in fact, highly aberrant historically. Markets staying down and washing away a whole generation’s false expectations, high animal spirits, and excessive risk-taking – that would be normal. In the long run, a prolonged period of lower priced assets would lead to a much-improved, less risky, and less bubble-prone environment. In short, a more manageable world. It would also mean much higher returns from investing at lower prices. Long-term benefits from short-term pain. Just the kind of trade-off that the children in charge now would never make deliberately. But it may well happen anyway.

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Source: Jeremy Grantham, GMO, August 9, 2011.

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6 comments to Jeremy Grantham: “S&P worth no more than 950”

  • Frank W

    Prieur, thank you ever so much and most sincerely for posting this article based on Grantham’s latest newsletter. As you well know Jeremy Grantham has an envious record for calling tops and bottoms in the market. He got this one nearly spot on after a bit of shimming and swaying. To the best of my knowledge, nobody else can come close to his fortune telling. Mauldin is as good as he at calling tops, but is silent when it comes to bottoms. I was going to email you shortly to ask about Grantham’s latest position, but now don’t have to because I read here that Grantham is saying the the ideal bottom is 950 on the S&P 500. This is up from his last prognostication of 920. Of course, no one is perfect so it is possible that he could get it wrong. The other thing is that Wall Street analysts are busy redoing future earnings and GDP. Weeks ago Goldman Sachs and Wells Fargo stated that GDP will not rise above 2% till 2013. What’s all this going to do for Grantham’s estimated value of the S&P 500?

  • Frank W

    I forgot to say that if memory serves me correctly Edwards and Montier are saying 400 on the S&P 500.

  • […] post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail. Jeremy Grantham: “S&P worth no more than 950″ was first posted on August 16, 2011 at 10:20 am.©2011 “Investment Postcards from Cape […]

  • innertrader

    The article states, “The S&P 500, for example, is worth no more than 950 on our estimates.” Grantham did not predict an “ideal bottom of 950”, but provided an estimated value, which is very different from a “bottom”.

  • Frank W

    When I said “ideal”, what I meant was that that’s where the descent in the market might be expected to stop, 950 being a fully priced market and the market supposedly being omniscient. However, as we all know markets generally overshoot their targets. Technically speaking, one might expect a downside target of 800, it being the next even round number below 950. However, because the economic situation has degenerated from the time that Grantham made his computation and Edwards and Montier apparently still think that the bottom is at 400, I wouldn’t bet much on the S&P 500 stopping in the 950-800 range.

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