Jeremy Grantham says his firm is now “very modest buyers” of equities for the first time since mid-2009.
“At the close on August 8, a slightly cheap equity portfolio could be put together comprised of U.S. high quality, emerging markets, Japan, Italy, and European growth stocks,” Grantham writes in the second half of his quarterly letter, which is available on GMO’s web site. “On our data, the imputed 7-year return of the package today would be about 6.5% real!” Grantham says that in its asset allocation accounts, GMO is now only “modestly underweight equities, partly because of the desperately unattractive yields on fixed income. We are now very modest buyers for the first time since mid 2009.”
Grantham offers a bleak view of the economy, however, saying that the data shows the post-recession economy has been even worse that he initially expected when he said the 2007-2014 period would be one of “seven lean years”. On the positive side, according to Grantham, emerging market growth has been excellent, the U.S. savings rate has increased sharply, and U.S. companies have huge cash hordes (though they’re sitting on them, for now). On the down side, many have become utterly disillusioned with government and capitalism, which keeps “animal spirits” down and suppresses growth; resources prices are even higher than he expected; an aging population is going to make balanced budgets impossible without reneging significantly on commitments, or tax hikes, and the sluggish growth only magnifies that; and a few more rough years are left for the housing market.
One point Grantham focuses on: He says the U.S. must rework its income distribution.
“An average hour’s work has not received a material increase for 40 years. Without increased debt and without gains in hourly wages, how can there be sustained broad gains in consumption?” he asks, saying we “need to divide the pie more evenly”. That means “lower income and sales taxes for the bottom 75% of earners and higher taxes for the top 10%! We have allowed the vagaries of globalization and the plentiful supply of cheap Chinese labor to determine our income distribution, which has become steadily steeper, to the point where we have become one of the least egalitarian developed societies.” (his emphasis)
Grantham suggests going back to the levels of income equality that existed under President Eisenhower. “And don’t think for a second that this more equal income distribution somehow interfered with economic growth: the 50s and 60s were the heyday of sustained U.S. economic gains,” he adds.
As for stocks, Grantham says the “great threat” to equity prices is profit margins, which are unnaturally high and likely will come down. He also says quality stocks have been outperforming junk-type issues since April, a sign indicative of the market being in the late stages of a bull market.
Grantham offers a few areas of the market he’s bullish on: for long-term investors, he likes well-managed forestry and farmland, and resources in the ground, hydrocarbons, metals, and fertilizer; for a “regular” time horizon, he likes quality stocks.
Finally, Grantham says that with the Federal Reserve possibly out of ammunition, new developments that lead to a global double-dip recession could result in a more “typical” pattern than we saw in 2009. “That is, instead of quickly recovering, markets will become cheap and stay below long-term averages for several years [his emphasis] as was the case pre-Greenspan. … Markets staying down and washing away a whole generation’s false expectations, high animal spirits, and excessive risk-taking – that would be normal.”