Jeremy Grantham: 'I'm Fed Up'

In his latest quarterly letter to shareholders, legendary manager (and longtime bear) Jeremy Grantham of Grantham, Mayo Van Otterloo conveys his frustration with what he sees as an ongoing 'carefree', overvalued market situation. Key excerpts:

Of course I’m fed up. We had Risk on the ropes. His followers were panicking. They were calling for the ref to stop the fight: “He has absolutely no idea how badly our boy is hurting ... he has no idea!” And what does the ref do? Ends the round early, extends the break, and allows a dangerous injection of adrenaline. Risk then leaps out of his corner, apparently rejuvenated, and wins the next couple of rounds. And here we are, wondering whether Risk has taken enough punishment to make him vulnerable to a knockout blow in a later round. Or has he completely recovered? ...

For a short while I had touching faith that the more “academic” Bernanke would take a tougher line than Greenspan, and he did sound fairly fierce early on, but as the heat turned up he overcame any qualms and threw in the towel quickly enough...

There was indeed a genuine severe credit crisis. Either the Fed and others were told some pretty dire things about the state of some major institutions or they are even sillier than I think. The New York Times, The Economist, and others all gave their opinion that some serious financial failures (worse than Northern Rock) must have been feared by the authorities to justify such early and powerful intervention. One can wonder how Countrywide and Northern Rock would have played out with no interference. Big chunks of the credit system had simply frozen. Risk premiums in fixed income widened very substantially in general, with a few exceptions. Liquidity premiums, not surprisingly, widened in particular. But, give or take a few down days, the equity market continued in denial. Perhaps in the short term they had a brilliant understanding of the lack of strength in the Fed’s knees and in those of their European colleagues. Given the developments in the real world, the equity market’s ability to close up for the quarter is truly remarkable. In the quarter, the housing market was in ragged disarray; corporate profits were okay, but growing far less than in recent years; the dollar was disturbingly weak; and the credit crisis had raged. So equities rally to a new high. Of course that is because it’s a discounting mechanism! Let’s consider what it is discounting: presumed continued dollar problems, almost certain housing weakness, slower economic growth in the U.S. and Europe, weaker estimated profit growth in the U.S., higher commodity prices (particularly agriculture), and more global pressures on inflation. Yes, I get it!

Where has the credit crisis left us other than with a carefree stock market? Banks are still not happy lending to other banks, and their rates for this, which surged in the crisis, are still not far from their highs. Mortgages are harder to get and will probably worsen. Leveraged corporate debt is still more costly, harder to get, and contains more careful provisions. On the other hand, credit default swaps, the indices of which doubled in a few days, have backed down 60%. The good news is that very probably the worst part of the crisis – the freezing of all lending – has passed. The bad news is that the reappraising of risk and other economic effects of the credit crisis will play out slowly over the next year or so.

Comments

[Malkiel]

We now have a 35-year long history of the Fed using interest rates to make sure that another 1973 bear market and mega-recession never happen again. That's a pretty long track record, long enough to convince anyone paying attention that the Fed is never going to not act to head off a recession when there are enough warning signs. The experience of the last 20 years has convinced the Fed and economists that just enough tweaking will stave off disaster and is infinitely less risky on many levels than letting the markets take their course. So why all this daydreaming? You could not have seriously believed the Fed wouldn't act, you just needed an opening to recite your pure-market fantasy reveries...