Maya_

Jeremy Grantham: Collapse is Over, But Monumental Challenges Remain

As always Mr. Grantham's work is a pleasure to read. Though this time round it confuses me. On the one hand he observes that in real terms, the index may well take 20 years to recover. On the other, the recent 7 year asset class return forecast indicates real returns of 7.5% on US large cap and 7.4% on small caps at end of March 2009. With SP500 at 797 at end March, in about 9.5 years the real index expectation in today’s $ could run to 1584 (higher in nominal terms) which is somewhat higher than the Index high in the economic cycle just past.

I also get the feeling that the despair and anger in the publication comes because Mr. Grantham is shifting out of the bearish camp where the visibility was clear to a more normal opaque environment which will apply to the future. He is out of his comfort zone and it is clouding his vision.

On his comments about the bank rescue & moral hazard; I think he is wrong. Allowing the banks to fail would have disrupted society and destroyed wealth like never before - besides the loss of intellect, idle factories and minds are destroyed wealth. I do not see any moral hazard; when you give a kid too much candy he/she eats it; surfeit of sweatness leads to sourness; at least in the tummy. Do you blame the kids or the giver of Candy. Banks created a bubble actively encouraged, even forced, by the Fed; now that time to pay has come, and the price must be paid. While the worst might be over, it is likely that the price will be paid through restrained growth for many years - until inflation and growth (albeit slow) debase the debt now undertaken to a lower level. The option of letting banks fail is inconceivable - the idle managements, scientists, factories would lead to a massive and spiralling destruction of wealth. What the Obama administration is doing is distasteful but exactly right - rescue, then regulate and later unwind. It is a delicate task and one where the outcome is by no means certain. I think Mr. Grantham is missing the point that there are several paths to the same destination; and sometimes an amiable amble is more fun than a vigorous work out.
I also think he is wrong on China. Domestic consumption will rise and rise and rise with no reduction in the savings rate. The consumer rise will come from increased wealth and earnings as opposed to withdrawal from the ATM that is the home. The problem is over consumption and under saving in America NOT under consumption and over saving in Germany/China etc.
My view on the next economic cycle is slower growth (1.75%-2% GDP); higher inflation (3.5%-4%); weakening $; rising risk premiums (5% over earnings yield); rising savings rate (7%-8%). Debt supply will fall below equity. Quality large cap companies with high debt levels (D not more than 50% of E but not less than 20% of E) because I feel these will benefit from ability to raise debt ahead of debasement of debt through inflation will outperform. You can look forward to the next economic cycle delivering earnings of roughly 69 {2% annual growth over the prior cycle average earnings of 60} and multiples of 8X to 18X of the average prior cycle earnings depending on sentiment. Market fair value based on this is 1250; adverse sentiment market bottom is 550. Most likely bottom has been seen at 666.
New bottom lower could be formed in 2014.At this time I think market will do well in 09, not too good in 10 (because impact of stimulus will go and not be fully replaced by private consumers). 2011 / 2012 should be good years presidential cycle will make sure public is happy through growth oriented fiscal and monetary policy); 2013/2014 gets too far out but based on historic comparables, I think these will be difficult years; probably very difficult because the hangover this crisis will leave behind will be monumental.