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Jeremy Grantham's Blue Chip Call

Recently, I met Jeremy Grantham, whose work I had commented on earlier, as presented through the seekingalpha site. He is a contrarian who has been bearish for most of the decade, but who is now selectively bullish. I amend my earlier comment that his call for a blue chip rally would lead to a Nifty Fifty scenario, because the circumstances are different from 1972,

His first call is that quality, blue chip stocks will return an average of 11%-12% a year for the next few years. That is only slightly remarkable. That's what such stocks are "supposed" to do; grow 5%-7% a year on average, and yield 3%-5%. Granted, there is an upward "regression" term of about 1%-2% a year. They are now selling at lower absolute P/E ratios than they have for some time. More to the point, their multiples relative to the overall market, are low, typically around 1.00 (less in the case of the drug stocks). A market multiple, not a premium.

What makes the blue chips stand out is the 2% total return that Mr. Grantham forecasts for the S&P as whole. The P/E multiple is now reasonable relative to earlier earnings, $80 a share on the S&P. But the market is overlooking the recent drop in S&P earnings to about $50. More to the point, we believe that S&P earnings will "flatline" between $50 and $60 a share over the next five years, "growing" more slowly than usual off a depressed base. Apparently Mr. Grantham would agree with us, conceding only the 2% dividend yield on the S&P 500 as its total return.

The synthesis seems to be as follows: blue chip stocks will do going forward what they usually do, having corrected earlier overvaluation. But they won't suffer a hit to earnings growth even in a prolonged recession. Value Line forecasts a 15% total return for the average stock, 2% from dividends, 13% from growth and re-valuation off a low base. But we think these "average" stocks will suffer a hit to earnings, go nowhere pricewise, and will therefore be "relativized" by the blue chips.