Famous investor and predictor of bubbles, Jeremy Grantham finds a lot to worry about these days. For starters he’s no fan of the Federal Reserve’s ongoing behavior. Also, he’s pretty sure “we’re running out of everything” when it comes to commodities. And Grantham thinks the S&P 500, currently trading at 1178 is more properly valued at 900. His advice to the clients of his firm, Grantham Mayo Van Otterloo (GMO), is predictably circumspect: pile up cash so you can buy when the current, growing US equities bubble bursts, overweight great franchise companies like Coca-Cola (KO) and Johnson & Johnson (JNJ), modestly overweight emerging markets and “underweight everything else.” Oh, and one more thing: “patience.”
If he wasn’t so charming to listen to, Grantham would really be depressing. Though he thinks the economy will “muddle through” that’s about as positive as he got in the course of a very good video interview (video below) with CNBC’s Maria Bartiromo. In it, Grantham outlines some positions that won’t be completely foreign to readers of his GMO missives. (You can get access to some of his writings by registering here, including his October 27 quarterly report “Night of the Living Fed: something unbelievably terrifying” which as you can see from the title is quite a good read, if not so much fun.)
About 11 minutes into the interview, Grantham launches into an interesting defense of the importance of weighting your asset allocation correctly. It comes up while he’s discussing emerging markets and how they have returned 3.3 times the S&P 500 since he first recommended overweighting that asset class in 2000.
…That incredible discrepancy…says the main event in investing should be getting the big picture right. It’s nice to pick stocks, but how many good stocks do you have to pick in a whole portfolio to equal that incredible move between the biggest asset class in the world, US equities, and the third or fourth biggest asset class, emerging markets? It’s these movements between the big asset classes that make you money.
It’s worth taking 30 minutes to hear Grantham make his full argument, but to summarize, here are some of the highlights:
- The Fed has spent most of the last 15-20 years manipulating the markets because when stocks go up we feel richer and go out and spend, boosting GDP. This time it’s not working so well because of the huge counter force of the housing bust, but things could have been worse. This particular move will be harder to keep pulling since 1. rates are already rock bottom and 2. people are catching on.
- Because of Fed action (making borrowing so cheap and cash so unappealing that people buy stocks) US equities are now “substantially overpriced” and could be moving toward “dangerously overpriced.”
- It would be more effective if Congress tried to fix the economy with fiscal policies that create jobs for “lightly skilled” workers. Especially since it’s very expensive (unemployment benefits, etc.) for the government to have a bunch of people sitting around out of work with their skills decaying.
- Pushing down the dollar is very dangerous. “We’re already in a currency war in a way. It’s a mild one and I hope it stays that way.” That’s because there hasn’t been a real currency war since the 1930s and basically there’s no way to predict what would happen if one breaks out.
- Even after the big run in emerging markets, they’ve got “at least a few years left” since these markets are growing at about 6% and the developed markets about 2%.
- Because we’re running out of everything, we’re headed for repeating “chain linked crises in commodities”. Investing in companies with assets in the ground (timber, oil) should pay off, but mere commodities processors should be sold.
- The Feds moves are hitting retirees and near-retirees the hardest, entering an “infamous trade” in which they devalue retirees “safe” investments, and thereby removing money from retirees who would have spent it, and instead giving that to financial institutions who pay it out in bonuses to staff who save more of it because they’re well-off.
In his recent quarterly report, Grantham writes with wit about his belief in blue chips and the run in emerging markets as well:
On the challenge of continuing to admire blue chips:
Being (still) British, this is likely to be my nth opportunity to show a stiff upper lip. There is, though, one quite friendly influence lurking around that may help us lovers of quality stocks. They are getting so cheap relative to the market that a wider range of buyers is finally noticing them. In the third quarter, in a market up a significant 12%, quality stocks held the market. To say the least, this has not been the law of nature recently: for the past eight years, quality stocks usually won in down quarters and usually lost badly in extreme up quarters.
On why emerging markets may still have room to go:
Everyone and his dog are now overweight emerging equities, and most stated intentions are to go higher and higher. Emerging markets are admittedly fully priced, but they still sell at a decent discount to the 75% of the S&P 500 that are not quality stocks – a particularly strange quirk in a strange market. With their high commodity exposure, their strong finances, and their strong GDP growth especially, I believe that they will sell at a premium to the S&P, perhaps a big one.