Notes from Jeremy Grantham’s Latest Letter
Long-time market tactician and observer Jeremy Grantham, of the money management firm Grantham Mayo Van Otterloo (GMO), released his typically long quarterly letter last week. Like his last letter [link] Grantham expounds on the factors which will lead to the world growing at a much slower pace than experienced in the past.
Grantham also complains about the Fed’s policy of zero interest rates which is creating the dangerous financial situation where assets sell for more than replacement cost:
competition begins to filter into other securities, historically sought after for their higher yields: higher-grade real estate, where the “cap rates” slowly fall; and, unfortunately, also forestry and farmland, mainly of the larger and more standard varieties that appeal to institutions, which show declines in their required yields, i.e., their prices rise. The longer the engineered rates stay below true market rates, the higher asset prices become until, yes, you’ve got it, corporate assets begin to sell way over replacement cost.
The effect of the mispricing is that malinvestment occurs up to the point where Grantham notes:
if the heart of capitalism is still beating at all, a long period of overinvestment begins and returns are bid down and everything moves into balance, often helped along if asset prices get too high, as in 2000 and 2007, by a good, healthy market crunch.
Regarding the relative values available around the world Grantham writes:
But, as always, asset prices are not uniformly overpriced: emerging markets and, we believe, Japan are only moderately overpriced…. European stocks are also only a little expensive, but in today’s world are substantially more risky than normal. The great global franchise companies also seem only moderately overpriced. Forestry and farmland, which is not super-prime Midwestern, is also only moderately overpriced but comes with our nook and cranny sticker attached. But much of everything else is once again brutally overpriced.
Regarding the bond market, Grantham says:
As for fixed income—fugetaboutit!…Most of it has negative estimated returns on our data, and longer debt, as always, carries that risk that may be slight in any period, but is horrific if it occurs—accelerating inflation.
Source (requires free registration): GMO