Legendary investor (and we don’t say that lightly) Jeremy Grantham just released GMO’s quarterly letter to clients. The letter’s title, “Investing in a Low Growth World” – presents a very similar and rather sobering theme to that discussed in his last letter, released in November (reviewed here).
In this low growth world, GDP will decelerate to a long term growth rate of only 0.9%, which becomes 0.4% from 2030 to 2050. GMO’s 0.9% would be 1.5%, absent 2 factors creating headwinds, resources and climate – which reduce the 1.5% to 0.9%.
Grantham notes that the Congressional Budget Office just slashed its estimate of the U.S. long-term growth trend from 3.0% to 1.9%. He also cites a report from Chris Brightman of Research Affiliates that concluded that long-term GDP growth would become 1.0%, a number that corresponds to GMO’s 1.5% (because his report has no reference to GMO’s two special factors, resources and climate). These 2 factors result is a large deduction due to a cost squeeze: that from resources (0.5%), and a very slight but increasing squeeze from climate damage (0.1 rising to 0.4 after 2030)
With that set up, Grantham goes on to make several cogent points:
- Would lower GDP growth necessarily lower stock returns? This is where he break ranks with many pessimists because Grantham believes theory and practice strongly indicate that lower GDP growth does not directly affect stock returns or corporate profitability.
- The fact that growth companies historically have underperformed the market – probably because too much was expected of them and because they were more appealing to clients – was not accepted for decades.
- By about the mid-1990s, however, the historical data in favor of “value” stocks began to overwhelm the earlier logically appealing idea that growth should win out.
- Interestingly, the faster growing countries, at least for the last 30 years, have simply had more slowly-growing earnings per share. GMO deduces there is a logically appealing tendency for overvaluation to contribute this factor behind the market underperformance of more rapidly growing countries.
- A lower growth world might plausibly be less volatile because managing a world where the apparent growth is 1.5% (and real growth is 0.9%) is likely to be easier to stabilize than one (as from 1870 to 1995) appearing to grow at 3.4% but actually growing at 3.6%, almost four times higher.
Grantham goes on to talk about the Fed’s negative real rates regime, designed to badger us into riskier investments in order to push up equity prices and grab a short-term wealth effect (that must be given back one day when least comfortable and least expected). This regime has gone on for a long and, for Grantham, boring time. This low interest rate period is serving, therefore, as a sneak preview of what a permanently lower rate regime might look like. He talk about some of the consequences and effects of low rates.
Grantham closes with this missive: Courtesy of the above Fed policy, all global assets are once again becoming overpriced.
Asset prices are not uniformly overpriced: emerging markets and 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.
Notably, U.S. stocks (ex “quality”) now sell at a negative seven-year imputed return on GMO’s numbers, and most global growth stocks are close to zero expected return. As for fixed income – fugetaboutit!
Of course, the entire letter is compelling reading. Click here to access it.