Monday, December 5, 2011

Jeremy Grantham's 3Q Letter: The Shortest Quarterly Letter Ever

I’ve been having one of those quarters where everything that can get in the way of writing and thinking does, notably our client conferences and unexpected travel requirements. Like many, I find it hard enough to write at the best of times. So sorry for the delay. But rather than skip a quarter, I thought I’d make a simple list of points that I’m thinking about.



  • Profit margins dominate the P/E equation above, so that the market is unlikely to come down even to fair value, about 975-1000 on the S&P in our view, and stay there until profit margins decline. And the longer you look at these record and still-rising margins and compare them to the miserable unemployment and substantial spare capacity, the stranger these high margins look. They will come down to more normal levels eventually, of course, and when they do they will bring the market down with them. Probably by then, some of the negatives mentioned above will have resolved themselves. If not, then the market could decline a lot and test my “no market for young men” thesis that follows.
  • “No Market for Young Men.” Historians would notice that all major equity bubbles (like those in the U.S. in 1929 and 1965 and in Japan in 1989) broke way below trend line values and stayed there for years. Greenspan, neurotic about slight economic declines while at the same time coasting on Volcker’s good work, introduced an era of effective overstimulation of markets that resulted in 20 years of overpriced markets and abnormally high profit margins. In this, Greenspan has been aided by Bernanke, his acolyte, who has continued his dangerous policy. The first of the two great bubbles that broke on their watch did not reach trend at all in 2002, and the second, in 2009 – known by us as the first truly global bubble – took only three months to recover to trend. This pattern is unique. Now, with wounded balance sheets, perhaps the arsenal is empty and the next bust may well be like the old days. GMO has looked at the 10 biggest bubbles of the pre-2000 era and has calculated that it typically takes 14 years to recover to the old trend. An important point here is that almost no current investors have experienced this more typical 1970’s-type market setback. When one of these old fashioned but typical declines occurs, professional investors, conditioned by our more recent ephemeral bear markets, will have a permanent built-in expectation of an imminent recovery that will not come.