Saturday, October 18, 2008

Jeremy Grantham: Third Quarter Letter

Mr. Grantham's firm, GMO, manages $126 Billion.
From GMO:
The time to blame should be past, or at least in abeyance until the crisis is past, but I find it impossible to avoid it completely. Sorry. In any case, just to set the scene, it is necessary to review briefly the poisonous wind that we all sowed....
Read the entire letter if you have time but do not miss the first two pages for the most concise explanation of how we got to this sorry state that I have seen. Why might you want to read more?:
...Our 10-year forecast for the S&P 500 10 years ago was a lowly -1.1% real, an extreme outlier among forecasts. At the end of September the real return was exactly nil (0.0%). But it only took three days of October to hit our -1.1% forecast on the nose! Ten years and three days. For emerging equities, our forecast was +10.9% real and the actual was +12.8%. Not too bad, but even here in seven days – horrible days, admittedly – the return of emerging crossed our forecast on the way down....
Mr. Grantham concludes his discussion of China:
...Simple old “Econ 101” thinking would suggest that their capital goods sector will have a bigger drop than the rest of the economy, and that export growth rates might slow from very large to even nil or worse. The one openended offset might be in Keynesian or Rooseveltian government spending, upping their already massive infrastructure spending by A LOT. (This is a specialized
economic term.)...
And ends this letter:
...Provisional Recommendations
(October 10 - S&P 900)
At under 1000 on the S&P 500, U.S. stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10th prices, but even more so. History warns, though, that new lows are more likely than not. Fixed income has wide areas of very attractive, aberrant pricing. The dollar and the yen look okay for now, but the pound does not. Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry! Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows. As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.
Part 2 of this Letter will be posted in two weeks or so.
(8 page PDF)
HT: ClusterStock who headlined their post:
Grantham: Stocks May Fall Another 50%, But Still Time To Buy
Their second and third paragraphs:
...First: As we've noted before, the three great stock-market bubbles of the 20th Century--US in 1929, US in 1965, and Japan in 1989--were all followed by price troughs that were 50% below fair value. (See charts below right). The bubble that peaked last fall was every bit as spectacular as these earlier bubbles, so it seems reasonable to expect that stock prices might trough 50% below fair value this time, too.

Jeremy puts fair value on the S&P 500 at about 975 (vs. Friday's close of 940). A trough of 50% below fair value, therefore, would be about 500, or some 45%+ below today's levels....