From Barron's:
The legendary investor thinks the S&P 500 can rise 8%, though foreign stocks are a better bet.Jeremy Grantham: U.S. Stocks Still Have Legs
As you know, dear reader, I have been hacking on for several years about the downward pressures on U.S. long-term growth prospects. What amazed me two years ago was to see the authorities, including the Federal Reserve, estimating a nearly 3% trend for the U.S., which seemed to me then and now as impossible.
Negligible growth in population and man-hours offered to the workforce is the most important brake to growth, with a net drop of fully 1% from the pre-2000 trend. Less capital investment and growing income inequality do not help. But the most underappreciated important factor, in my opinion, is the drag on growth from the loss of sustained cheap energy as oil has moved from a $16/barrel 100-year trend pre-1972 to today’s approximate $75/barrel trend price.
The global financial crisis, in contrast, was a temporary factor and one that I believe (on my own, apparently) was given an exaggerated importance. Given these negative factors, I estimated a few years ago that the U.S. trend line growth for GDP was likely to be no higher than 1.5% a year, and perhaps only 1% for Europe and Japan. Well, wheels turn and estimates are re-estimated: official estimates for the longer-term growth trend of the U.S. have been falling slowly but surely over the last few years to a range from 2% to 2.5%. In the two or three years since 2012, I had expected to see them in the range of 1.5% to 2%.
Well, into this quiet world of creeping adjustment, an International Monetary Fund paper released in early April of this year acted as an unexpected jolt of excitement as, unusually, estimates tumbled all the way down to 1.5%.
Wonders never cease. Now, the question is how much will this affect the Fed’s beliefs? Presumably enough to matter. This would be timely because, as you may remember, I have been anxious about the Fed’s whipping our actual 1.5% donkey in the mistaken belief that it was a 3% racehorse. The danger was, as I said, that they would keep on whipping it until either the donkey turned into a racehorse or dropped dead. Death from overstimulation.
Not only has the IMF paper been a necessary gust of reality that might just convince Ms. Yellen that she is indeed dealing only with a humble donkey, but it has also raised some interesting further questions. It made its main point the reduced rate of growth and the ageing of the workforce. How, by the way, does this point, straight from the U.S. Bureau of Census, take over five years to make it into semi-official GDP growth estimates? It then references lower capital investment ratios in a traditional way.
Also obvious enough. But what does it leave out? Resource limitations! I like to joke that the only thing that unites Austrians and Keynesians is their complete disregard for the limitations imposed by Spaceship Earth. In their thinking, a dramatic increase in price trend from the old $16/barrel to the new $75/barrel had no effect. Mainstream economics continues to represent our economic system as made up of capital, labor, and a perpetual motion machine. It apparently does not need resources, finite or otherwise. Mainstream economics is generous in its assumptions. Just as it assumes market efficiency and perpetually rational economic players, feeling no compulsion to reconcile the data of an inconvenient real world, so it also assumes away any long-term resource problems. “It’s just a question of price.” Yes, but one day just a price that a workable economy simply can’t afford!
I am still just about certain about three things: first, our secular growth rate in the U.S. is indeed about 1.5% (at least as stated in traditional GDP accounting, wherein expensive barrels of oil increase GDP; perhaps closer to 1% in real life); second, economists move their estimates slowly and carefully in order to stay near the pack and minimize career risk (despite the recent IMF heroics); and third, that we do not like to give or receive bad news and, when in doubt, we tend to be optimistic.
A brief update on the U.S. market: still not bubbling yet, but I think it will
The key point here is that in our strange, manipulated world, as long as the Fed is on the side of a strong market there is considerable hope for the bulls. In the Greenspan/Bernanke/Yellen Era, the Fed historically did not stop its asset price pushing until fully-fledged bubbles had occurred, as they did in U.S. growth stocks in 2000 and in U.S. housing in 2006. Both of these were in fact stunning three-sigma events, by far the biggest equity bubble and housing bubble in U.S. history. Yellen, like both of her predecessors, has bragged about the Fed’s role in pushing up asset prices in order to get a wealth effect.
Thus far, she seems to also share their view on feeling no responsibility to interfere with any asset bubble that may form. For me, recognizing the power of the Fed to move assets (although desperately limited power to boost the economy), it seems logical to assume that absent a major international economic accident, the current Fed is bound and determined to continue stimulating asset prices until we once again have a fully-fledged bubble. And we are not there yet.
To remind you, we at GMO still believe that bubble territory for the S&P 500 is about 2250 on our traditional assumption that a two-sigma event, based on historical price data only, is a good definition of a bubble. (As we like to describe it, arbitrary but reasonable, for it fits the historical patterns nicely.)
For the record, probably the best two measures of market value – Shiller P/E and Tobin’s Q – have moved up over the last six months to 1.5 and 1.8 standard deviations (sigma), respectively. So, just as with the price-only series, they are also well on the way to bubble-dom but, clearly enough, not there yet. If we used these value series instead of just price it would add 5%-10% to the bubble threshold, further improving my case that the current market still has a way to go before reaching bubble territory. Historically, we have often used the price series as both less judgmental than using measures of value, and as a much fairer comparison with other bubbles (e.g., commodities currencies and housing)....MORE
Here's the letter at GMO's website.
Previously on Grantham through the looking glass:
July 18, 2014
Jeremy Grantham: M&A Boom Poised For a ‘Veritable Explosion’
July 19, 2014
If You Want to Make Serious Money Listen to GMO's Jeremy Grantham Right Now
Oct. 24, 2014
Revisiting Jeremy Grantham's Bullish 2 Year Outlook
Nov. 18, 2014
"Jeremy Grantham's Bubble Watch Update: 'S&P To 2250 Before It Crashes'"
Nov. 19, 2014
More Jeremy Grantham: "Calling the Next Market Top"
See also:
Feb 2010
"Grantham’s ‘Horrifically Early’ Calls Challenge GMO"
March 2014
How Good Is Jeremy Grantham's Forecasting Record?
His strong pessimism drives GMO managed funds toward the most stable (large capitalization) value stocks, and these funds have performed fairly well (reflecting perhaps a value premium rather than market timing).
