Leave it to Jeremy Grantham to blast Fed Chairman Ben Bernanke and former chairman Alan Greenspan in a rightfully scary missive titled "Night of the Living Fed."
Jeremy Grantham, the institutional money manager in Boston who oversees nearly $100 billion, has been as critical of the Fed's interest rate policies over the past 15 years as he has been adept at spotting bubbles fueled by the low rates. He warned clients of tech stocks more than a decade ago and more recently called a worldwide asset bubble before the meltdown in 2008. (Though he's labeled a perma-bear, Grantham pounces on opportunities: on March 10, 2009, at the market's lows, he encouraged clients to load up on stocks in a note titled "Reinvesting When Terrified.")
His latest quarterly note reminds investors how dangerous it is for Bernanke and Co. to rely on ultra-low interest rates, and the resulting cheap debt, to promote economic growth. "My heretical view is that debt doesn't matter all that much to long-term growth rates," he writes. "In the real world, growth depends on real factors: the quality and quantity of education, work ethic, population profile, the quality and quantity of existing plant and equipment, business organization, the quality of public leadership (especially from the Fed in the U.S.), and the quality (not quantity) of existing regulations and the degree of enforcement."
A graph of total debt compared to U.S. GDP growth drives home the point: as the U.S. tripled its debt compared to GDP in the past three decades, GDP growth slowed to 2.4% from its 100-year average of 3.4%.
Read Grantham's entire note below (and we really encourage you to do so, even if it takes the better part of an afternoon). The most sobering section must be the effect that near zero percent interest rates has on retirees in the U.S.
"When rates are artificially low, income is moved away from savers, or holders of government and other debt, toward borrowers," Grantham writes. "Today, this means less income for retirees and near-retirees with conservative portfolios, and
more profit opportunities for the financial industry; hedge funds can leverage cheaply and banks can borrow from the government and lend out at higher prices or even, perish the thought, pay out higher bonuses. This is the problem: there are more retirees and near-retirees now than ever before, and they tend to consume all of their investment income."
Flight to quality
Since Grantham is foremost a stock investor, we'll let you read his criticisms and instead highlight what he thinks it means for stocks. Grantham's takeaway: don't fight the Fed.
Stocks, which are overvalued by historical standards, can still run up 20% or more, he says.
Year three of a presidential cycle is typically a good time for stocks. Since FDR's presidency, some 19 cycles have passed with only one bear market. That, coupled with low short-term interest rates, leads Grantham to affix 50/50 odds on the S&P 500 Index reaching 1,400 or 1,500 in the next year.
"There is also the definite possibility that we could slide back into a double dip, so we may get lucky and have a chance to buy cheaper stocks," he writes. "But probably not yet. And, of course, if we get up to 1400 or 1500 on the S&P, we once again face the consequences of a badly overpriced market and overextended risk taking with six of my predicted seven lean years still ahead."
To cope with seven lean years (more here), Grantham still proselytizes high-quality stocks: the 25% of companies in the S&P 500 with low-debt and high, stable returns.
"For good short-term momentum players, it may be heaven once again," he writes. "Being (still) British, this is likely to be my nth opportunity to show a stiff upper lip." And it may be easier even for average investors, he observes, to buy high-quality blue chips because they are getting "so cheap" relative to the market.
Recently, in the largest stock rally since 1932, Grantham often notes, high-quality blue chips have trailed the speculative, debt-laden companies within the S&P 500. He writes that chances are one in three that, come another rally in the next year, high-quality stocks will join in. "….Quality stocks are so cheap that they will 'unexpectedly' hang in," he writes.
View this document on Scribd Tags: stocks, Federal Reserve, Economy, Jeremy Grantham 4 Comments | Add a Comment Email Print RSSAs any classically trained economist can tell you, there do exist conditions under which monetary policy will not have any discernible effect on output. This is the so-called "liquidity trap" -- when the system has excess liquidity, incremental changes have no effect and adding more liquidity accomplishes nothing.
Only prudent changes in fiscal policies can have significant effect on the economy when it is in a "liquidity trap".
*** That said, the Fed has a huge problem -- America has continuing deflation in housing prices caused by continuing deflation in wages. Workers can't afford to pay for housing at existing prices, and, as their wages continue to fall, the amounts they can afford to pay for housing must, perforce, fall as well.
Falling housing prices [and falling rents] put a huge squeeze on property owners, especially those owners who have significant indebtedness on the property.
As I write this, about 2/3rds of owner occupied homes in America have some debt and over 20% of those currently owe more than the home would fetch in today's market. [The owners are "underwater".]
It follows that some 14% or so of America's homeowners could not move to take a better job, even if they could find one. [of course, some portion of these people do not presently have a job at all and their home will shortly be foreclosed and sold at a loss to the loan's owners.]
Contrary to uneducated thought, economic conditions in any particularly hard hit region do not magically get better. What really happens is people move away -- to where they can get work -- and the labor market in the place left behind finally rights itself at much lower levels of employment and wage incomes.
"Underwater" housing interferes with this adjustment mechanism.
Of course, the owners of the loans are all quietly praying that the Fed can inflate incomes and thus reduce the size of the gargantuan losses they'd otherwise have to record if today's circumstances do not improve.
Still, as the economists would tell you, real output won't be changed by Fed action when the country is in the liquidity trap, all that can be done is to change the nominal dollar amounts by permitting inflation to sap the purchasing power of the savers in order to prevent the borrowers from losing their homes and thus inflicting further huge losses on the investors in home mortgages.
Jobs, of course, are a symptom of the real economy, and won't be much affected by Fed actions while America is in the liquidity trap.
And lack of jobs is the fuel under the political fire.
It may just be that fiscal policy is going to be revised beginning January 2011 because the voters will have thrown the free spenders out of office here next week.
We can only hope.
Posted By Spock_rhp, Miami, FL: October 28, 2010 5:55 pmWith the S&P 500 at a current P/E ratio of over 21.5, I'd consider stocks overpriced. No one expects a rapid recovery, and there is still a good possibility of a double dip. Indeed, the only reason for current price levels is the expectation of a large influx of money from Titanic 2, or QE2, whatever they want to call this disaster in the making. I predict a short term spike, much of which has already occurred, followed by a sharp sell off, when investors realize there is no more short-term gain in the market, only a high level of risk.
With companies already having squeezed as much profit through cost-cutting, there is no prospect of significant earnings growth until the economy at large recovers. Since that recovery is a way off, the current P/E ratio is a clear indication of a bubble market, mostly brought on by Fed policy.
Posted By Dean, Cincinnati, OH: October 28, 2010 2:33 pmSo... are stocks overpriced, or incredibly cheap at the moment?
Posted By Saphora, NYC NY: October 28, 2010 8:29 amThis guy gets my vote if he ever decides to run for office. He correctly points out that your grandmother has been thrown under the financial bus with this zero interest policy. Millions for Wall Street and a penny on the dollar for grandmas investment income.
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