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Grantham Pins a Macroeconomic Tale on a Donkey



February 22, 2013 – Comments (1)

Board: Macro Economics

Author: ADrumlinDaisy

To those (my children) who say I never post macroeconomic content, I say, “Pshaw!”

And to prove my point, here (with a great deal of paraphrasing) is a summary of the ideas raised in Legendary Investor Jeremy Grantham’s latest quarterly letter:

1. A lot of smart people agree with Mr. Grantham’s view that the US long-term growth rate will be 1.5% -- lower if you adjust for the effects of increasing resource costs and climate change.

2. But, GDP growth does not directly affect stock returns or corporate profitability. Growth (in companies and countries) sucks up capital, so that GDP growth is not mirrored by earnings growth. In fact, real earnings growth is negatively correlated with GDP growth.

[You should check out the two graphs Mr. Grantham offers in support of this idea – they are kind of shocking. E.g., Canada and Australia are sort of the Sargasso Sea of earnings growth – sorry, guys, do not shoot the messenger!]

3. The above ideas have some connection with the notion of “replacement cost.”

[This whole discussion can safely be skipped by all but the most masochistic of readers. Although I could not figure out what this discussion had to do with anything, I have memorized the following sentence for use at parties:

For there to be a stable equilibrium, assets, including entire corporations in the stock market, must sell at replacement cost. (emphasis in original)

I am pretty sure that I can bring any conversation in the state of West Virginia to a screeching halt by throwing that baby out there. If you decide to try this, I think it would probably be best to say the last two words very loud, and then stalk off in a huff: you will be regarded as an enigmatic genius; and no one will be able to ask you what the heck you are talking about.]

3.5 Value stocks outperform growth stocks, mostly because growth stocks are overpriced.

4. A low risk-free interest rate would seem to result in lower growth, but the risk premium might be unaffected, or might drop only a small amount.

5. Blah blah blah about GMO’s procedure for estimating future GDP growth, with the conclusion that, and this is a definite paraphrase, GMO’s critics have their heads . . . in the sand. Any normal human being will want to skip this long section.

6. Low interest rates will ratchet prices of all sorts of investment assets up for a while until yes, you’ve got it, corporate assets begin to sell way over replacement cost. And then overinvestment and, ultimately, a correction will ensue. This even applies to farmland and timberland, two of Grantham’s favorite types of assets.

7. What does this mean? . . . for us at GMO it means emphasizing care and maintaining a heightened sense of value discipline, not only in stock selection, as the whole world is once again bid up over fair value in a way so typical of the post 1994 era, but also in forestry and farmland.

8. Blah, blah, blah about the Fed, which basically boils down to (i) in the recent past, the Fed had its head . . . in the sand and (ii) at this point, the Fed has its head . . . well, you get the idea.

Mr. Grantham concludes his discussion of the Fed by pinning a tale on a donkey (note there is a pun in this phrase!):

I like the analogy of the Fed beating a donkey (the 1% growing economy) for not being a horse (his 3% growing economy). I assume he keeps beating it until it either turns into a horse or drops dead from too much beating! Fine-tuning economic growth, an impossible job for the Fed anyway, is hardly likely to get any easier by badly overstating trend-line growth. It seems nearly certain, therefore, that the Fed will keep trying to whack the donkey for far too long.

OK, two things.

First, kudos to Grantham for the phrase “whack the donkey,” which hopefully will work its way into the jargon of the dismal science.

Second, any child who was raised in the Catholic faith will undoubtedly join me in remembering, from Mr. Grantham’s donkey reference, our famous, ringing chant of mortification and guilt:

Meus asinus;
Meus asinus;
Meus maximus asinus.

(loosely translated: “I am a donkey; I am a donkey; I am a gigantic donkey.”)*

9. Mr. Grantham – who, all joshing aside, deserves a careful hearing – concludes with the following advice:

Courtesy of the above Fed policy, all global assets are once again becoming overpriced. . . . emerging markets and, we believe, 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 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 our numbers and most global growth stocks are close to zero expected return. As for fixed income – fugetaboutit!

The full letter can and (with appropriate exceptions, noted above) should be read here:


A Drumlin Daisy

*I believe the comedian Dave Barry was the first to report a nonstandard version of the Confiteor. 

1 Comments – Post Your Own

#1) On February 22, 2013 at 1:54 PM, constructive (99.97) wrote:

"E.g., Canada and Australia are sort of the Sargasso Sea of earnings growth – sorry, guys, do not shoot the messenger!"

Going over 30 years back, Australia had actually been a significant outlier against this correlation. It may or may not be an outlier going forward. Certainly their political and economic system is more stable than many fast growing countries.

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