Thursday featured another break out session attended which featured Jeremy Grantham, co-founder of GMO. This session was primarily about where we are heading economically. Grantham was engaging and quite charismatic.
Grantham used the analogy of a hurricane in Florida picking up bird feathers and scattering them randomly along the eastern shoreline to illustrate marketÂ bubbles. He stated that some come down quicker than others, but the only completely factual statement that can be made is that all feathers (bubbles) eventually come down to theÂ ground. This was an interesting way to discuss risk and over inflation of prices and frankly it makes a lot of sense.
Grantham was extremely critical of the financial services industry for betraying the investor, their customer. He told a story about his attendance in late 1999 at a conference with the world’s leading economic advisers and how they all saw the bubble and knew it would burst soon. He further stated that no fund manager nor broker would dare speak of this to their customer. He quieted his skeptics by saying that anyone could see the bubble with price to earnings ratio of dot com and tech companies double, even triple, the normal P/E of 12-16.
The current pricing in the equities market Grantham feels is normal and for theÂ most part fair value.Â However, he strongly asserted that the days of the bull maretÂ are over. Grantham asserts that there has been an on going bull market (short typical cyclical downturns) for the past 40 years. He feels that we are facing a prolonged stagnated growth cycle that could lastÂ upwards to 20Â years. He is sure ofÂ his theory that for at leastÂ the next 7Â years we will see a lean market with marginal returns on equity.
He spoke of the consumer and how he has spentÂ the better part of the past tenÂ years not saving and instead investing in real estate and stacking up consumer debt. Grantham spoke of the loss of confidence on the side of the investor and how difficult it will be to restore the integrity of the market in the mind of the investor.Â Grantham made a very interesting statement in regard to when he felt the current downturn began. He feels that it wasÂ five years ago when the average homeowner in Modesto,Â CA purchased a home for $150,000 with a sub prime mortgage with aÂ teaser interest rate of 1%. Then, they saw their homeÂ value rise to $500,000 and felt they wereÂ wealthy because on paper they had seen a $350,000 increase in their home value. Therefore, they spent moreÂ and over-leveraged themselves toÂ a teetering point. Then the market tanked and interest rates reset to levels that the homeowner could no longer afford. Multiply that individual case and, in Grantham’s view, is the initial cause for the mess we face today.
Also, it should be noted that Grantham felt that commercial real estate is the next pillar to fall.
Here is a link to the Q1 letter from Grantham to shareholders: http://www.gmo.com/websitecontent/JGLetter_1Q09.pdf.