Jeremy Grantham, famous for growling gloomy forecasts, is surprisingly sanguine in the face of a stock market that keeps on testing new highs and hasn’t seen a 10% correction since 2011.
The Grantham, Mayo, Van Otterloo & Co. hedge fund manager refers to himself as a “value-driven bear,” most likely as part of his general personality, but he musters little but the case for bullishness in his new quarterly investment letter.
The widely followed GMO manager notes the apparent strangeness of the market’s unrelenting rise despite a shocking 2.9% GDP contraction in the first quarter (“forecast by no one,” he adds), a decline in corporate earnings and “very low” market volatility despite “Middle Eastern problems.”
The rise comes, he says, despite the fact that the so-called "January effect" predicts a negative market this year, and another Wall Street omen — the dread of a presidential third year — is on the horizon, reinforcing his recent forecast that the S&P 500 must wend its way up to 2,250, minimally, before the bubble is fully blown.
A further contrarian indicator of bullishness is the voluminous surge in financial deals — “a veritable explosion, to levels never seen before,” Grantham writes.
Corporations are engaged in mergers and acquisitions because the cost of debt is lower than in previous deal frenzies and profit margins remain “at very high levels and are widely expected to stay there.”
Compelling as that may be, the hedge fund manager is even more impressed with the fact that the economic recovery, to him, appears quite young.
Grantham draws that conclusion based on the room he sees for a growing economy to draw discouraged workers back to jobs, foreseeing the possibility of a 2% increase in the labor participation rate; he similarly envisions space for a robust increase in capital spending, which he bases a pace of capital spending that has “never, ever” been so slow.
All this points to an economic recovery “that seems to have enough slack to keep going for a few years,” Grantham writes.
The money manager forecasts the next year or two will see all previous deal records broken.
“This of course will help push the market up to to true bubble levels, where it will once again become very dangerous indeed,” he writes.
But market bears be warned: “Perhaps the single best reason to suspect that a severe market decline is not imminent is the early-cycle look that the economy has,” Grantham writes.
Based on Friday’s S&P 500 close of 1,978, stocks can gain another 14% before passing Grantham’s minimum threshold for a fully formed bubble.
In that forecast, released May 1, Grantham was expecting the market to reach that lofty level some time around the fourth quarter of 2016. He did not say in his current letter whether he expects the market peak to come any sooner based on the stock market’s surge over the past quarter.
Fueling market speculation until the bubble gets fully blown is Federal Reserve Chairwoman Janet Yellen’s easy money policy, which Grantham says, critically, follows the pattern of her predecessors Alan Greenspan and Ben Bernanke.
Grantham calls that policy an “affirmation of moral hazard,” which he characterizes as “we will not move to stop bubbles, dear investors, but will help you out when things go badly wrong.”
The money manager and environmental activist devotes most of his letter, as he frequently does, to sundry other topics including Malthusian economics, the Keystone natural gas pipeline and to the story of an early financial wipe-out that forever turned him away from speculation and formed him as a “patient, long-term value investor.”
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