In his opening keynote address last month at Morningstar’s annual investment conference, Jeremy Grantham began by saying he now has an “ideal job” in which he has many colleagues at GMO to handle the quotidian duties of being an investment guru. In GMO’s second-quarter letter to investors, released Wednesday, he reiterates the good feelings about his job, which he writes makes him “free to obsess about anything that seems both relevant and interesting.”
So what’s his obsession now? He lists “10 topics that really matter,” along with recent research elucidating some of those topics. He also addresses his penchant for doomsaying, saying those 10 topics “can all be viewed as problems: potential threats to our well-being.”
Why engage in such a “lopsidedly negative” practice? “Surely it is more important to obsess about threats,” he writes, “which we often prefer to ignore. Good news, in contrast, will usually look after itself.”
In the Morningstar speech, he lamented that corporate managers are more interested in their stock options than building better businesses, which he said leads to those managers conducting stock buybacks rather than building new plants. He also railed about the outsize role of the Federal Reserve not just in the U.S. but worldwide—“the Fed rules the developed world”—and fretted about “financial elites” overly influencing U.S. legislation.
In his letter, he revisits some of those topics, including the deficiencies of the Fed and of democracy and capitalism, and adds new threats. Here are his ten Quick Topics to Ruin Your Summer:
1. Pressure on GDP growth in the U.S. and the balance of the developed world: count on 1.5% U.S. growth, not the old 3%
Grantham lists seven trends working against the “old 3%” growth forecast, among them the aging and slow growth rate of the working population, rising income inequality, sub-average capital spending (in June he called the rate of capex spending “dismal” and a “drag” on growth) and “partially dysfunctional government,” especially in the U.S. and E.U.
The Commerce Deptartment announces its first estimate of 2015’s second-quarter GDP on July 30, with the consensus forecast of 2.7% growth in Q2, following Q1’s 0.2% decline. But in his letter Grantham has no time for “mainstream economists” whose “highly theoretical models” would lead them to “disregard all or most of these factors as theoretically unsatisfactory.”
(UPDATE: The Commerce Dept. reported July 30 that GDP increased at an annual rate of 2.3% in the first quarter; its revised estimate of first quarter GDP swung from a negative 0.2% to a positive 0.6% in its final Q1 estimate. The “second” estimate for the second quarter will be released on August 27, 2015.)
2. The age of plentiful, cheap resources is gone forever.
Grantham cites GMO’s own research on prices and supply and demand for commodities, highlighted by shifting demand in China for a number of resources, notably coal, to conclude that “what seems extremely unlikely, assuming we have no global depression, is a return to the declining price trend” of commodities “of the 100-year period ending in 2000.”
Speaking of energy and commodities, Grantham says that oil has been “king and still is. For a while longer.” While oil has “driven our civilization to where it is today” now we are “running out of oil that is cheap to recover,” so our “economic system is becoming stressed and growth is slowing” as it becomes more expensive to produce oil.
There is a silver lining, however, to the oil story. Fifteen years from now, Grantham says, “cheaper electric vehicles and changes in environmental policy will enable steady decreases in oil demand.”
4. Climate problems
Grantham is very worried about climate change, citing an unusual lineup of authorities on the topic, incuding Pope Francis, Angela Merkel and a long list of scientific studies — along with the facts that “last year was the hottest year ever recorded, and this year…has gotten off to a dreadful start.”
He praises Merkel, “a chemist by University training,” for “arm twisting” the G7 nations into committing to “decarbonizing their economies completely by 2100,” but says that promise and other actions taken by groups and individual nations only constitute “a respectable improvement” which is nevertheless “still very insufficient for the long term.”
The research he cites concludes that climate change is happening far faster than predicted even five or 10 years ago, that some changes are irreversible and that it will make occurences like hurricanes and drought “worse than they would have been in a lower-temperature world.” Taken together, these changes may well lead to disruptions in the economies of many nations, and even destabilize certain countries, especially in the Mideast.
5. Global food shortages
Population growth worldwide and the growth of the middle class in emerging countries like China, with a concurrent growth in meat consumption in those countries, will put “steady pressure on our grain and soy producing capabilities” just as farming productivity gains are declining, and “show every sign of continuing to slow.” He cites a British university’s forecast of a world 25 years from now where prices of grain quadruple from 2000 levels and where, absent any significant change, “the global food supply system would face catastrophic losses and an unprecedented epidemic of food riots. In this scenario, global society essentially collapses.”
6. Income inequality
Grantham cites more research — from, separately, Thomas Piketty, Robert Gordon and Dan Ariely, that “extreme and growing” income inequality in the U.S. is “holding back growth.” Most Americans have little understanding of the scope of income inequality, though they also (regardless of party affiliation) believed such inequality to be patently unfair. Grantham writes that Ariely’s research on income inequality provides “good material with which to ponder the question as to how our current misbegotten, adversarial political system has drifted so far away from what the ordinary voters actually think would be fair.”
7. Trying to understand deficiencies in democracy and capitalism
Here Grantham expands upon his Morningstar speech’s lament upon the “economic elite” having an inordinate amount of power over legislation, especially economic legislation, at the expense of the great majority of Americans. Further, he argues that capitalism itself “has steadily dropped its baggage of stakeholders, with the exception of senior corporate officers in first place and stockholders in second.”
So is Grantham not a fan of capitalism? Far from it. He writes that “those of us capitalists who would like to be proud of our capitalist system are not going to get back the glory days of the 1960s when there was over 4% productivity growth per year and roughly the same substantial growth in all incomes, from CEOs to floor sweepers. But we should complain, I think, when the capitalist machine starts to malfunction. And it is.”
8. Deficiencies in the Fed
Grantham briefly summarizes the Federal Reserve’s complicity with slowing growth by calling the Fed “a counterproductive job description, poorly executed.” In his Morningstar address, as reported by ThinkAdvisor’s Janet Levaux, Grantham said that the Fed, “along with the corporations benefiting from low interest rates and executives growing wealthy from their stock options, create a steady stream of bull markets that end badly. They brag about their ability to push up stock prices and thus admit there is market manipulation.”
That situation is driven, he said then, by the Fed’s “bad job description,” which fuels market inefficiencies and keeps markets from reverting to their historic means, leading to future bubbles or cycles of overvaluation.
9. Investment bubbles in a world that is, this time, interestingly different
So what’s different this time? Grantham writes that, first, profit margins in the U.S. “seem to have stopped mean reverting in the old, normal way” and that “I used to say that profitability was the most dependably mean-reverting series in finance.” Second, he writes that real estate markets around the world “have bubbled up and then stayed there at high prices.” Grantham returns to his complaints about current-day capitalism, saying that the “housing markets are a good example of how the capitalist process can easily be gummed up.”
Then how to fix these issues? Grantham returns to his criticism of the Fed, or what he calls the “Greenspan-Bernanke-Yellen Regime – that promotes higher asset prices and lower borrowing costs, which facilitate stock buybacks amongst other speculative forces.”
He’s cautiously optimistic, at least in the long term. “Well, this regime, too, will change. Regression of regime, if you will. Painfully, politicians, the public, businessmen, and possibly even some economists will recognize the current regime as a failed experiment.”
In 30 years, “we will of course have a different regime (perhaps even the third or fourth different one), and we can be pretty sure that short interest rates will be between 1% and 2% after inflation once again; asset price manipulation will be seen as a spectacularly painful dead end; and the embedded return on virtually all asset classes up to and including farms and forests will yield 2% a year or so more than they do today, as they have averaged since time immemorial before the Greenspan-Bernanke-Yellen era. But as regressions go, I certainly prefer the easy and quick old-fashioned way of high profits being naturally competed away.”
10. Limitations of homo sapiens
After bringing everyone down, Grantham says readers shouldn’t think of him as being “particularly pessimistic.” Instead, he writes, “It is all of you who are optimistic!” Homo sapiens are predisposed to optimism, but that “we are particularly good at listening to agreeable data and avoiding unpleasant data that does not jibe with our beliefs or philosophies.”
Channeling his inner advisor, Grantham says, “We do a terrible job of planning for the long term, particularly in postponing gratification, and we are wickedly bad at dealing with the implications of compound math.”
He then adds an actual optimistic footnote:
10.5. The good things in “The Race of our Lives”
Grantham ends his article by writing that he also obsesses about “the remarkable acceleration in helpful technologies – mainly in alternative energy but also in agriculture – that may just save our bacon” – before concluding that he’ll write about those positive developments in GMO’s third-quarter letter.
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