A bear turns bullish
BY Steven Goldberg, Kiplinger.com — 11/19/08
After warning of disaster for the market for more than a decade, Jeremy Grantham is buying stocks.
Jeremy Grantham is a favorite speaker at investment conferences. Given his nearly perpetual bearishness, I never knew why. I grew so tired of hearing him give the same warnings of gloom and doom in his high-class British accent that I tuned him out. My mistake.
What you need to profit from Grantham's advice is a healthy dose of patience. Grantham, co-founder and a director of GMO, a Boston investment firm that manages more than $140 billion, turned bearish more than a decade ago. Standard & Poor's 500-stock index (.SPX) "was overpriced for 14 years," he says now. The 2002-07 bull market, he adds, was "the greatest sucker's rally in history." He concedes he "felt like a perma-bear" as he repeatedly warned of disaster and stocks continued to rise.
Here's the surprise: Grantham has turned bullish -- or at least mildly bullish. He says the global financial panic has brought stock prices down to reasonable levels, although he acknowledges that they could fall more. In his newly published third-quarter investment update, he writes: "With the S&P at 900, stocks are cheap in the U.S. and cheaper overseas. We will therefore be steady buyers at these prices." (The S&P closed at 806.58 on November 19.) Grantham thinks foreign stocks and emerging-markets stocks should do even better than U.S. stocks.
In making his forecasts about U.S. stocks, Grantham worships at the altar of "reversion to the mean" -- the notion that valuations eventually return to their long-term averages. He calls it "our single big truth." Over the long term, he notes, the stock market's average price-earnings ratio is about 15. When stock prices are higher than those long-term medians, he turns bearish. And vice versa.
Grantham also pays attention to profit margins. The long-term average net-profit margin for S&P 500 companies is 5.6%. Currently, Grantham thinks profit margins are way too high. As the recession deepens, he believes margins will fall much lower -- back to their historical averages. That's a negative for stocks. But because of the bear market, P/Es have fallen so far that he sees stocks as good buys now.
Just because Grantham is buying stocks doesn't mean he thinks the worst is over for the economy. He says deleveraging -- the process of individuals, governments and corporations paying down debt -- will slow growth in the U.S. for "the next decade or so." The process, he adds, will benefit the economy over the long term.
Grantham predicts a steep and lengthy recession. "The downturn is likely to rival 1982 or worse." More write-downs and defaults are coming, he warns. On the plus side, he sees no risk of inflation for a couple of years -- part of the reason he's also bullish on bonds. Commodities, he thinks, will remain weak, but the dollar will remain strong.
Over the years, Grantham's words have been more bearish than his actions. After all, if he had entirely avoided stocks over the past decade, he probably would have been left with few assets to invest now that's he's turned bullish. Instead, GMO uses Grantham's forecasts to decide when to underweight or overweight stocks and other securities.
What is he buying now? Grantham's favorite stocks are high-quality U.S. and foreign blue chips. He's also turned bullish on emerging-markets stocks -- they have been pummeled even worse than U.S. stocks during the bear market.
Grantham is negative on stocks of small U.S. companies and real estate investment trusts.
For investing in high-quality stocks through a mutual fund, Vanguard Primecap Core (VPCCX | Get Prospectus) is my favorite choice. Marsico Growth (MGRIX | Get Prospectus) is another good pick.
For foreign stocks, look to Artio International Equity II A (JETAX | Get Prospectus) (formerly a Julius Baer fund). And for emerging markets, try T. Rowe Price Emerging Markets Stock (PRMSX | Get Prospectus).
All of these funds have suffered mightily in the bear market. But then again, so has everything else. |
