Jeremy Grantham’s latest quarterly letter is out. And it is loaded with clever, Shakespearean investment wisdom.But it’s long. In fact the 14-page letter is titled “The Longest Quarterly Letter Ever.”
The whole thing is a must-read. But we pulled some nuggets that may help you manoeuvre your portfolio.
From Part III: Investment Observations For The New Year, here’s what Grantham thinks about stocks:
It is always exciting for an asset allocator to work in a world where all assets are badly mispriced. Regrettably, this is not now the case at all. The majority of global equities are within spitting distance (a technical term) of fair value. Only the S&P 500 is materially overpriced, with an imputed return on our 7-year forecast of about 1% real, and because the high quality quarter of the S&P is priced to deliver 5.5% real (about a fair return), the 75% balance of the S&P has a slightly negative return. The rest of the world’s equities were (when I sat down to write this in January) on average slightly cheap at close to 7% real, so that non U.S. equities plus U.S. quality stocks offered a slightly higher average return than normal (a normal mix is about 6.1% real). (Today, after a dazzling rally, the forecast for the same global equity mix has dropped by 1.1%, to very slightly expensive.) This is not exactly whoopee time, but compared to the typical overpricing of the last 20 years, it’s not bad at all.
For those fearing inflation, stocks are a pretty good asset class to be in. Most experts including Grantham agree that stocks act as a good hedge for inflation. Grantham offers some granularity on the matter:
The 800-pound gorilla (the one that prefers bond holders to bamboo) is not in the room yet, but you can hear him thumping his chest up in the hills. He will come eventually, and before he does, you should remember that stocks are underrated inflation hedges. The underlying corporations have real assets, employ real people, and sometime even make real things, although a good idea embedded in a small thing (like an iPad) or a service is just as good. Equities have been tested over and over again in different places and in different decades and they have always been found to be very effective hedges. Serious resources – oil and copper in the ground and forestry and farmland – will almost certainly also be good and very probably much better than broad stocks in the short run. Gold may be good too. Who knows? But for stocks to work dependably as inflation hedges one has to have a several-year time horizon: in the short term, rising inflation can hurt stocks badly, for as mentioned last quarter, inflation is usually a powerful negative behavioural input. Investors hate jumps in inflation because they sharply raise the levels of uncertainty. Fairly quickly, though, earnings always catch up, and after multi-year surges in inflation (as in Brazil in the ’80s) we end up with the total market value in its normal range as a percentage of GDP while regular bonds if they exist, get destroyed.