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An Interview with Jeremy Grantham

Known for his bearish views, Grantham sees a recovery coming, but not a big one.

Joel P. Bruckenstein, 05/14/2009

Jeremy Grantham is a cofounder and chairman of GMO, LLC, a global institutional investment-management firm. Its clients include endowments, pension funds, public funds, foundations, and cultural institutions. GMO manages more than $85 billion in client assets, $28 billion of which is in asset-allocation strategies.

For most of the last decade, Grantham has also been one of the more bearish personas on the U.S. financial scene. As Russel Kinnel detailed in a July 2007 article titled "Grantham Sees Huge Opportunity in 'Anti-Risk,' " Grantham was even then very bearish on the markets. He also warned that we were in a "financial-debt-soaked bubble." He could not have been more correct. So what does Grantham think now?

Grantham made the case in a speech a few weeks ago, when the S&P 500 was at the 740 level, that we could have a rally to over 1,000. At the time, he thought such a rally might be the last desperate twitch in a 20-year bull-market cycle.

Grantham based his projections on years of studying U.S. presidential cycles since 1932. He says that historically, year three of the cycle is best, and year four is usually good as well. Historically, year three has outperformed years one and two by about 22 points. In addition, he points out, there's never been a major bear market in year three of a presidential cycle. That's because the Fed tends to have a more accommodating monetary policy in years leading up to elections. There's also a sense that the Fed is "more likely to look after you in years three and four, but not necessarily in years one and two," Grantham says.

Recently, we've had much more stimulus than during the third year of a typical presidential cycle, and in many sectors of the economy there continues to exist the potential for a bailout should things go wrong. Given this environment, "why wouldn't there be a rally?" Grantham asks. He makes the point, however, that this rally does not necessarily indicate that the economy has hit bottom, although it is a possibility.

The stock market is a leading indicator, and it usually turns up before the economy does. Grantham says that he thinks the economy will recover soon (late this year or early next year), although the recovery will be a modest one. "I do think the U.S., China, and some other important economies will pick up later this year/early next year," he says. "Markets anticipate the upticks by six months (plus or minus two months). That means that this could be the rally." He puts the probability of this scenario at 50%.

Grantham say that if the economy turns a bit later, and if we get hit with more seriously bad news, the market could buckle, and he puts the odds of this happening at about 30%. He says a more bearish scenario, which has been articulated by George Soros and Marc Faber, is that we are in the midst of a bear-market rally, but the economy is not on the verge of recovery. If this scenario, to which Grantham assigns a 20% probability, turns out to be correct, we will almost certainly see new lows, he says.

Grantham says the only thing he is certain of at the moment is that there is no certainty with regard to the economy. For example, he says that in the popular media there is almost universal acceptance of the fact that government stimulus is a good idea, but, if anything, history indicates that the opposite may be true. "If we keep all the GMs alive and all the Citibanks, we'll end up with more dilution than if we handed their market share over to Ford and Toyota," he says, adding that propping up weak firms and refusing to write off losses could lead to the type of scenario that Japan endured when the bubble burst over there. Grantham fears that the issue is not being decided strictly based upon sound economics, but rather by political expediency.

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