Grantham's 'Seven Lean Years' Hypothesis

Pat Dorsey: Can you expand a little bit on the seven lean year hypothesis? It's something I think you didn't have enough time to expound upon perhaps in your session this morning.

Jeremy Grantham: The most important thing is the loss of perceived wealth. We thought for years we were getting rich rapidly with our houses, even though the underlying reality is a house is a house. The house didn't change! But suddenly it was going to have you retire to Florida. And we were also doing nicely in stocks and other real assets, even finance and collectibles were on a roll. As far as we could tell, they totaled about $50 trillion for the US alone.

It dropped below 30, and that's a terrible whack. Even though stocks have recovered, houses and commercial real estate continue to go down, but we are probably not far off the 30 level now and that stranded an enormous debt on the part, mainly in the US this cycle, of consumers.

All that debt has to be restructured. And that's a problem in its own right. But the thing that I obsess about more is just the idea that you felt you were rich and now you are not. You felt you had a nice fat pension fund and a 401K and now you don't.

So just as you took holidays based on your capital gains, now you are taking un-holidays based on your capital losses. You're going to Rhode Island instead of to the beach.

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Pat: Do you think prospect theory fits into this at all with losses giving us two times more pain than gains give us pleasure? Is there perhaps an idea that, because of these losses, the propensity to save is going to be even sharper than the propensity to spend was when our assets values were rising?

Jeremy: It's quite possible. The thing about the gains is that they went on so long, they were reinforcing. And making unexpected money seven years in a row or five years in a row is not the same as five times one year. It's cumulative. Your confidence rises and rises. Your faith that you are getting rich in the end becomes almost uncontrollable. And that very seldom happens on the downside. The downside packs more punch per month...

Pat: But it's compressed into a shorter time.

Jeremy: Because it's compressed into a shorter time. No, we are probably not more unrealistically bearish and nervous than we were unrealistic bullish, because we were so unrealistically bullish and optimistic. We were just completely out of touch with reality. There are a few people, professional and otherwise, who perhaps are locked into a mindset that is too bearish. But there were millions on the other side who were locked into being to bullish.

Pat: So you would say this paints a fairly negative picture for, say, consumer spending and sort of all these things that are really driven by confidence and emotion.

Jeremy: Yes, I would. And I would also add that we're getting older, so there are more retirees per worker than there used to be. There are more people cashing in their houses and going to a cheap, a very cheap now, condo in Florida. There are more people liquidating their portfolios and fewer people building them. So that is, on the margin, a bit of a drag pushing down compared to the past 20 or 30 years pushing down a marginal pricing of houses and stocks.

There is also a loss of confidence in the effectiveness of our institutions, the effectiveness of our leaders, and maybe even to some extent in capitalism itself. That doesn't help.

And by the way on people, not just people getting older, but there are fewer people lining up to work each year. Not fewer in an absolute sense, but the growth rate has been diminishing steadily.

And so it's a downward pressure on GDP growth rates. And the GDP of all the developed countries is suffering, mainly for a lack of a supply of workers.

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