Sunday, October 19, 2008
avoid stocks in a depression
among the views -- avoid banks for many years from now; we are looking at depression as a result of a scenario still much worse than almost everyone is discounting; the fed could be headed for ZIRP for a few years; the lack of capital investment that will result in that time will ultimately result in commodity scarcity in five or ten years; relative (though not absolute) performance in depression may well be in commodities, as it is the least leveraged aspect of the global economy.
in the same vein, via clusterstock comes a window on jeremy grantham's third quarter letter.
The three “near certainties” we talked about in mid-2007 have all behaved themselves. They were that U.S. and U.K. house prices would decline, that profit margins globally would decline, and that risk premiums everywhere would rise, and all three with severe consequences on markets and the financial and economic systems. ... Global profit margins, the second near certainty, are also declining rapidly, but have a long way to go. ...
... The real growth in the index has historically been only 1.8% per year for the S&P, but for technical reasons (low payout rates in particular) we have allowed for moderately more real growth in recent years. In the six years since October 2002, the trend line has risen to 975 (plus or minus a little – we are constantly fine-tuning a percent here or there). Needless to say, two weeks ago the market crashed through that level ... [B]randishing our old 10-year forecasts and resisting the idea that even a blind pig will occasionally find a truffle, we have had some confidence in saying that by October 10th global equities were cheap on an absolute basis and cheaper than at any time in 20 years.
There is also a terrible caveat (isn’t there always?), and that is presented in Exhibit 3, which shows the three most important equity bubbles of the 20th Century: 1929, 1965, and Japan in 1989. You will notice that all three overcorrected around their price trends by more than 50%! In the interest of general happiness, we do not trot out these exhibits often and, until recently, they would have been seen as totally irrelevant and perhaps indecent. But, after all, it’s just history. Being optimistic like most humans, we draw the line at believing something so dire will happen this time. We can hide behind the fact that there are only three data points, and therefore no self-respecting statistician can give them much weight. We can convince ourselves that things are different this time since the background to each of the four events, including this one, is different. One of them had high inflation; three, including the current situation, did not. Japan and 1929 were characterized by complete incompetence, while this time we had only – shall we say – very widespread incompetence. This time we have thrown ourselves more quickly into battle, although not so quickly as some would have liked. Not all of the differences are favorable: we have a more global, interlocking, and complicated system, including non-bank players like hedge funds. We also have the “financial weapons of mass destruction” – asset-backed securities that are tiered and sliced and repackaged – and, perhaps most destabilizing of all, totally unregulated credit default swaps. Did we have even more greed and short-term orientation this time than they did? Well, we certainly didn’t have less! Still, a 50% overrun seems unacceptable. Probably governments would feel that the consequences of such a loss in asset value would simply be too awful and would do anything to prevent it. And perhaps, just perhaps, their “anything” would work. But a reasonably conservative investor looking at the data would want to allow for at least a 20% overrun to, say, 800 on the S&P 500, and have a tiny portion of their brain loaded with the notion that it just might be quite a bit worse.
and this leaves out what follows -- an incisive view on the depressing consequences of consumer deleveraging from a starting point of deep indebtedness -- and a well-grounded skeptical view of the ability of china to navigate the crisis without suffering a period of outright contraction, something nowhere in the consensus forecast.
for the record, a standard-issue 50% overrun of the trend would push the s&p to around 500. notably, that level comports rather well with the implication derived by robert shiller and relayed by jason zweig in the wall street journal regarding a return to a trailing ten-year price-to-earnings multiple of 10 for the s&p. dr. steenbarger also cites a tobin's Q study in the new york times, where the s&p is known to have fallen to about one-half replacement value (currently thought to be around 910) at major market bottoms.
UPDATE: via paul kedrosky -- grantham has released part two of his quarterly review. it's uploaded here by investment postcards.