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This time is really different


This time is really different

Perhaps the four most dangerous words in investing are; this time is different. History shows however that it is never different, and the belief that today we are more educated, experienced or advanced than ‘last time’, or that conditions have permanently changed, perpetuates the behaviour that is causing the problem.  A sign that we might be near the end is the preponderance of died-in-the-wool value investors who simply give up plying their trade and join the momentum.

Thirty-six years of declining global interest rates and a more recent flattening of the yield curve, thanks to unprecedented central bank bond buying, has made investors pawns in a great global game of monetary policy chess.  Of course, record prices, and associated paper-wealth, have accrued to those who have purchased anything from low digit number plates, to wine, art and inner city apartments, but paper gains that are the result of a global tide of cheap money is not the same as investing wisdom nor a sign of genius.

Some investors however are regarded as talented and their utterances respected.  So what to make of the investment genius that declares this time is indeed different?  That’s the question I am confronted with as I read the latest GMO Quarterly Letter by esteemed investor and co-founder Jeremy Grantham.  How you respond will also determine your returns for the next decade so a lot is riding on the answer.

Grantham argues that three of the most important inputs in equity markets have changed, and they are prices, profit margins and interest rates.

With respect to prices, Grantham plots a ‘trend’ P/E ratio for the S&P500 and defines a trend as “a level below which half the time is spent”.  You might recognise this definition as  simply ‘the average’. Grantham then explains that since 1997 the highest P/E ratio achieved (during the Tech Boom) and the lows achieved shortly afterwards were both much higher than previously recorded booms and busts.  He note,s “the failure of the market in 2002 to go below ‘trend’ even for a minute should have whispered that something was different.”  Grantham then observes that even in 2009 – the depths of the GFC – the market P/E “went below trend for only six months.”  Therefore in the last 25 years the market P/E has only been below trend for six months.

This time is therefore different, and Grantham believes the market now oscillates normally enough but around a much higher P/E.

In 1927, John Maynard Keynes pronounced, “We will not have any more crashes in our time.” Eighty eight years ago economist Irving Fisher, posthumously declared by Harvard economist Milton Friedman as “the greatest economist the United States has ever produced”, said “Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months.” It was October 1929.  The great Crash commenced days later and plunged the world into the Great Depression.

I couldn’t help but compare Grantham’s new, higher trend P/E to Fishers ‘permanently high plateau’.

Next, Grantham examines corporate profit as a share of GDP.  This is the ratio that in 1999, Warren Buffett declared, “In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there’s a public-policy point: If corporate investors, in aggregate, are going to eat an ever-growing portion of the American economic pie, some other group will have to settle for a smaller portion. That would justifiably raise political problems—and in my view a major reslicing of the pie just isn’t going to happen.”

I would argue that corporate profits, in particular profitability as measured by returns in incremental equity is the most important factor in determining an equity investors long term return.

Grantham, who used to call profit margins “the most dependable mean reverting series in finance” makes the observation that between 1970 and 1997 the average or ‘trend’ profit/GDP ratio was 3.8%, but since 1996 the average has been 4.5%.  He then asks the question “why did they stop mean reverting around the old trend?”, perhaps unwittingly declaring another permanently high plateau.

Split the difference between these two numbers and you get 4.15%.  So what? And what is so significant about 1997?  Why should the new average be calculated from that date onwards? Don’t get me wrong, I hope he’s right but I dare say he, like many other forecasters, won’t be, and in 100 years time, investors will be calculating a completely different average. That future-past average will be the average of what happens next, and what happens next is what we are all interested in discerning.

More directly Grantham points out that globalisation, which has made brands more valuable, steadily increasing corporate power and influence – consummated through the Supreme Court’s Citizens United decision, Justice Department inertia with respect to anti trust matters, a decline in capital spending as a percentage of GDP, and cheap money failing to spur competition, suggests profit margins will remain elevated for some time.

On the subject of interest rates – remembering their decline has provided the helium for elevated asset prices – Grantham concludes that any change to the dominant and “deeply entrenched” central bank policy, over the last twenty years, of using lower rates to stimulate asset prices, is difficult and unlikely to change any time soon.

I cannot say whether the market will correct anytime soon. I do know however when a genius value investor throws in the towel, hangs up the tools or takes his bat and ball home, joins the bullish bandwagon, eight years after it commenced, its worth being cautious. Of Jeremy Grantham, Irving Fisher may yet be proud.

Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.


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  1. Hi Roger, it was interesting that only a couple of letters ago Grantham talked about not even being close to a bubble and “if only we could get a run over 2300 and a few bears throwing in the towel” we might be in for “the big one”. Well here we are but he wouldn’t have figured himself as one of the bears!
    If you look at gmos positioning, they are extremely defensive regardless of grantham’s commemtary.
    I think James Montier is one of the sagest when he says caĺl it what you like but stocks are very expensive and there’s next to no value out there.

  2. Roger, you make reference to 1996/1997 – wasn’t it around this time that the Clinton administration deregulated the financial system away from the Glass-Steagall measures (therefore, being a major catalyst for profits on US listed companies) ?

    Regulation/Deregulation, it’s like a pendulum, as soon as it goes too far in one direction, it swings back and they can never strike the right balance it seems.

  3. andrew ronan

    Yep it’s different this time, we are at record debt levels per capita in most of the developed world in combination with the lowest interest rates ever in combination with bubbles in nearly every asset class in combination with slowing consumer spending as a result of indebtedness in combination with a no GDP growth world ATM. I wonder how this will play out? Or should the question be how many ways can it play out?

  4. Roger, given that Mr Grantham over the past few years (from the posts here) was famously bearish and was calling a bubble on the S&P500 around 2300 (as his statistical definition of a bubble threshold), are you near the exit or in the car park and hailing a cab at this metaphorical party ?

  5. Hi Roger, thanks for the article. I agree that Grantham’s argument regarding prices is unconvincing.
    Regarding interest rates, the probability is that its likely to go up, given the over 30 year bull market in bonds. But by how much and at what pace? Nobody really knows, as Andrew Macken set out in a blog post recently. Anyone who says they know is just guessing.
    With profit margins though, there is a good evidence that the US corporate landscape is becoming more monopolistic in nature, with the decline in the number of companies and some of the technology platform companies really becoming monopolies. Is competition alive and well, as Warren Buffett said his quote in 1999? May be not. One of the reasons Buffett has invested in airlines recently is because competition has reduced significantly in that industry in the US. But I guess as bottom up value investors Montgomery doesn’t have to worry about this explicitly – when you’re analysing companies individually you will be able to assess the competitive landscape for each and find those that are dominant or becoming dominant in their industry.

  6. Nice article. Totally agree with this. Irving Fisher’s 1929 call is a classic.
    I have an overseas stock index model that tells me markets peak in approx 6 months and then tank for the next couple of years. Let’s see if it happens.

  7. Brett Edgerton

    Glad you nailed your colours to the mast here, Roger…

    We also need to acknowledge that Buffett is doing things quite differently of late (airlines and “cash equivalents” as Charlie Munger described in that video you linked to a while back) – and is being questioned (as usual – too old, losing his marbles, etc, etc)… While some of the reasoning for his change of behaviour can be attributed to the huge cash pile that Birkshire now grows (currently at US95 billion), it is also due to their disdain for such low yields on treasuries…

    I would also point out that any reader of Grantham would recognise a description of him as “joining the bullish bandwagon” as being “slightly” “colourful” – after all his team have sketched out a range of futures lying somewhere between “purgatory” and “hell”… hardly optimistic let alone bullish…

    Over the next few years we are going to learn who are the really smart investors… but one thing of which I am certain is that they will be those with supple minds capable of robustly flexible thinking…

    Of the many invaluable kernels of wisdom offered up by Charlie in that video, perhaps the one I took away most wanting to hold on to and to act upon was the practice of not banging ones own views into others because what we are really doing is trying to bang them more into ourselves… he went on to say that he cherishes disproving and dispelling long held beliefs, and pats himself on the back for doing just that…

    I am not saying that I think you are wrong… How can any mere mortal be certain when so many legendary value investors are voicing such disparate views… I think it just proves the value of diversification for all investors including investors in managed funds… And your transparency in directly expressing your views on this issue are most welcome…

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