Jeremy Grantham: Stock markets face 'seven lean years'

If people had paid attention to Jeremy Grantham over the past two years, their portfolios would be in much better shape, say Russell Pearlman and Jonathan Dahl in Smart Money.

In early 2007, Grantham, who oversees institutional investment management firm GMO, warned that there was a global bubble "everywhere, in everything". Once the crisis broke, he said that "at least one major bank" would fail. In March, he noted that the S&P 500 was 30% below fair value, while global equities were even cheaper. It was time to buy.

The key driver of the S&P's rebound was the unprecedented monetary and fiscal stimulus in the US. Stocks are always much more sensitive to huge increases in liquidity than the economy, so a sharp rally could take the S&P all the way up to 1,000-1,100 from 660, he wrote in May. With the S&P now in this range and way past his fair value estimate of around 880, what happens next?

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Given that there are still plenty of institutional investors who feel "left behind" by the rally, it could continue for "longer than reasonable investors expect". But this isn't a long-term bull market. Investors should now take some profits as the rebound has "nothing to do with the logic of long-term fundamentals", which remain lousy. "We are in for seven lean years following about seven overstimulated very fat ones."

The stimulus packages, which essentially boil down to treating excessive borrowing and spending by doing yet more of both, will only provide a temporary lift. "This is like when you revive the drunk: he staggers down a few blocks, then falls down again."

Once it wears off, a protracted period of "sub-normal growth" beckons as consumers and businesses gradually work off their huge debts. "We will save more, spend less, waste less." Without the stimulus from cheap lending, the developed world will have to settle for growth of around 2% over the next few years, instead of the 3.5% "we used to aspire to".

Lacklustre growth will bear down on profitability and consequently on price/earnings ratios. While we may well have seen the bottom, stocks are likely to struggle for years and it will be a long time before the S&P reaches a new high.

For now, the only appealing stocks are US blue-chips, which have been overlooked in the run-up, while emerging markets and commodities remain promising long-term bets. But developed-world stockmarkets in general face "long, drawn-out disappointment".

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