Bubbles as Policy Tool

Grantham: 'Almost Criminally Inept Fed'

The Federal Reserve's asymmetric policy of stimulating stock moves by setting artificially low rates and then leaving the bull markets, when overstimulated, to bubble over, is dangerous. It is probably the most dangerous thing to inflict on a peace time economy with two possible exceptions – runaway inflation and a housing bubble.

--Jeremy Grantham

Leave it to Jeremy Grantham to lay bare exactly why the Fed has so many market watchers -- myself included -- baying at the moon in exasperation.

On the one hand, it denies any duty or ability to contain the damage from asset bubbles (or even recognize them!).

On the other hand, it pursues policies -- first zero percent interest rates, now quantitative easing -- guaranteed to inflate serial bubbles.

Grantham devotes most of his current quarterly letter (see, "Night of the Living Fed") to explaining why this is irresponsible, and -- in the case of housing -- especially dangerous.

Amongst other things, in their wake burst asset bubbles leave squeezed consumers, taxpayers, savers, retirees, pension funds, states, and municipalities -- and, when they are compelled to clean up the mess, ultimately a broke Fed and federal government.

Grantham again:

Distorted asset prices have been like the deliberately misplaced signal lanterns, which the Cornish, in the stormy west of England, used to lure ships onto the rocks for plunder. Individuals, as well as institutions, were fooled into believing that the market signals were real, that they truly were rich. They acted accordingly, spending too much or saving too little.

So what does Grantham prescribe, besides not inflating any more bubbles?

Noting on the one hand the "army of non-frictional unemployed ready to get to work," and on the other hand the country's "dreadfully deteriorated infrastructure and desperate need for improvements in energy efficiency" . . . Grantham thinks it's obvious.

You owe it to yourself to read the entire article.

Jeremy Grantham on "the 'Flation Issue"

As Flummoxed as Everyone Else

What we are seeing now is a tussle between the 50% sustained speculation branch and the branch where two or three things go wrong and crack confidence. This struggle is an unusual one, and has created market effects I have never seen before, and you have not either.

--Jeremy Grantham, GMO Q2 2010 Newsletter

Somewhere [in the last 30 years], without any formal announcement of the change, the “client” in a trade mutated into a “counterparty” who could be exploited.

--Jeremy Grantham, GMO Q2 2010 Newsletter

Today is "Jeremy Grantham day" on the financial blogosphere.

That's because the influential investor just released his most recent quarterly newsletter.

For once, I didn't glean anything new or groundbreaking; the main highlight making the rounds is that Grantham has officially come down on the "deflation" side of the 'flation issue, at least in the short run.

The other sign that Grantham is flummoxed by today's uncharted financial waters: his three "weighted probability" scenarios, in which the chance of a big "up" move is put as just about the same as a big "down" move.

He might as well have just shrugged his shoulders.

Gold(en) Ambivalence

The Gold Debate

Want to know what to think about gold?

So do I.

As best I can tell, here are the opposing camps' two best arguments:

I hate gold. It does not pay a dividend, it has no value, and you can’t work out what it should or shouldn’t be worth. It is the last refuge of the desperate.

--Investor Jeremy Grantham

Just because the lifeboats leaving the Titanic are crowded doesn't mean you shouldn't be on one of them.

--Commodities trader on CNBC, who was asked whether it was worrisome that gold was becoming "an increasingly crowded trade."

My thoughts on gold are already on record ("The Gold Tax").

As they say, "you pay your money and you take your chances."

Jeremy Grantham, Animal Spirits, and "Bubble Business"

"Don't Just Stand There -- Buy Something!"

Some people wait for a new episode of a favorite TV series (Seinfeld, The Sopranos).

Others for a new album from a favorite artist.

I look forward to Jeremy Grantham's latest quarterly newsletter. Seriously.

The man's honest, brilliantly insightful -- and a great writer, to boot:

Greenspan was lucky enough to inherit Volcker’s good work, and that gave him a base from which he could launch or blow a huge equity bubble; he also had the advantage that the country’s balance sheet was in excellent shape. Even Bernanke inherited a reasonably solid position from which to fund a second bailout. But a third time? It is hard to work out where the resources would come from to resuscitate the economy if a real shock were to be delivered by another collapse of a major asset class.

--Jeremy Grantham, "Playing With Fire"; GMO Q1 2010 Newsletter

Subscribing to the notion that the "bigger the bubble, the more damaging the bust," what is Grantham's antidote?

"We had better hope that something lucky turns up to break the speculative spirit."

Can't Anyone Write a Headline Anymore?

Misleading, Sensationalized Headlines

Just days ago, Barry Ritholtz called out The Wall Street Journal for its (increasingly) misleading, out-of-context headlines.

I just ran into another example yesterday on the otherwise credible RealClearMarkets.com, which aggregates the top 30 or so business-related print and blog pieces daily (mine have appeared more than a dozen times in the last two years!).

Compare this headline on RealClearMarkets (look under "Evening Edition" for Jan. 26):

"Looks Like the S&P Is Going to 1,200 or Higher" -- Jeremy Grantham

With this quote, directly from Grantham's (excellent) piece:

I thought last April that the market (S&P 500) would scoot up to 1,000 to 1,100 on a typical relief rally. Now it seems likely to go through 1,200 and possibly higher. The market, however, is worth only 850 or so; thus, any advance from here will make it once again seriously overpriced.

Just in case the foregoing is too subtle, Grantham continues:

Equity markets almost always peak when rates are low, so moving in desperation away from low rates into substantially overpriced equities always ends badly.

See my point!!?

P.S.: If you haven't read Grantham's missives, you should; they're every bit as pithy as Warren Buffett's. In particular, his "Lessons Learned in the Decade" at the end of his most recent quarterly newsletter is full of great nuggets.

In fact, when it comes to "pithy financial insights," these two are really on a plane of their own (Michael Lewis and Thomas L. Friedman also write at this altitude, but, unfortunately, they both cover business all too rarely).

Goldman Sachs & the Swine Flu Vaccine

Feeding the Hand That Bites You

Some of New York's biggest companies, including Wall Street giants Goldman Sachs and Citigroup, received doses of swine flu vaccine for at-risk employees, drawing criticism that the hard-to-find vaccine is going first to the privileged.

"Wall Street banks have already taken so much from us. They've taken trillions of our tax dollars. They've taken away people's homes who are struggling to pay the bills," union official John VanDeventer said. "But they should not be allowed to take away our health and well-being."

--"Goldman Sachs, Citigroup got swine flu vaccine"; Yahoo! News (11/5/2009)

I get "not biting the hand that feeds you."

What I find puzzling is "feeding the hand that bites you."

Not Just Dibs on Vaccines

Getting dibs on a scarce vaccine is the least of the harm that Wall Street does.

Much worse is the gravitational pull that it exerts on our capital -- and talent.

Jeremy Grantham puts it this way:

Every country needs a basic financial system to function effectively with letters of credit, deposits, and check writing facilities, etc. But as you move beyond that it is worth remembering that every valued job created by financial complexity is paid for by the rest of the real economy, and talent is displaced from real production, as symbolized by all of the nuclear physicists on prop trading desks. Viewed from the perspective of the long-term well-being of the whole economy, the drastic expansion of the U.S. financial system as a percentage of total GDP in the last 20 years has been a drain on the health and cost structure of the balance of the real economy.

--Jeremy Grantham, "Lesson Not Learned: On Redesigning Our Current Financial System"

FYI, "prop trading" refers to "proprietary trading," or bets that Wall Street makes with its own money.

Jeremy's Jeremiad

"Redesigning the Financial System" -- Or Not

In a world with few wise men -- financial or otherwise -- Jeremy Grantham certainly makes the cut (Paul Volcker, Warren Buffett, and John Bogle also come to mind).

It's hard to improve upon Grantham's own words, from his 3rd quarter letter to shareholders (his fund manages a measly $87 billion for investors).

Here are a couple choice excerpts:

In general, countries with simpler and less aggressive banks have had much less pain in the recent crisis . . . “Oh!” say the bankers, “If we become smaller and simpler and more regulated, the world will end and all serious banking will go to London, Switzerland, Bali Hai, or wherever.” Well, good for those other places. If that means they will have knee-buckling, economy cracking, taxpayer-impoverishing meltdowns every 15 years and we will be left looking like a boring back water, that sounds fine to me.

And this nugget, capturing the current mindset towards reining in a clearly out-of-control financial sector:

I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship’s construction, of the company’s policy, or of the captain’s competence.

“No one could have seen this coming,” would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises.

Grantham's take on Alan Greenspan, Ben Bernanke, Geithner, Goldman Sachs and a long list of others is bracing, infuriating, refreshing -- and most of all, accurate.

Global Glass Steagall

Canadian De Tocqueville Does Finance

The world's concentrated financial sector has been grabbing more than its fair share of wealth because it has been able to and this must stop.

"This is like looting," said outspoken Boston money manager Jeremy Grantham. "This industry can grow to gobble up all the benefits of the real economy if allowed to. It is trying to grab our cash. It's obscene."

--Diane Francis, "Time to Bust Up the World's Banking Giants"; National Post (10/24/09)

The above quote is just one of the highlights from Diane Francis' SUPERB piece in Canada's National Post yesterday.

What makes the piece especially worthwhile are: 1) her sweeping, historical take, alighting on everything from Standard Oil more than a century ago to the Microsoft anti-trust saga in the '90's; and 2) her non-U.S. perspective (think of her as "de Tocqueville does finance").

Here's one of Francis' milder indictments of the financial status quo: 'Excessively large banks destroy democracies, like the United States, through inordinate influence on policy, politicians and regulators.'

Her prescription -- and one endorsed by such luminaries as Paul Volcker and Bank of England Governor Mervyn King:

Enact a "global Glass Steagall on steroids" -- making sure that investment banks can't make bets with savers' insured deposits -- and break up the too-big-to fail banks, starting with Goldman Sachs.

Not just great, timely ideas -- but, in Glass Steagall's case, the law of the land for 67 out of the last 76 years.

Devastating arguments, and a truly great read.

P.S.: So is Jeremy Grantham a bomb-throwing Commie? Hardly. More like a Boston Brahmin-type, very Establishment, who runs an $87 billion investment fund.

Grantham's Latest

Grantham Sounds the All-Clear (Sort of)

Bubbles in global profit margins, risk premiums, and U.S. and U.K. housing prices . . . have thoroughly burst and are in their overcorrection phase with the single exception of U.K. house prices, which I’m confident will do their duty.

--Jeremy Grantham, "The Last Hurrah and Seven Lean Years"; Q1 '09 Letter

Maybe it's just because I agree with him, but money manager Jeremy Grantham continues to provide one of the most comprehensive, astute takes on the current investing landscape. His first quarter newsletter is no exception.

As the paragraph cited above indicates, Grantham believes that the bubble in U.S. housing prices has fully burst, and that prices have now overcorrected. Of course, that judgment is at odds with consensus economic forecasts, which call for continued declines.

P.S.: If you're looking for a term sure to gain added currency, it's "the financial-industrial complex" (go ahead and Google it and see what comes up). I had no idea when I used it in a post this Thursday that Grantham had already beat me to it.

Jeremy Grantham on Market Timing

"Waiting for the Light"

"Be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before."

--Jeremy Grantham, "Reinvesting When Terrified"; (March 2009 Newsletter)

Grantham, who manages $85 billion and is one of the most astute investors around, was actually talking about stocks, but his advice is equally applicable to the housing market.

In the same piece, he also makes two other indisputable points: 1) you'll never catch the low -- by the time it's clear that that has happened, prices will already be higher; and 2) market commentary will be most negative at the bottom. So if you listen to it, you'll either do the wrong thing, or nothing at all.

Interestingly, he rejects conventional wisdom about how to get (back) into a market that has fallen dramatically and still looks risky: 'Since every action must overcome paralysis, what I recommend is a few large steps, not many small ones.'

Prospective home buyers will definitely relate . . .