Grantham: Stocks Not This Cheap Since 1987

Market seer and GMO chief Jeremy Grantham predicted financial debacle. Now he's buying.

Russel Kinnel 15 October, 2008 | 1:57PM
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A couple weeks ago I had a scary thought: Things are worse than Jeremy Grantham predicted. It's a bit frightening when one of the most bearish market seers has understated the risks and intriguing at the same time because he was spot on in terms of the direction of his predictions. So, I checked in with him on Monday, Oct. 13 to see what he makes of the current situation. The markets were up about 5% when we spoke, and Grantham thought it had come close to returning to fair value.

Back in July 2007, I spoke with Grantham, who predicted half of the hedge funds and at least one major U.S. bank would be wiped out. Grantham is chairman of asset manager GMO LLC which runs mutual funds and hedge funds. He advocated going into all manner of anti-risk baskets such as Treasury bills and TIPS a

s a way of preserving capital while waiting for markets to get cheaper. At the time, he sounded like a prophet of doom but now he just sounds like a prophet. In fact, his firm, GMO, got its 10-year predictions for returns on the S&P 500 and emerging markets for the period ended third quarter 2008 almost exactly right.

In July 2007, Grantham warned of a financial bubble as hedge funds, private equity, and homeowners gorged on debt.

Today Grantham says we're in for slowing global economic growth. In particular, he believes China will slow down more than expected as most economists have taken in their forecasts for Chinese growth only a touch. He argues that China is very dependent upon exports and that the countries on the other end of the trade are too weak.

Grantham expects that slowing growth will also keep commodity prices falling. "I would keep out of commodities for the near term," he said. In addition, he sees the deleveraging--an unpleasant unwinding of debt-- leading to a reverse wealth effect for companies and consumers alike. Both had been living beyond their means and now will have to adjust to below-average earnings and income, and that means they'll be tight with spending.

Nonetheless he's now more constructive about equities because he believes they are trading at severely depressed prices. He said that at the end of Friday, global equities were trading as cheaply as they had been since the 1980s. In fact, the U.S. had traded below GMO's fair value estimate--though as we spoke Monday morning a rally had brought it back to around fair value. Specifically, he prefers blue chips to small caps or highly leveraged companies.

"We're buying carefully and slowly," Grantham notes. Why slowly? "When bubbles correct, they usually overcorrect so that the market is selling well below fair value."

Interestingly Grantham also says he's now neutral on financials--a sector he has long disliked. He notes that most of the credit crisis is likely behind us and that the newest plan of worldwide governments to inject capital into banks in exchange for shares is a big improvement on past plans.

So, add Grantham to the list of sage investors who see this as a huge buying opportunity. The list includes, among others, value maven Marty Whitman of Third Avenue, bond expert Dan Fuss of Loomis Sayles, and Fidelity International's Anthony Bolton.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Russel Kinnel  is Morningstar's director of fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping US investors build winning portfolios.

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