Warren Buffett’s Letter to Shareholders 2009

Sunday, February 28th, 2010

Warren Buffett shares his letter to shareholders just ahead of this year’s Annual General Meeting of Berkshire Hathaway.

Berkshire Hathaway Annual Report - via BRK
Warren Buffett’s Letters to Shareholders - via BRK

Here are some of this year’s nuggets. Buffett discusses how he and Charlie Munger, apply Charlie’s thinking to investing.

• Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding.

• Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy. At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes.

• We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses.

• When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system, not a supplicant. At the very peak of the crisis, we poured $15.5 billion into a business world that could otherwise look only to the federal government for help. Of that, $9 billion went to bolster capital at three highly-regarded and previously-secure American businesses that needed - without delay - our tangible vote of confidence. The remaining $6.5 billion satisfied our commitment to help fund the purchase of Wrigley, a deal that was completed without pause while, elsewhere, panic reigned.

• We pay a steep price to maintain our premier financial strength. The $20 billion-plus of cash- equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.

• We tend to let our many subsidiaries operate on their own, without our supervising and monitoring them to any degree. That means we are sometimes late in spotting management problems and that both operating and capital decisions are occasionally made with which Charlie and I would have disagreed had we been consulted. Most of our managers, however, use the independence we grant them magnificently, rewarding our confidence by maintaining an owner- oriented attitude that is invaluable and too seldom found in huge organizations. We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly - or not at all - because of a stifling bureaucracy.

• With our acquisition of BNSF, we now have about 257,000 employees and literally hundreds of different operating units. We hope to have many more of each. But we will never allow Berkshire to become some monolith that is overrun with committees, budget presentations and multiple layers of management. Instead, we plan to operate as a collection of separately-managed medium- sized and large businesses, most of whose decision-making occurs at the operating level. Charlie and I will limit ourselves to allocating capital, controlling enterprise risk, choosing managers and setting their compensation.

• We make no attempt to woo Wall Street. Investors who buy and sell based upon media or analyst commentary are not for us. Instead we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur. If Charlie and I were to go into a small venture with a few partners, we would seek individuals in sync with us, knowing that common goals and a shared destiny make for a happy business “marriage” between owners and managers. Scaling up to giant size doesn’t change that truth.

• To build a compatible shareholder population, we try to communicate with our owners directly and informatively. Our goal is to tell you what we would like to know if our positions were reversed. Additionally, we try to post our quarterly and annual financial information on the Internet early on weekends, thereby giving you and other investors plenty of time during a non-trading period to digest just what has happened at our multi-faceted enterprise. (Occasionally, SEC deadlines force a non-Friday disclosure.) These matters simply can’t be adequately summarized in a few paragraphs, nor do they lend themselves to the kind of catchy headline that journalists sometimes seek.

• Last year we saw, in one instance, how sound-bite reporting can go wrong. Among the 12,830 words in the annual letter was this sentence: “We are certain, for example, that the economy will be in shambles throughout 2009 - and probably well beyond - but that conclusion does not tell us whether the market will rise or fall.” Many news organizations reported - indeed, blared - the first part of the sentence while making no mention whatsoever of its ending. I regard this as terrible journalism: Misinformed readers or viewers may well have thought that Charlie and I were forecasting bad things for the stock market, though we had not only in that sentence, but also elsewhere, made it clear we weren’t predicting the market at all. Any investors who were misled by the sensationalists paid a big price: The Dow closed the day of the letter at 7,063 and finished the year at 10,428.

• Given a few experiences we’ve had like that, you can understand why I prefer that our communications with you remain as direct and unabridged as possible.

The complete letter is available here.

Tags: American Businesses, Annual General Meeting, Berkshire Hathaway, Brilliance, Brk, Business World, Cardiac Arrest, Charlie Munger, Competitive Dynamics, Competitors Battle, Dramatic Growth, Fallback Position, Gusher, Img Src, Kindness Of Strangers, Letter To Shareholders, liquidity, Nuggets, Openx, Profit Margins, Random Number, Supplicant, Television Sets, Warren Buffett
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Jeremy Grantham: “Fair value on the S&P is 860″

Tuesday, October 27th, 2009

Jeremy Grantham has become a familiar and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, the co-founder and chief investment strategist of Boston-based GMO has just published the October edition of his quarterly newsletter entitled “Just desserts and markets being silly again”.

Before quoting from the report, Grantham recently put matters into perspective in a Kiplinger article, saying: “The recent rally has been very speculative, favoring risky assets over the past few months. I’m sorry if you missed investing at the market’s March lows, but don’t compound the damage to your portfolio by chasing gains in risky assets. We’re at the beginning of a seven-year period of lean returns. You should only be buying the highest-quality blue-chip com­panies, where valuations are most attractive.”

Here are a few excerpts from the Grantham’s newsletter.

“Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year. Doesn’t it seem odd that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal?

“Price … does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors. First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away. Second, the slow gravitational pull of value as US stocks reach +30-35% overpricing in the face of an extended difficult environment.

“It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1,100. It can certainly happen. Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. ‘Painfully’ is arbitrarily deemed by me to start at -15%. My guess, though, is that the US market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1,098 on October 19).

“Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.”

Click here for the full report on Grantham’s reasoning for his cautious stance.

Source: Jeremy Grantham, GMO, October 2009.

Tags: Chief Investment Strategist, Co Founder, Desserts, Excerpts, Gmo, Guess, Horizon, Jeremy Grantham, Lean Years, Lows, October 19, Panies, Price Earnings Ratios, Profit Margins, Quarterly Newsletter, Rally, Risky Assets, S Market, Valuations, Wreckage
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Bill Gross: From Feast to Fast - July 2009 Outlook

Friday, July 3rd, 2009

Bill Gross, the “Bond King” is going to great lengths to get us to understand that the world is in a state of reversion to what he and El-Erian, his co-chief at PIMCO coined as the “New Normal” 3 months ago, in his latest missive - “Bon” or “Non” Appétit?.

Our economy which once feasted, no, binged, unable to stop itself, on debt and leverage, and on the basis that home and other asset prices would rise to the sky, is now fasting, cleansing itself of the fat that accumulated, and it is a long-term process that will take many years to complete.

Click Play to Listen to Bill Gross’ Investment Outlook:

Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.

Here are some of the highlights from the letter, which you may download here:

Gross re-iterates the “New Normal” - Its starting to sound a lot like “The Emperor’s New Clothes“:

Our economy’s lights, if not switched off in a rehash of the 1930s Depression, have certainly been dimmed in a 21st century version likely to be labeled the Great Recession. Much like John McSherry, U.S. and many global consumers gorged themselves on Big Macs of all varieties: burgers to be sure, but also McHouses, McHummers, and McFlatscreens, all financed with excessive amounts of McCredit created under the mistaken assumption that the asset prices securitizing them could never go down. What a colossal McStake that turned out to be. Now, however, with financial markets seemingly calmed and an inventory-based recovery in store for the balance of 2009, there is a developing optimism that we can go back to the lifestyle of yesteryear. PIMCO’s driving thesis however, if not a juxtaposition, is succinctly described as a “new normal” where growth is slower, profit margins are narrower, and asset returns are smaller than in decades past based upon the delevering and reregulating of the global economy, which in turn should substantially inhibit the “gorging” of goods and services that we grew used to in decades past.

Forecasts based on econometric models inevitably miss these secular/structural breaks in historical patterns because it is impossible to quantify human behavior, and long-term trends involving risk-taking and in turn derisking are decidedly human in their origin. Bell-shaped curves with Gaussian/random distributions fail to anticipate that human beings do not make decisions by chance or independently of each other, but in many cases in reaction to one another. Humanity’s personal and social computers appear to be programmed that way. And so, instead of “normal” distributions, economists and investors must learn to be on the lookout for “black swans,” and if not, then certainly “fat tails,” which differ from the measurement of natural phenomena accepted in science. “New normals,” flatter-shaped bell curves, and structural shifts in previously accepted standards become not only possible, but probable as human nature reacts to itself and its prior behavior. The efficient market hypothesis was always dead from the get-go, but academic tenure and Nobel prizes were food for the unwilling or perhaps unthinking.

Others are starting to wonder about the emperors new clothes, the “green shoots”:

I was impressed this weekend by an article in the Op-Ed section of The New York Times by staff writer Bob Herbert. “No Recovery in Sight” was the heading and his opening sentence asked, “How do you put together a consumer economy that works when the consumers are out of work?” That is really all one needs to ask when divining our economy’s future fortune. Unless an optimist can prescribe how to put Humpty Dumpty back together again and shuffle him/her back to work then there can be no return to an “old normal.” As unemployment approaches 10%, what is less well publicized is that the number of “underutilized” workers in the U.S. has increased dramatically from 15 to 30 million. Those without jobs, as well as those individuals who only work part-time and have become discouraged and stopped looking, total 30 MILLION people. The number is staggering. Commonsensically, one has to know that many or most of these are untrained for the demands of a green-oriented, goods-producing future economy. Imagine a welding rod in the hands of an investment banker or mortgage broker and you’ll understand the implications quicker than any economist using an econometric model.

Fifteen Words to describe the era that led us to our current economic crisis:

The supersizing of financial leverage and consumer spending in concert with the politicizing of deregulation describes in fifteen words our most recent brush with irrational behavior and inefficient markets. Greed will come again. But for now, the trend is the other way and it promises to persist for a generation at a minimum. The fact is that American consumers have suffered a collapse in wealth of at least $15 trillion since early 2007. Global estimates are less reliable, but certainly in multiples of that figure. And when potential spenders feel less rich by that much, the only model one can use to forecast the future is a commonsensical one that predicts higher savings, lower consumption, and an economic growth rate that staggers forward at a new normal closer to 2 as opposed to 3½%. There’s no magic in that number, and no model to back it up, just a lot of commonsense that says this is how people and economic societies behave when stressed and stretched to a near breaking point.

Where do we go from here:

Investors who stuffed themselves on a constant diet of asset appreciation for the past quarter-century will now be enclosed in a cage featuring government-mandated, consumer-oriented fasting. “Non Appétit,” not Bon Appétit, will become the apt description for the American consumer, and significant parts of the global economy, including the U.S. Because this is so, short-term policy rates will be kept low for longer than cyclical norms, and the outlook for risk assets - stocks, high yield bonds, and commercial and residential real estate will involve just that - risk. Investors should stress secure income offered by bonds and stable dividend-paying equities. Consumer Cuisinart consumption is a relic of the past.

Tags: Asset Prices, Asset Returns, Bill Gross, Burgers, Econometric Models, Excessive Amounts, Financial Markets, Global Consumers, Global Economy, Great Lengths, Gross Investment, Investment Outlook, John Mcsherry, Juxtaposition, Missive, Mistaken Assumption, PIMCO, Profit Margins, Recession, Reversion, Yesteryear
Posted in Emerging Markets, Markets | No Comments »

China: Profit Margins Recovery Should Help Stocks

Monday, May 11th, 2009

BCA Research has published the following analysis on the strong general corporate earnings recovery in China, May 8, 2009:

Overall Chinese corporate profits will likely recover strongly from deeply depressed levels in the coming months as the broader Chinese economy stabilizes. Rising earnings expectations for listed firms should sustain the rally in the stock market.

Chinese corporate profit cycles have historically been highly sensitive to volume expansion. The reason is that China’s highly competitive business environment has long kept pricing power weak and profit margins trim.

This means that volume expansion, which is highly sensitive to China’s business cycle, has long been the determining factor in corporate profit growth. As various leading economic indicators have all been turning up strongly in recent months, volume expansion has begun to reaccelerate. In addition, input costs have dropped more deeply than output prices.This means that the severe profit margin squeeze for the Chinese corporate sector in 2008 may have also eased.

Thus, a sharp recovery in the corporate profits from currently deeply depressed levels is likely in the coming months. Longer term, we expect the overall macro environment will likely remain challenging for the corporate sector and it is unrealistic to expect an across-the-board profit boom. Investors should focus on equity sectors that are able to capitalize on the economy’s top-line growth.

Tags: Boom, Business Cycle, Business Environment, Chinese Economy, Corporate Earnings, Corporate Profit, Corporate Profits, Corporate Sector, Depressed Levels, Earnings, Input Costs, Leading Economic Indicators, Macro Environment, Profit Growth, Profit Margin, Profit Margins, Rally, Sectors, Squeeze, Stock Market, Volume Expansion
Posted in Economy, Emerging Markets, Markets | No Comments »

Jeremy Grantham: The last hurrah and seven lean years

Thursday, May 7th, 2009

Jeremy Grantham’s keenly awaited quarterly newsletter, entitled “The last hurrah and seven lean years”, has just been published. Grantham, who co-founded Boston-based GMO in 1977, covers a lot of thought-provoking ground in this letter, but focuses mostly on where to invest now.

The widely-respected Grantham’s newsletter is must-read material. The first few paragraphs are published below and a link to the full article is provided at the bottom of the post.

“First, let me lament the loss of near certainties in investing. The financial and economic collapse that I described as ‘the most widely predicted surprise in the history of finance’ about 18 months ago is behind us. More precisely, we believed that bubbles had formed in global profit margins, risk premiums, and U.S. and U.K. housing prices, and that all three were ‘near certainties’ to break, with severe consequences for the economic and financial system. All have thoroughly burst and are in their over correction phase with the single exception of U.K. house prices, which I’m confident will do their duty. Normally there are, of course, no near certainties in investing.

“Life is not meant to be that easy. Asset allocators have been blessed in the last 10 years with a large collection of extraordinary outliers. As my favorite quote by Mandelbrot (1983) says, ‘Even though economics is a very old subject, it has not truly come to grips with the main difficulty, which is the inordinate practical importance of a few extreme events.’ If this last 10 years did not prove him right, nothing will.

“Since 1988, we have been offered 8 or 10 2-sigma events. (A 2-sigma event is our definition of an important bubble or bust.) All of these events were bubbles, and all behaved themselves by bursting. Now, sadly, there are probably none.

“Government bonds are the one serious candidate. In our opinion, they are badly overpriced but probably not by enough to justify the bubble title. Global equity markets are still cheap, but in major markets are nowhere near 2-sigma, 40-year bust levels. Some smallscale 2-sigma bargains may exist in the fi xed income markets in rate differentials, but need skillful analysis and knowledge to disentangle from value traps. And, they are a very far cry from, say, the opportunities offered by buying credit default swaps at a handful of basis points on overleveraged financials in early 2007. So, all in all, welcome back to the age of guesswork.”

Click here for the full report.

Source: Jeremy Grantham, GMO, May 2009.

Tags: Asset Allocators, Bubb, Bubbles, Certainties, Correction Phase, Economic Collapse, Extreme Events, Favorite Quote, Gmo, Government Bonds, House Prices, Jeremy Grantham, Lament, Lean Years, Mandelbrot, Outliers, Paragraphs, Profit Margins, Quarterly Newsletter, Risk Premiums
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Vitaliy Katsenelson: The pain of mean reversion

Friday, February 20th, 2009

This post is a guest contribution by Vitaliy N. Katsenelson*, author of Active Value Investing: Making Money in Range-Bound Markets and director of research at Investment Management Associates.

The stock market has dropped. Corporate profits have collapsed. And profit margins have reverted toward the mean. What is next?

Before I dive into the discussion, let me explain the chart below, which I named appropriately, “The pain of mean reversion.”

I looked at reported earnings for S&P 500 and compared them to the “average case” earnings scenario. In the “average case” scenario I took reported earnings of S&P 500 in the early 1990s and grew them at 6% - an average growth rate of GDP over the last century which happens to be the same as earnings growth for stocks during the same century.

If the economy had no cyclicality and profit margins remained constant, you would see nice, steady growth earnings for S&P 500 stocks like the one in the chart.

Of course, profit margins do not stay constant - they fluctuate, thus actual earnings swing above and below the steady 6% trend line.

Click here for larger chart.

How far will earnings drop?
You’ll never go wrong quoting Mark Twain when he said “History doesn’t repeat itself, but it does rhyme.” Our challenge as investors is to look at the past and figure out how history will rhyme with the future.

If you were to look at the recent history of the 2001 recession, earnings dropped 54% from their highs to their lows. If S&P 500 reported earnings were to drop by the same amount this time around they’d be at about $39. We are already below that level, 2008 estimates for S&P 500 were revised down again, now to $28. However, this is where Twain’s rhyming thinking becomes important - note that in 2001 earnings went only 18% above the “average case” line; in 2007 they were 31% above that line. If we were to follow the higher they climb the harder (deeper) they fall logic, this would lead us to believe that earnings will drop further this time, estimates for early 2009 earnings indicate that.

When will we see average earnings?
The good news is S&P “average case” earnings are about high $70s to low $80s a share (see big red squares in yellow shaded area) - which would make the market cheap (with a PE of about 10). But here is the bad news (don’t shoot the messenger please) - we just won’t see those “average case” numbers for a while.

The 2001 recession was driven by the overcapacity in the corporate sector. Corporations rationalized their inventories and factories, higher unemployment followed - we were in a recession. Excesses were worked out, corporations started to hire, and voila - we were out of the recession. Of course the recovery process was also aided by a “friendly” Fed, it took interest rates to (at the time) an unprecedented low levels and kept them there until corporations and consumers got seriously drunk on cheap money and spent themselves into serious debt for which we are paying now.

In the 2001 recession it took two and a half years for earnings to rise from their bottom to their average.

Unfortunately we’ll not be that lucky this time - we are in a consumer recession. Consumers are two thirds of the economy and they are deleveraging. As a side note: This deleveraging goes beyond big ticket discretionary items like large screen TVs and SUVs. Now it is showing up in lower consumption of staples like iced tea by Snapple which competes with cheapest commodity of all - tap water. Now, more expensive branded products like diapers and tissue made by Kimberly Clark are forced to compete with generic store brands. The meaning of the word staple is being redefined by this economy.

The Fed, being even “friendlier” than the last time, has lowered interest rates to almost zero, buying long-term bonds etc. But this time around the Fed’s booze will not do the trick - consumers are still suffering a hangover from the last Fed’s “help” - they don’t want to borrow and banks, after incurring huge losses, are behaving like real banks - only giving loans to people who’ll pay them back.

In addition to consumer deleveraging, government debt is skyrocketing with every bailout, thus taxes and interest rates are likely to be significantly higher once the economy normalizes.

The Earnings recovery will likely take longer than many expect, therefore, there is a very high possibility that the “average case” earnings growth going forward will be below the historical average of 6%

Are we about to embark on a secular bull market?
The market is a discounting mechanism - stocks will rise in the anticipation of a future earnings rebound, before the rebound. Similar to the stock market forecasting ten out of the last three recessions, it will discount a few recoveries before the real one takes hold.

What does this mean? We’ll likely have a few “fake” head starts and disappointments before the actual earnings recovery takes place.

As I argued in my book Active Value Investing: Making Money in Range-Bound Markets, we are very likely in the midst of a secular range-bound (trendless, volatile but going nowhere) market that started in early 2000. Historically, range-bound markets started at the end of the secular bull market when P/Es were above average. They ended when P/Es stopped declining (mean reverting), after a visit to below average territory (around 10-11 or less). The current range-bound market started at much above average valuation and will likely rhyme with the past finish at below average valuation as well.

Based on the Pain of mean reversion chart we are trading somewhere between 30 and 10 times earnings. However, neither number is very meaningful. Let me explain:

2008 estimates of $28, the “E” in P/E of 30, are distorted by massive charge offs.

The “average case,” the “E” ($80) that went into P/E of 10, lies in a far away land that … well, let me put it this way, you and I will get to grow sick of presidential campaign advertisements at least once or maybe even twice before that “E” is in sight.

Even based on 2010 “E” estimates ($40) stocks in the S&P 500 are trading at 21 times earnings.

Despite the decline, the market is still not cheap. Sorry, we are not likely to embark onto the new secular bull market anytime soon. History and data suggest that the choppy markets that we have seen since 2000 will likely continue. Owning a broad market index will not pave a road to prosperity. It comes down to not just owning stocks but owning the right stocks.

P.S. As a side note I believe significant earnings write-offs will continue well into next year as financial stocks will pass their write-off torch to companies in energy, materials and industrial sectors - stuff stocks - that will be writing off the investments they’ve made over the last five years.

By the time, I finished putting these thoughts together, which on and off took about two weeks, 2008, 2009 and 2010 estimates were taken down by about 20-25%.

If you missed it, Vitaliy did three 5 minute segment interviews on Yahoo TechTicker on Tuesday with Aaron Task and Henry Blodget.

1. Only Time Can Cure What Ails Us: Stocks Slump on Bailout, Stimulus News

2. Range-Bound at Best: The Long View on Stocks Isn’t Much Better, says Vitaliy Katsenelson

3. Active Value Investing: The Bull Case for EBAY, Philip Morris and Supervalu

* Vitaliy Katsenelson is author of Active Value Investing: Making Money in Range-Bound Markets and director of research at Investment Management Associates. He is also an adjunct faculty member at the University of Colorado at Denver, Graduate School of Business where he teaches Practical Equity Analysis and Portfolio Management. Vitaliy, a CFA charter holder, received both his degrees - bachelor of science and master of science in finance - from the University of Colorado at Denver, where he graduated cum laude.

Tags: Case Line, Case Scenario, Corporate Profits, Director Of Research, Early 1990s, Earnings Growth, Estimates, GDP, Growth Stocks, Investment Management, Lows, Management Associates, Mark Twain, Market Profits, Mean Reversion, Profit Margins, Recent History, Recession, Stock Market, Stocks, Trend Line
Posted in Bonds, Economy, Markets, Oil and Gas | No Comments »

Jeremy Grantham: Riveting Interview with Steve Forbes

Thursday, January 29th, 2009

Whoa! Jeremy Grantham gives a riveting, in-depth, specific and eloquent must-see interview. It is a clear and enlightening discussion with one of the finest and quiet geniuses in the investment world.

Subsequent to publication of Jeremy Grantham’s quarterly newsletter a few days ago, Steve Forbes conducted this interview with the chairman of Boston-based GMO. The video clip and transcript are published below.

Click here or on the image to view the video.

Click here for the transcript of the interview.

Here are the topical headings from the interview:

• Steve: China’s Long Tale
• Grantham’s Big Call
• A Whole New Bubble
• Time To Buy
• Cheapest in 20 Years
• Japan A Blue Chip?
• Emerging Markets
• Buy Big US Stocks
• Stimulus!
• Our Leaders Failed
• Dysfunctional Markets
• China Bubble

Here are a few paragraphs:

Steve Forbes: Well thank you, Jeremy, for joining us today. First, since you have bragging rights in this situation, what made you a bear, [a] great skeptic? Between 1999 until about a couple of months ago, you were saying, “Stay out.”

Jeremy Grantham: Well, really very simple. Not rocket science. We take a long-term view, which makes life, in our opinion, much easier.

Steve Forbes: Well everyone says it, but you certainly practiced it.

Jeremy Grantham: We actually do it. Well, we tried the short-term stuff and it was so hard; we thought we’d better do the long-term. We just assume that at the end, in those days, of 10 years, profit margins will be normal and price-earnings ratios will be normal. And that will create a normal, fair price. And more recently, we’ve moved to seven years, because we’ve found in our research that financial series tend to mean revert a little bit faster than 10 years–actually about six-and-a-half years. So we rounded to seven.
And that’s how we do it. And it just happened from October ‘98 to October of ‘08, the 10-year forecast was right. Because for one second in its flight path, the U.S. market and other markets flashed through normal price. Normal price is about 950 on the S&P; it’s a little bit below that today.

And on my birthday, October the 6th, the U.S. market, 10 years and four trading days later, hit exactly our 10-year forecast of October ‘98, which is worth talking about if only to enjoy spectacular luck. The P/E was a little bit lower than average and the profit margins were a little bit higher, so they beautifully offset. And given our methodology, that would mean that on October the 6th, the market should have been fairly priced on our current approach. And indeed it was–that was even more remarkable–950, plus or minus a couple of percent.

Steve Forbes: And what did you see during that 10-year period that made you feel–other than your own models–that this was something highly abnormal, that this couldn’t last?

Jeremy Grantham: Well, first of all, the magnitude of the overrun in 2000 was legendary. As historians, you know we’ve massaged the past until it begs for mercy. And we saw that it was 21 times earnings in 1929, 21 times earnings in 1965 and 35 times current earnings in 2000. And 35 is bigger than 21 by enough that you’d expect everyone would see it. Indeed, it looks like a Himalayan peak coming out of the plain.
And it begs the question, “Why didn’t everybody see it?” And I think the answer to that is, “Everybody did see it.” But agency risk or career risk is so profound, that even if you think the market is gloriously overpriced, you still have to get up and dance. Because if you sit down too quickly–

Steve Forbes: Famous words of Mr. Prince.

Click here for the transcript of the interview.

Source: Forbes, January 23, 2009.

Download the Forbes: Jeremy Grantham Briefing Book here.

Tags: Blue Chip, Boston, Bragging Rights, China, Dysfunctional, Emerging Markets, Few Days, Flight Path, Geniuses, Gmo, Half Years, Interview Source, Investment World, Japan, Jeremy Grantham, Paragraphs, Price Earnings Ratios, Profit Margins, Quarterly Newsletter, Rivetting, Rocket Science, S Market, Seven Years, Skeptic, Steve Forbes, Steven Forbes, Stimulus, Stocks, Topical Headings, Video Clip
Posted in Emerging Markets, Markets | No Comments »

Jeremy Grantham: Obama and the Teflon Men, and other Short Stories

Friday, January 23rd, 2009

In October last year perennial bear Jeremy Grantham, chairman of Boston-based GMO, said: “We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.

“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”

Given Grantham’s forecast, it was with keen interest that I have been awaiting his latest quarterly newsletter entitled “Obama and the Teflon Men, and Other Short Stories. Part 1“. The following paragraphs are a summary of his investment recommendations from this report:

“The current disaster would have been easy to avoid by making a move against asset bubbles early in their lifecycle. It will, in contrast, be devilishly hard to get out of. But, we are deep in the pickle jar, and it seems likely that, in terms of economic pain, 2009 will be the worst year in the lives of the majority of Americans, Brits, and others. So break a leg, everyone!

“Slowly and carefully invest your cash reserves into global equities, preferring high quality US blue chips and emerging market equities. Imputed 7-year returns are moderately above normal and much above the average of the last 15 years. But be prepared for a decline to new lows this year or next, for that would be the most likely historical pattern, as markets love to overcorrect on the downside after major bubbles. 600 or below on the S&P 500 would be a more typical low than the 750 we reached for one day.

“In fixed income, risk finally seems to be attractively priced, in that most risk spreads seem attractively wide. Long government bond rates, though, seem much too low. They reflect the short-term fears of economic weakness and the need for low short-term rates. We would be short long government bonds in appropriate accounts.

“As for commodities, who knows? There were a few months where they looked like a high-confidence short, but now they are half-price or less, and are much lower confidence bets.

“In currencies, we know even less. It is easy to find currencies to dislike, and hard to find ones to like. There are no high-confidence bets, in our opinion.

“For the long term, research should be directed into portfolios that would resist both inflationary problems and potential dollar weakness. These are the two serious problems that we may have to face as a consequence of flooding the global financial system with government bailouts and government debt.”

Click here for the full report on Grantham’s views.

Tags: Blue Chips, Bond Rates, Cash Reserves, Economic Activity, Economic Pain, Economic Weakness, Emerging Market, Global Equities, Government Bond, Income Risk, Investment Recommendations, Jeremy Grantham, Keen Interest, Lows, Obama, Overrun, Pickle Jar, Profit Margins, Quarterly Newsletter, Value Estimate
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US stock market confirms primary downtrend

Wednesday, January 9th, 2008

Jan. 9, 2008 - Prieur du Plessis provides his clarity on the current downtrend that is unfolding in the US Market.

The original post is here:

“Winter, spring, summer or fall, all you have to do is call, and I’ll be there, you’ve got a friend …” These are the lyrics of Carol King’s song. Yes, as life swings from boom to gloom it is the support of friends that often provide the necessary solace.

It is unlikely that Mr Market will come patting you on the back when your investments go pear-shaped, but he does provide his own unique variety of comradeship. In an environment cluttered with noise, Mr Market offers us the very simple but true adage of “the trend is your friend”. This sounds comforting enough, but Mr Market still expects us to fulfill a task: to identify the direction of the trend.

An important point to realize is that there are trends within trends, varying from ultra short (intra-daily) to short (daily) to intermediate (weekly) to long term (monthly). Although day traders play short-term trends from minute to minute, I believe that it is really the identification of the primary (multi-year) trends that holds the key to successful investing.

One way of approaching this is to gauge the fundamental landscape – factors such as unfavorable valuations, stretched profit margins, mounting evidence of an imminent recession and increasing default risk. These paint a fairly bleak picture, but keep in mind the discounting nature of the stock market, having already factored in the gloomy news we are faced with 24/7. In order for the market to fall further the nature of the problems should turn out to be broader and deeper than currently discounted. As mentioned previously, I believe that the fallout of the housing and subprime situation has not been fully discounted.

A more visual way of recognizing the primary trend is by means of analyzing the technical picture, especially using a longer-term perspective.

The following graph indicates how the Dow Jones Industrial Index has been mapping out a series of lower lows and fallen below its 200-day moving average (often seen as an indicator of the primary trend). The shorter term 50-day moving average is trending down and provides an early indicator of what is in store for the longer-term average. The Index has just dropped below its November low on increased volume, serving as further confirmation of a downtrend.

Source: StockCharts.com

The chart below shows the percentage of stocks on the NYSE that are trading above their 200-day moving averages. As of yesterday’s close the reading was 28.1%. This is the lowest reading in five years and indicates that more than seven out of every 10 stocks are in primary downtrends. Although the current level appears low, the number has fallen as low as 10% at previous bear market bottoms (such as 2002).

Source: StockCharts.com

Next is the 10-year graph of the NYSE Composite Index (based on monthly data), indicating the price trend together with the MACD oscillator. The failed year-end rally in December witnessed the histograms falling below the zero line (see blue circle) for the first time since the start of the bull market in 2003. (The previous MACD sell signal was given eight-and-a-half years ago in July 1999.)

Source: StockCharts.com

Turning to a monthly graph of the Dow Jones Industrial Index, a similar picture emerges when using the 14-month RSI oscillator. This indicator is overbought at levels above 70 and oversold below 30. The RSI’s trend is now falling for the first time since the bull market commenced in 2003.

Source: StockCharts.com

My assessment of the above is that there is more weakness for the stock market ahead. Although the market is oversold on a short-term basis, I would be very reluctant to take long positions in the face of what I believe is a market topping out and embarking on a primary downtrend. I therefore concur with Nouriel Roubini, professor of economics at New York University, when he says: “… a lousy stock market in 2007 will look good compared to an awful stock market in 2008.”

I wrote a series of bearish articles on the stock market (and bullish on gold) during the latter months of 2007 of which the last one on December 17 was entitled “Is this the end of the stock market party?”. Mr Market has provided the answer and it is a rather discomforting one. Yes, “the trend is your friend”, but only if you heed Mr Market’s warnings and appreciate that the stock market is in a downtrend. Be inordinately cautious with your investment strategy.

Source: Unknown

Tags: Adage, Bear Market, Blog, Carol King, Chart, Comradeship, Day Traders, Default Risk, Economics, Economy, Fallout, Gloom, Gold, Important Point, Investment, Investment Strategy, Life Swings, Markets, Miscellaneous, Nouriel Roubini, Pear, Prieur, Profit Margins, Rally, Recession, risk, S Song, Solace, Stock Market, Term Perspective, Term Trends, Trading, Valuations, Winter Spring Summer
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