Where you stand often depends on where you sit. So it was that two bearish
equity fund managers, FPA Capital's Robert Rodriguez and Grantham Mayo's Jeremy Grantham, sat down to argue with a bond fund maven, Citigroup's Joe Deane, who was much more bullish on stocks than on his own asset class.
The dyspeptic exchange took place last week at Morningstar's annual mutual fund conference.
Deane is a top-rated municipal bond fund manager who now oversees more than $7 billion in fixed-income assets at Citigroup. The U.S economy is "in the early to middle phase of a really solid economic recovery," Deane declared. "If I had risk money I'd put it in equities."
Where will the markets and the economy be 18 months from now? Deane believes the Federal Reserve Board will shift back into a neutral posture and raise the Fed funds rate to about 4.0% or 4.5%. "I don't think a rise in rates
needs to be negative for stocks," he opined. "It's (the same reason) why
they are going up."
Then it was Grantham's turn. For the last three years, Grantham has become
the rock star of the financial conference speaking circuit, delighted to
deliver his bearish view to anyone and everyone with a degree of certainty
and confidence that is unparalleled in the investment business. "The bad
news is that my story doesn't change very fast,' he began.
Reversion to the mean is the central theme of Grantham's thesis. "The
trouble with mean reversion is that it doesn't tell you when it's going to
do it," he explained. "Everything will go the norm, we just don't know
Trend line price-to-earnings ratios started the 20th Century at 12 and moved
up to the current level of 16. Grantham asserted that fair value for the
Standard & Poor's 500 Index is about 750 and, since the bubble burst in
early 2000, it has fallen as low as 775. Yet he was quick to point out that if
the market decline didn't overshoot fair value this time, it would be the
first time in history this didn't happen in a bear market.
So how does Grantham explain the strong rally that began in the spring of 2003 after the invasion of Iraq proved initially successful? It was a "classic
bear market rally," he said. "Last year was the biggest return to speculation we can find... Everything risky went up."
While everyone was talking about the importance of protecting capital, they
behaved otherwise, as risk and return became synonymous just like during the late '90s. "This is not how bear markets end," he added.
Grantham, who has no shortage of explanations of why the Dow Jones
Industrial Index hasn't crashed below 5,000 as he predicted a few years
ago, also has spent some time studying the presidential cycle as it relates
to stock prices. In the third year of a presidential administration, he said, the market gets juiced up. Presidents "don't rock the boat in year four and then clean up the mess in years one and two" of a second term in office. But in year three, he said, "value is irrelevant."
In other words, he said, investors should get the Valium ready for 2005. "Next year is the great black hole," he proclaimed.
Upon that cheery note, Grantham turned the microphone over to FPA Capital's Robert Rodriguez, who started by describing the financial markets as a "vast wasteland of value" that represented a "time for extraordinary protection."
Before going any farther, Rodriguez was quick to mention that his firm had
just announced it would close his own FPA Capital fund "because we can't
find anything" in which to invest. Rodriguez has about 37% of FPA Capital's assets in cash.
Unlike Grantham, Rodriguez didn't see a near-term apocalypse looming. "We don't expect stocks to collapse this year," he told attendees. "It's very
hard to deploy capital rationally. Earnings (growth) will decelerate rapidly
in 2005 and 2006 and will start to approach the rate of nominal GDP growth.
If interest rates rise, it will be tough for stocks."
But there are numerous other problems, like the threat of terrorism, on the
horizon. "People are not being compensated adequately for unquantifiable
risk," Rodriguez contended.-Evan Simonoff