In his latest quarterly letter, Jeremy Grantham postulates that if the Standard & Poor's 500 overcorrects like the average of the past 10 great (pre-Greenspan) equity bubbles, the index could remain mired beneath its current 1,250 level for the next decade.
Yet as he implicitly acknowledges, this is unlikely to happen. "The S&P 500, unlike other global equities, has hung in and staged rallies [this year] whenever the bad news has ebbed," Grantham writes. "Why? Well, 15 years ago, Ben Inker and I designed a model to explain (not predict) the ebbs and flows of the P/E ratio. It had a surprisingly high explanatory power. We found that everything that made investors comfortable worked. That is to say, it was a behavioral model. Fundamentals like growth rates did not work. The two (out of three) most important drivers were profit margins and inflation."
Today, we have the highest profit margins in modern history and stable, low inflation, he continues. All other things being equal, equities should be 20% higher.
Of course, when the "cloud" of negatives gather into an army of negatives, as they have this year, investors' comfort dissipates.
Grantham calls the December letter his shortest ever, but he is at no shortage of words when it comes to diagnosing our dyspepsia. The U.S., in particular, has rapidly "acquired relative deficiencies over the last 20 years that will hamper our growth" and threaten declining competitiveness. Here he cites depleted infrastructure, a fall-off in the "effectiveness of education and training," and the inability and unwillingness of government to address long-term issues.
Singling out income equality, Grantham argues the U.S. has become a less upwardly mobile society than even the highly stratified U.K. "The net result of these factors is a growing feeling of social injustice, a weakening of social cohesiveness, and possibly, a decrease in the work ethic," he writes.
The U.S. is becoming a mean-spirited plutocracy "backed by a mean-spirited majority on the Supreme Court," he writes, adding he intends to pen a missive to the "Occupy. . . Everywhere" folks shortly.
It's obvious that corporate profits can't continually rise in an era of sustained stagnant incomes. Eventually, people won't have the money to buy what their companies are producing. But right now, U.S. multinationals are benefitting from strong exports, which represent the only part of the economy that can enable us to escape this mess.
Grantham's gloomy diagnosis doesn't square with the number of surprisingly positive economic data points that have surfaced in recent months. Collectively, they have confounded even the most implacable bears. It's almost enough to ask if there is a real economic revival at hand.
The early Christmas retail results were truly startling, with both brick-and-mortar and online distribution channels showing double-digit gains. Typically, a strong Christmas season results in mid-single digit increases. That's why last month's Black Friday numbers raised eyebrows. It's true that retailers were going up against very weak numbers over the last three years, so there was lots of pent-up demand. But as of today, this brisk pace of sales was holding up.
Of course, tales of shoppers pepper-spraying each other doesn't say anything good about our social fabric improving as it emerges from the Great Recession.