The jury – unless you are the Fed and Ben Bernanke or the Congressional Budget Office, which cannot make lower growth assumptions without really blowing their deficit projections out of the water – is pretty well in on GDP growth: it’s going lower. Ed Easterling and I wrote a recent Thoughts from the Frontline on multiple pieces of research suggesting slower future growth. We asked the question, “So what about stock prices; will they follow suit?” Our thought was that, over time, they would.Not so fast, says Jeremy Grantham in today’s Outside the Box. He was part of the cabal of researchers suggesting slower future GDP growth whose work we used as the basis for our analysis. Longtime readers know that I think Jeremy Grantham (who heads GMO, which now manages $106 billion – see GMO LLC for more wonderful GMO team research) is one of the smartest men on the planet as well as one of the best investors. With his usual thoroughness, Jeremy makes the case, based on in-house research, that both stock-market returns and corporate earnings growth are negatively correlated to GDP growth. At the same time, he’s not overselling his thesis:
For the record, there is also: a) a moderate relationship between higher-priced countries (on Shiller P/E and price/book) and future underperformance; and b) a tendency for more rapidly-growing countries to be overpriced. Therefore we can deduce a logically appealing (but statistically weak) tendency for overvaluation to contribute a second reason for the market underperformance of more rapidly growing countries. (Please notice how carefully said that is.)
He goes on to reiterate important points he has made over the past few months about the effect of growing resource costs on growth, and then adds:
The main new point I wanted to make was that resource costs are treated like GDP increases. Hence, prior to 2002, steadily falling resource costs were treated as a debit when of course steadily lower costs were a great help to well-being and utility. We calculated that adjusted GDP actually grew 0.2% a year faster than stated. Conversely, since 2000, rising costs were a detriment, not a benefit, as shown in GDP. Treated correctly as a negative, resource costs would have reduced real growth by 0.4% a year. This squeeze on growth will continue as long as resource costs rise faster than the growth rate of the balance of the economy.Always careful of the ground he stands on, Jeremy then throws in a very important caveat to say:
… it is worth remembering that we don’t really know what caused resource prices to spike from 2002 to 2008 so impressively. This was a much bigger price surge than occurred during World War II! Indeed, it may easily turn out that the resource price rises will squeeze future GDP growth substantially more than our estimates.
In any case, a careful reading of Jeremy’s work is always instructive. This one is an important think piece, as the direction and magnitude of future GDP growth will be critical as we make business, retirement, and investment decisions. Simply talking past performance is risking your future on the unlikely prospect that the future will look like the immediate past.
I am personally doing a lot of thinking and research on this topic. I strongly suspect that other significant factors will arise to play havoc with projections, in both fantastically positive and uncomfortably dire ways. I am more and more seeing the future as very “lumpy,” that is, quite uneven as to how it will affect individuals and even entire countries. For those who espouse more equality in incomes and outcomes, this is not your optimal scenario. But even with all the “lumpiness,” the average person will be much better off in 20 years – though “average” will cover a much wider spread of outcomes than it does even today. But rather than launch into that book now, we’ll let Jeremy take over.
Have a great weekend. I am enjoying being at home this week. I will be in Palm Springs at the California Resource Investment Conference, February 23-24. My good friend Grant Williams, who writes the blockbuster Things that Make You Go Hmmm… and the Mauldin Economics' Bull’s Eye Investor letter, will be there, as will the best resource investor I know, Rick Rule, along with my favorite data maven, Greg Weldon. There is a full two-day slate of speakers. The event is free to investors and is always fun, and it’s a great time of year to be in California (hate the pensions, love the weather). Come see us! You can read all about it and register at the Cambridge House website.
Your looking forward to catching up this weekend on my reading analyst,
John Mauldin, Editor
Outside the Box
Investing in a Low-Growth World
By Jeremy Grantham
This quarter I will review any new data that has come out on the topic of likely lower GDP growth. Then I will consider any investment implications that might come with lower GDP growth: counter intuitively, we find that investment returns are likely to be more or less unchanged – a little lower only if lower growth brings with it less instability, hence less…