Outside the Box

Investing in a Low-Growth World

February 16, 2013

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.

Or not.

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

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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…

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Feb. 20, 2013, 3:02 p.m.

Although I would like to accept Grantham’s thesis and conclusion, I believe the analysis putting stock market returns versus economic growth is flawed. Underlying the GDP number is a balance sheet effect: some economies have grown more than others due to massive debt financing (I think Peter Connor makes the same point). Secondly, some economies are really growing due to resource booms, eg Australia and Norway so they have very different dynamics than net importers of resources. To summarize: the GDP number hides more of an economy than it shows, so any correlation with stock market performance is more coincidental than causal.

Philip Price

Feb. 17, 2013, 9:19 a.m.

Exhibits 1 & 2 are used to make the points that there is “moderately negative correlation” and “moderate relationship”. Your plotting software dutifully and correctly returned an R2 value of 0.06.  Please consult with a statistician before using something like this to make a point!
Or, try some successive re-plots with one potential outlier removed - THEN try and convince yourself that there’s a relationship here.

Ronald Nimmo

Feb. 17, 2013, 4:11 a.m.

  I think that stocks will continue to rise because, at these low interest rates, the present value of the future income stream of corporations continues to move higher, even at modest annual increases in earnings. This is what will probably occur in a slow but steady growth environment. If a deep recession occurs, the future income stream of companies will be diminished and the present value of future earnings will decline along with the earnings themselves.
  Concerning Grantham’s Resource Price Adjustment, I thought that the calculation of real GDP already took inflation into account by dividing nominal GDP by the inflation rate. Of course, accurate real GDP calculation does require the use of accurate inflation stats. As numerous analysts have pointed out, there are good reasons to question the validity of the US government CPI.
  The last section of Grantham’s article seems to contradict the first section. Near the beginning of the article, he implies that the fast-growing economies of the emerging world are overpriced and the slower growing economies of the developed world are undervalued, but near the end of the article he states the exact opposite. In general, his reasoning from cause to effect is hard to understand and lacking in clear linkage. He frequently uses the word “returns” without explaining what kind of return he is referring to or to whom the return is being paid.

Don Snow

Feb. 16, 2013, 9:18 p.m.


I believe you said you personally buy gold on a monthly basis.  Based on Grantham’s previous column that you sent us, as well as this one, if you subscribe to Grantham’s prognosis would he not say that is an unwise decision?


Don Snow
Santa Fe, NM