GMO co-founder and chief investment strategist Jeremy Grantham is well known for having predicted both the late 90s tech bubble and the recent housing bubble, and now he sees an equity bubble driven by the Federal Reserve’s loose monetary policy and years of qualitative easing.
Seven years of lean
“Over the next seven years we think the market will have negative returns,” says Grantham, reports Jared Lynch for The Sydney Morning Herald. “The next bust will be unlike any other because the Fed and other central banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before.”
Most value investors think that US equities are expensive right now, and many are expecting tapering to cause a stock market correction in the near term, but Grantham goes even further, saying that “the next bust will be unlike any other.”
Grantham is concerned about the relative weakness of the US recovery compared to other major recessions and the Great Depression. In the past, the US economy has come roaring back, and Fed critics argue that policies meant to keep to spare the country suffering in 2008-2009 hamstrung future growth. Instead of allowing inefficient companies to go under so that capital and resources could be shared among more productive firms (so-called creative destruction), high liquidity has allowed inefficient firms to stumble along.
Falling into the QE trap?
One alternative that Grantham doesn’t address in this brief interview is that the Federal Reserve could start putting liquidity back into the system at the first sign of trouble (and many think that Federal Reserve Chair Janet Yellen would). This would save the markets short term pain, but if Grantham’s basic thesis is correct then it would do even more damage to the economy.
The QE Trap, as some Fed critics have called it, would cause a slow decline in the nation’s health instead of a sharp drop with the possibility of a future rebound.
Grantham’s prediction is that assets, which he sees as generally expensive right now, will fall in value over the next seven years until they are cheap once again. Since we’ve never been in this situation before, Grantham is relying partially on anecdotal evidence to frame his argument (as he acknowledges), but for someone who correctly called the last two stock market drops, to predict a third should at least get people’s attention.