MarketWatch reports “Much more pain to come, says fund manager.” Let’s look at some highlights:
Investors hoping to see an economic improvement in 2009 may be in for a rude awakening if one fund manager is to be believed.
Jeremy Grantham, chairman at value shop GMO, said that he thinks there will be far more write-downs than is currently assumed, and that to reach the necessary debt levels the U.S. will suffer some serious pain.
“To be successful, we really need to halve the level of private debt as a fraction of the underlying asset values,” said Grantham. “This implies that by hook or by crook, somewhere between $10 trillion and $15 trillion of debt will have to disappear.”
Grantham calculated his figure by assuming write-downs of 50% in equities, 35% in housing, and 35% to 40% in commercial real estate, amounting to a loss of about $20 trillion of perceived wealth from a peak of about $50 trillion. He then estimates private debt — corporate and individual — to be about 50% of that peak level. In straitened times, he said, debt will be lent at closer to a 40% level, meaning that today’s $30 trillion in wealth will lead to ideal private debt levels of $12 trillion.
Grantham believes that there are only three ways to bring private debt levels down in relation to reduced asset values: drastically write down debt, inflate the debt to reduce its real value or adopt the Japanese model of long-term saving.
“Each of the three realistic possibilities…would be extremely painful, each is loaded with uncertainties and even the quickest of them would take years,” said Grantham.
Despite his feelings about the broader economy, Grantham sees value in the markets. He recommends investors “slowly and carefully” invest cash into stocks, with a preference for high-quality U.S. blue chips and emerging markets stocks.
“But be prepared for a decline to new lows this year or next, for that would be the most likely historical pattern, as markets love to overcorrect on the downside after major bubbles,” he warned. “Six hundred or below on the S&P; 500 would be a more typical low than the 750 we reached for one day.”
Value in the markets? Here’s that nebulous phrase again that can cost you a lot of money. Value translates to something that is subjectively considered cheap. Cheaper than what? Last year’s price? Who cares if it’s cheap; it can get a lot cheaper.
The best definition of value I have heard is by Al Thomas who said “that a mutual fund/ETF only has value if it goes up after I buy it.”
Grantham’s forecast of the S&P; 500 dropping into the 600 range is now the 4th or so prediction I have heard for this number to be reached. That would represent a 25% drop from current prices. Whether we get there or not is not as important as is the question whether the Buy-and-Hold folks are prepared to deal with another major set back.
This market environment can humble anyone at anytime if you’re not prepared to work with an exit strategy that may produce a small loss but will prevent your portfolio from suffering a serious meltdown.