Jeremy Grantham: The market is 25% overvalued; 15% correction coming

Jeremy Grantham is out with his much anticipated Quarterly Letter and it’s a good one. “Just Deserts and Markets Being Silly Again” is a cutting, snarling, and sarcastic rejection of the prevailing V-shaped recovery bull market view.  But Grantham is far from ultra-bearish, giving a more nuanced and realistic assessment for the medium and longer-term.

He starts his letter with sarcastic allusion to Obama’s Nobel Prize, titling the section “Just Deserts.”

I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just deserts? Let’s review some of the more obvious examples.

But, he is just warming up, as he goes on to heap vitriol on 13 groups he feels are equally undeserving of rewards in a scathing condemnation of status quo ante in the economic and financial establishment.

They are:

  1. Ben Bernanke
  2. Larry Summers and Tim Geithner
  3. Mortgage Brokers
  4. Homebuilders
  5. Over-spenders and under-savers
  6. Too-big-to-fail banks
  7. Over-bonused financial types
  8. Overpaid large company CEOs
  9. Stock holders of overleveraged Corporations
  10. The U.S. Auto Industry
  11. Over-vehicled America
  12. Stock options
  13. And, of course, Sir Alan Greenspan

This letter is a polemic against the financial elites of a ferocity the likes of which I have never seen from a major fund manager. I see it as a must-read.

As for the markets, he is not all doom and gloom.  But the point that certainly jumped out at me was this:

Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year.

Translation: the market is so overvalued now that you should expect pretty meager long-term returns in equities.  Does that mean a crash is right around the corner? Not necessarily – but a brutal correction is probably in the offing. Grantham says:

I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at -15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19). 

Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.

The bottom line here is this: the market is significantly overvalued at present levels because of a technical rally super-charged by stimulus. This necessarily means lower returns over a longer-term horizon. The possibility of a major correction is high.

Update: the full letter with a lot more detail, market history and asset allocation recommendations is now linked below instead of embedded due to copyright restrictions.

One other thing: a GMO representative reminded me you that can register with their site and subscribe to the letter and receive it automatically as well.


Jeremy Grantham’s 3Q 2009 letter – GMO website

(the link to the GMO splash page above will guide you to registration in order to view the letter – and to subscribe to future letters)

  1. Anonymous says

    These stooges should be handed striped outfit with a sledge hammer forced to pound on some rocks for the rest of their lives.

  2. Anonymous says

    He left out the Realwhores. Do not forget the realwhores.
    The realwhores still coming out with their questionabler predictions and info.

  3. Anonymous says

    why can’t the S&P trade down below 600?
    This is not even 1 times book.
    With this phoney money pumping up this artificial economy the day of reckening is near when the ponzi schems from the fed faikl to work. When this happens the wipeout hits. Then we get the long lasted multi decade correction needed to correct all this fraud!

    1. Edward Harrison says

      Look at what Bill Gross is saying in one of my next posts:

      He points out that the ‘body politic’ is not going to allow the kind of environment in which Dow 6000 is likely. They will do everything they can to prevent this. So, if you believe Gross (and I do to a point) that necessarily means there is a floor to stocks which in the short-term can only be broken by some serious exogenous shock ($120 oil for example).

      I generally think we will EVENTUALLY see inflation adjusted lows lower than 666 on the S&P, but Grantham makes some good points.

  4. Anonymous says

    I agree. In addition, Oil at these levels and potentially higher add to the headwinds. Let’s see if Mr. Grantham is right. Track this call overtime….

  5. ChartingStock says

    Great Post-Seems Like Granthams View Of A Near Term Sharp Correction Is Shared By More & More Legendary Traders Recently.
    Good Trading

  6. Anonymous says

    That’s mortgage BORROWERS not BROKERS. No one has tried to help them out thankfully.

  7. richard says

    Well, Jeremy Grantham is someone you don’t take lightly but many gurus have made calls that worked at one time and didn’t another. Someone mentioned that other gurus are in accord. I got news for you: some other gurus are not in accord. Steve Leuthold, James Stack, Dan Sullivan to mention just a few(who have had maybe more success than Grantham). It’s easy for him to lambaste Bernanke and all but time will determine this. I’m open: he could be right. I’ll place my bets here on Bernanke. I’m thinking we are lucky to have the team of people we have at this time in history. This is what those Ivy league educations are all about.

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