Institutional investors should ‘slowly and carefully’ invest cash reserves in emerging market and high-quality US blue chip equities, says Jeremy Grantham co-founder of GMO, who expects imputed 7-year returns for the sectors to moderately outperform and be substantially better than their averages in the last 15 years.
However, declines to new equity market lows should be expected in the next two years, since market corrections historically overshoot on the downside after major asset bubbles have burst, Grantham writes in his most recent quarterly letter.
The ever-bearish investor predicts that the S&P500 would probably fall to 600 or lower in the next two years, surpassing 750, which was reached in November 2008.
For long-term performance, investors should build portfolios that are more resistant to inflation and less sensitive to potential weakness in the dollar, Grantham writes.
“These are two serious problems that we may have to face as a consequence of flooding the global financial system with government bailouts and government debt.”
But Grantham’s commentary extended beyond government fiscal policy to criticise members of the finance team chosen by US President Barack Obama.
“These are momentous days in which government actions may well have make-or-break impact, but my confidence in government and leadership is at a low ebb.”
The self-proclaimed “contrarian and a nitpicker” tagged Obama’s Treasury nominees as the “Teflon men”, because they failed to question the policies set by Alan Greenspan, the former chairman of the Federal Reserve, or combat the formation of the US housing bubbles. Â
They drew criticism for their apparent links with Robert Rubin, the former US Treasury Secretary and special adviser to Citi as it amassed billions in treacherous mortgage-backed securities. According to Grantham, Rubin “helped to create an environment where prudence was a career risk and CEOs felt obliged to keep dancing”.
Members of the Obama finance team were scathingly labelled “Rubinesque retreads”.
Grantham took aim at newly sworn-in US Treasury Secretary, Tim Geithner, for not questioning Greenspan’s policies during his time as a member of the Federal Open Market Committee.
It was this perceived lack of dissent that concerned Grantham most.
“Our financial ship is not doing a passable imitation of sinking because of a lack of intelligence. What was lacking was the backbone to publicly resist the establishment’s greedy joyride of risk-taking and sloppy standards.
“There was plenty of intelligence, just not too much wisdom. So it would be very encouraging if there were someone included in Obama’s administration who had actually blown the whistle…If only there was someone with real toughness who could do unpopular things.”
The appointment of Paul Volcker, who as Fed chairman helped tame US inflation in the 1980s, to lead Obama’s Economic Recovery Advisory Committee, is an exception. But Grantham lamented the notion that Volcker, with his “preference for high standards of financial integrity and the backbone to push through unpopular but necessary actions,” would likely “resign in a year if they don’t get serious”.
However, Obama’s stress on strong, rapid government spending to combat the financial crisis has countered the “animal spirits”Â – or widespread negative sentimentÂ – affecting US economy.
“At times like this, animal spirits need nurturing. Obama’s election will help, at least for a while; talking up the power of stimulus will help, and avuncular, optimistic advice from influential figures will not go amiss.”