Jeremy Grantham, chief investment strategist at Grantham Mayo Van Otterloo & Co., said a longer period of below-average economic growth carries the risk of fueling a third stock-market bubble because Federal Reserve Chairman Ben Bernanke would likely keep interest rates low.
“If we get lucky and have a strong, broad, and sustained economic recovery, interest rates will probably rise before we reach real bubble territory,” Grantham wrote in his quarterly newsletter, posted on GMO’s Web site. “If, however, the economy only limps along, which seems more likely to me, then we run a very real danger of a third dangerous bubble in stocks and in risk-taking in general.”
Grantham, who estimates the fair value of the Standard & Poor’s 500 is 875, said the market’s 80 percent rally in one year is “excessive” and was fueled more by the Fed’s monetary policy than by the rebound in the economy, which is facing “seven lean years.”
U.S. stocks advanced again today, extending the Dow Jones Industrial Average’s longest weekly winning streak in six years, as the biggest jump in new home sales in almost five decades bolstered optimism the economy is improving.
“Speculators are not stupid. They see that after each crash, a long, artificial period of low rates and easy financial borrowing has been delivered,” Grantham wrote. “They see that Bernanke is an unreconstructed Greenspanite in that he refuses to address bubbles, but will leap to help ease the pain should a bubble break. With asymmetry like that, why not speculate?”
The Dow climbed 69.99 points, or 0.6 percent, to 11,204.28 at the 4 p.m. close in New York, completing an eighth straight weekly gain. The Standard & Poor’s 500 Index rose 0.7 percent to a 19-month high of 1,217.28, capping its seventh weekly advance in the past eight.
Grantham, 71, is best-known for his bearish calls on U.S. stocks. In 2000 he accurately predicted that U.S. stocks would lose money in the coming decade. The S&P 500 lost 1 percent a year in the 10 years ended Dec. 31, 2009.
In March 2009, he recommended investors get back into stocks, just as equity prices reached a 12-year low. By July 2009 he said stock prices had climbed too high. In a January speech in Boston, he referred to that brief period “as my short life as a bull.”
Grantham recommended investors buy high-quality U.S. stocks, which he defines as stocks of large companies with a high and stable return and low levels of debt. He mentioned Atlanta-based Coca-Cola and Redmond-based Microsoft Corp.
In his current newsletter Grantham also criticized Bernanke for helping bail out weaker companies, rather than let them be acquired by stronger competitors. Last year, he compared giving Bernanke a second term as Fed chairman to reappointing the captain of the Titanic.
“We are helping to restore the financial health of the banks and bankers, who under these conditions, could not fail to make a fortune even if brain dead,” Grantham wrote in the current newsletter.