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Grantham's latest letter


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It basically says, "Ok, I need to remind you how right I was because I spent 10 years looking wrong.  And now?  I really don't have a clue where Mr. Market is going and neither does anyone else."

 

I have been a Grantham follower for  many years and I like him tremendously.  He is just ranting and raving now without a clue like all the rest of us. 

 

How nice it would be today to be a great stockpicker like Mr. Buffett, Mr. Watsa, or Munger... and I really am not sure there's anyone else I'd like to be.

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  • 4 weeks later...

Admittedly, I don’t yet know enough about

1921, but as for the others, I could offer good reasons why

their lower levels might be understandable. One group

(the U.K. and the U.S. in 1974 and the U.S. in 1982) had

very high interest rates providing formidable short-term

competition with stocks. (In the long term, the Fed Model

logic is simply false, but in the short term – up to a year –

it does work for behavioral reasons.) These markets also

had very high infl ation, which in the short to intermediate

term has a compelling explanatory power for P/E ratios.

To keep it simple, high inflation rates typically come

with lower than average P/Es and vice versa.

 

 

I added the bold for emphasis.  We had a discussion back in March and when I said that the 1982 low had something to do with the high interest rates and high inflation I was accused of thinking in a Fed model (and Grantham's thinking around stocks being real assets was cited as a reason why the P/E shouldn't go down with inflation). 

 

Well, Grantham himself addresses this topic in his latest letter.

 

So anyways, he too thinks that investors took the high interest rates and inflation into account when they pushed the P/E down on the market.  Grantham doesn't say it needs to be that way or anything like that, but he acknowledges that it gives investors an alternative with high yield to earn while on the sidelines (one of my points), and that high inflation rates typically come with lower P/E ratios (perhaps because people want to feel like their earnings yield is at least as high as the going rate of inflation).

 

It's just funny that here we were talking about this very thing, and then Grantham writes about it in the same quarter.

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Yes.  Its interesting.  And it was probably me.  Stocks are real assets and thus should not be as affected as they are by inflation but now we are talking short terms vs. medium and long-term.  Of course its been clear for some time that in the early 80s stocks were much lower relative to GDP, etc. than they are today and that this was primarily due to inflation/interest rates.  Every model has its limits, and the Fed model breaks down because eventually replacement costs need to be considered as well and not only the value of the earnings yield relative to bond yields. 

 

 

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My brother is sitting on a bunch of cash that he saved and he wants to buy his first house mainly with cash.  My advice to him was to wait and hope for inflation which will send interest rates higher bringing down the value of homes.  This is exactly what Grantham is essentially saying in that bolded part - it presents an opportunity for the long-term investor.  Alternatively, we may have deflation in which case the cash will be worth more.  Pain is good if you are sitting on cash. 

 

 

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Mungerville,

 

Would there be logic in your brother financing his home purchase, at least in part, now to lock in lower interest rates. Presumably, if he can finance 50% locking in that rate, when inflation "hits" and rates increase, his cash yield will pay for the financing costs and then some on his mortgage. I understand that the cost of housing will be lower then, but buying the home with 50% or so financing does give a bit of a hedge.

 

-Crip

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Hi Mungerville,  Paying all cash for a house makes no sense to me, unless one doesn't have a steady job.  My variable interest rates are 2.85%, and I can lock in anytime.  Given the option, were I your brother, I would give you a chunk of my cash to invest, invest the rest in bonds, and finance the house to the 80% level (20% down) to avoid CMHC fees. 

 

A house is a truly crappy investment as investments go.  The only reason you would buy a house for investment purposes is to take advantage of the leverage to buy more real estate. 

 

If your living there then that's a different matter.  Just buy the damn house.  Pay the 20% and invest the rest at rates that are likely to be better than 3% annual return.   

 

Alternatively, buy the house outright and take out a line of credit against the house for investment purposes.  Then at least its tax deductible - mind you the line of credit will not be a 3% loan and after the tax refund it will still be more expensive than the 3%. 

 

I have worked through various scenarios and actually have decided to minimize the mortgage payments and invest the cash difference into my Wife's brokerage accounts.

 

Should we get an inflationary environment the best asset to hold is fixed debt.  This is what makes BAM so compelling as an inflation hedge.

 

RE: Inflation - Watsa et al dont feel inflation is any kind of a threat at the moment.  Inflation is driven buy consumer demand, and ultimately by demand for money.  If the US savings rate, and probably savings rates elsewhere keep staying high the demand for money is going to be low.  Supply will > demand. 

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My brother gave me a chunk to invest.  One third of it is invested so far: into ORH at around $37 and KO in the low 40s - keeping it safe at this point with lots of Canadian cash on the sideline (which has increased relative to the US dollar just sitting there doing nothing). 

 

He saves which is great and wants to buy his first house.  He's willing to forgo current desires in order to have some financial independence so you have to respect that.  In terms of housing although its not a good investment, its going down if we have inflation (and the higher interest rates that that entails as stocks did in the late 70s or early 80s) or if we have deflation like Japan and 1930s.  If we have something in between, which is probably going to be tough to achieve, housing is not going up in my opinion.  So under the first two scenarios, he wins, under the the last scenario he draws.  So cash is a good bet right now relative to housing.

 

He wants to move into a country home and there are 50% odds mine may be coming available for rent for 2-3 years - I'll know in a couple of weeks.  I would rather rent it to him below market than to someone I don't know so it would be win-win in my opinion if he rents my home which is a great family/kids type home for 2-3 years below market, continues to save, and buys a house in my area with cash in 3 years when, in my opinion, they will definitely be lower due to deflation or higher interest rates combined with some forced sales.  My recommendation to him is to try and buy at 70 percent or lower relative to replacement cost and I think he is going to get it despite the area he is looking at not being depressed at all at this point.  I bought mine for 60% of replacement value, and he'll be able to do the same I think.  Does that make more sense? 

 

I think we will have deflation personally - that's why in the Fall of 2008 I went variable on the mortgage about 2 days before all banks in Canada started reducing their discounts to prime on their variable product moving to prime plus.  The fuckin' mortgage broker did not understand why I was in such a rush and neither did the bank manager I was dealing with - but they were not understanding the only reason it hadn't moved already is because everyone thought things could come back to normal including bank funding costs which increased significantly in the Fall of 2008.  I was actually paying the fee to break my current variable rate which had a few months to go and was at Prime minus 75 bps to lock into a 5 year deal immediately.  The bank manager couldn't figure out why I was doing it and actually called me with the intent of ensuring I, the client, wasn't doing financial harm to myself!  Christ, this after I had completed the transaction and almost all banks in the country had raised the variable rate to prime plus 100 bps - I think a few were at prime plus something lower but the point was most went to prime plus a few days before she called.  I had to explain to the bank manager in detail before she got it.  I said, look, I paid the penalty to lock in at this low variable rate for 5 years because if I waited only a few days let alone months, the only rate I could get now would be prime plus something whereas now I am locked in in the go go era variable rate at prime minus which equates to somewhere around 1.5 to 2%.  She said "how did you know when I didn't even know they were going to change it"?  I felt like saying "Honey, I have forgotten more about finance than you have learnt in your lifetime" but I figured that might not go over well so I just said "Well, I guess I got lucky".

 

The investment in your personal residence is not bad if you buy it cheap like anything else.  Templeton bought his cheap and, actually, so did Prem after the real-estate collapse of the late 80s in Toronto I believe.  Why pay full price even on your principal residence?  I bet sometime in the next three years, my brother gets a deal, meanwhile he rents mine below market in the same area while he waits and looks, and as the vice grips clamp down on other highly levered home owners with questionable employment stability in what will be a long and tough recession including double and triple dips. 

 

In my opinion, there is almost no way housing is going up in real terms in the next 3 years in Canada overall.

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