A reader pointed to the quarterly letter (PDF file) by Jeremy Grantham titled “The Last Hurrah and Seven Lean Years.”
While the entire report is simply superb, I want to focus on two sections, namely “Seven Lean Years” and “The VL Recovery.” Let’s look at some highlights of the former first:
Probably the single biggest drag on the economy over the next several years will be the massive write-down in perceived wealth that I described briefly last quarter.
In the U.S., the total market value of housing, commercial real estate, and stocks was about $50 trillion at the peak and fell below $30 trillion at the low. This loss of $20-$23 trillion of perceived wealth in the U.S. alone (although it is not a drop in real wealth, which is comprised of a stock of educated workers and modern plants, etc.) is still enough to deliver a life-changing shock for hundreds of millions of people.
No longer as rich as we thought –under-saved, under-pensioned, and realizing it – we will enter a less indulgent world, if a more realistic one, in which life is to be lived more frugally.
Collectively, we will save more, spend less, and waste less. It may not even be a less pleasant world when we get used to it, but for several years it will cause a lot of readjustment problems. Not the least of these will be downward pressure on profit margins that for 20 years had benefited from rising asset prices sneaking through into margins.
Besides the loss of wealth being a life-altering shock for many, it will also postpone any inflationary effects. I am not an economist but, to my way of thinking, the Fed would need to first “replace” this lost wealth of some $20 trillion via the creation of new money before any inflationary effect can work itself through the economy.
The change of lifestyle along with saving more and spending less will also contribute to the current deflationary environment staying with us for some time to come. I believe that those betting on a fast return to growth and inflationary times lurking right around the corner will be sadly mistaken.
Here are some interesting highlights from “The VL Recovery:”
So we’re used to the idea of a preferred V recovery and the dreaded L-shaped recovery that we associate with Japan.
We’re also familiar with a U-shaped recovery, and even a double-dip like 1980 and 1982, the W recovery. Well, what I’m proposing could be known as a VL recovery (or
very long), in which the stimulus causes a fairly quick but superficial recovery, followed by a second decline, followed in turn by a long, drawn-out period of sub-normal growth as the basic underlying economic and financial problems are corrected.
I must admit that I have never heard of a VL type of recovery, but I find myself agreeing with its concept wholeheartedly.
As far as the market is concerned, we may be already in the rising part of the “V” (the superficial recovery), which then should be followed by a second decline. I have in the past referred to the recovery portion as a bear market rally but only time will tell if and when this VL concept comes to pass and if the next down-leg is upon us.
I believe things will play out like this to some degree. Since we are following trends, the type of recovery, nor the length of it, has really no bearing on our investment decisions. When a trend comes to an end, for whatever reason, we get out of our positions, head for the sidelines and wait for the next opportunity.
Unfortunately, those investors simply buying and holding, with no plan to ever exit the markets, will be paying a steep price for ignorance by watching their portfolios get annihilated again.