(By Jeremy Grantham)The good news is that we have not fallen off into another Great Depression. With the degree of stimulus there seemed little chance of that, and we have consistently expected a global economic recovery by late this year or early next year.
The operating ratio for industrial production reached its lowest level in decades. It should bounce back and, if it moves up from 68 to 80 over three to five years, will provide a good kicker to that part of the economy. Inventories, I believe, will also recover.
In short, the normal tendency of an economy to recover is nearly irresistible and needs coordinated incompetence to offset it – like the 1930 Smoot-Hawley Tariff Act, which helped to precipitate a global trade war. But this does not mean that everything is fine longer term.
It still seems a safe bet that seven lean years await us.
Corporate profit margins [excluding financials] 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 (P/E) ratios, adjusted for even normal margins, are also significantly above fair value after the rally.
Fair value on the Standard & Poor's 500 Index 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 [the] market [as of Oct. 19, when the S&P 500 closed at 1,097.91] at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% down by more than 3% a year. [Editor's Note: The S&P 500 closed yesterday (Tuesday) at 1,093.01 - essentially in the same neighborhood as the Oct. 19 close that Grantham referenced].
Doesn't it seem odd that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal? Major imbalances are unlikely to be quick or easy to work through. For example, we must eventually consume less, pay down debt, and realign our lives to being less capital-rich.
Global trade imbalances must also readjust. To repeat my earlier forecast, I expect developed markets to grow moderately less fast – about 2.25% – for the next chunk of time, and to look pretty anemic compared to emerging countries growing at twice that rate.
