Grantham's words of wisdom: Part I - Views on News from Equitymaster

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Grantham's words of wisdom: Part I

Mar 20, 2013

A little boy walking around the historical Roman fort in the English town of Doncaster, perhaps would have never thought that he would become a commanding authority in investments. It wouldn't be unreasonable to assume that he had not heard about the word, Economics. The little boy grew up. He became a student of Economics with The University of Sheffield, UK. Post completion of the degree, he started working with Royal Dutch Shell. It was here that his fascination with 'oil' began. Later on, an MBA from Harvard sharpened his finance and investment skills. Finally, in 1977 he became the co-founder of the Boston, US head-quartered firm, Grantham Mayo Van-Otterloo, popularly known as GMO. Yes, we are talking about none other than the legendary British investor, Jeremy Grantham.

Equitymaster presents the legend's views on three aspects. Those were revealed on the Charlie Rose show held in this month. The first part of the three series article would present Grantham's views on US economic growth, China's rise and its impact on resources. The second part on Grantham's experience in spotting 'market bubbles' and navigating safely through them. The third and final part would focus on his views on the elevated debt levels prevailing in America.

Views on US Economic Growth, China's rise and its impact on resources

Jeremy Grantham was categorical in pointing out that the premise of US reverting back to 3% growth level is a myth. He believes that the current US population growth in the range of 0.2-0.3% is here to stay. Further, productivity of the average US worker has dwindled over the years. In the last thirty years, productivity has been 1.3% a year. The figure had ranged between 1.7% and 1.9% in the forty years post World War II. Thus, even if one holds the productivity figure constant at 1.3%, the GDP growth works out as 1.5%. That is a far cry from 2.5% to 3% growth, projected by the IMF and World Bank.

Commenting on natural resources and their price levels, Grantham added that when the price of natural resources was declining as it did for a 100 years up until about 2000, people were effectively more well-off. The GDP growth was reflected by more of 'value addition' than 'cost of natural resources'. However, between 2002 and 2008 commodity prices shot up steeply. The rise was enough to compensate the fall that had happened in the 100 years till 2000. That was because of an enormous surge in China. China today consumes 53%, 47% and 46% of the world's cement, coal and iron-ore production respectively. So, even if China's growth rate stalls at 7% per annum, it will still continue to gobble up resources in huge quantities. That is the reason why 'oil' which averaged at around US$25 a barrel in 2000 is currently above the US$100 mark. Grantham believes that the long term range of oil in the 'new world' would be around US$ 80-85.

We agree with Jeremy Grantham on both counts. Much of the growth in the US in the past couple of decades had been debt and credit fuelled rather than being productivity driven. And with saturation having reached as far as credit is concerned, the US will have to settle for the new normal of lower growth rates.

Further, investors should also accept the fact that commodity prices have reached a higher plateau on a permanent basis. Thus, they will have to try harder than ever to reduce its impact on margins and improve quality of earnings.

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