Last message we introduced an article from Barron’s that interviewed Jeremy Grantham one of Wall Street’s most respected investment managers.
One of the comments that Grantham made in that interview was that Timber isthe only low-risk, high-return asset class in existence because people arenot familiar with it. What they are not familiar with they avoid. Hebelieves that timber is the only commodity that has had a steadily risingprice for 200 years, 100 years, 50 years, 10 years. And a unit of wood,just the price of a piece of wood — in real terms — beat the S&P overmost of the 20th Century, from 1910 to 2000. The price of a piece of woodactually outgrew the price of a share of the S&P, which is an unfaircontext, because there is some growth embedded in the share of the S&P andthere is no growth embedded in a single cubic foot of wood. The yield fromtimber averaged about 6.5%. The yield from the S&P averaged 4.5% Thecurrent yield on the S&P is 1.25% and the current yield on timber is 6.5%.In each of the three great past bear markets that I’ve referred to –1929-’45 and 1965-’82, and a third one that’s off everyone’s radar screen,which is post-World War I, 1917-’25 — the price of timber went up. It isthe only reliably negatively correlated asset class when you really needit to be. One reason for that is you can withhold the forest. If you findthe price of lumber is no good, you don’t cut. Not only is there no costof storage, the tree continues to grow and it gets more valuable. Granthamfeels this is a virtue.
Timber has been one of my favorite recommendations for some time so I could not agree more.
Grantham is also keen on emerging-market stocks because people have lost alot of money and the stocks have crashed. He feels if we look back 10years emerging equity was not cheap at all. Emerging equity sold at ahigher P/E than the S&P eight years ago. Now his portfolio trades at 6½times earnings and he has not seen anything like that since 1974. This isan incredible difference to the S&P at 26 times earnings.
The sectors Grantham is excited about right now begins with REITs. Hefeels they are still the best group in equities that you can buy, closelyfollowed by international small-cap value. Not only does internationalsmall-cap value have a 6.8% real embedded return in our opinion, but thestocks have a very nice currency kicker on a 10-year horizon. He alsofeels that data suggests that U.S. dollar is vulnerable and expects a1%-3% per year compounded bonus from currency for international small-cap.
He also feels that U.S. small-cap value look good.
All three of the categories above in his opinion have had big runs and allof them have moved substantially back toward trend. But none of them are attrend. Small-cap value, for example, has another 30-40 percentage points torun against the market before it goes back to trend. These are big numbers.What was typical in the ‘Seventies, by the way, was the continuedyear-after-year dominance of small-cap value.
These favorites are based on a 10-year forecast as he says he does nothave the faintest idea what will happen ion the next year. He feels theshort term is unknowable and in an uncertain world, it should be unknowable.
When asked in the article why he felt so strongly about these terns hereplied, “Intellectuals say if you can’t predict the short term, how canyou be certain about it reverting to trend in the long run, when the longrun is just made up of a series of short runs? It’s an elegant question andit took me a long time to find a thought experiment to answer it. Here’sthe thought experiment: Think of yourself standing on the corner of a highbuilding in a hurricane with a bag of feathers. Throw the feathers in theair. You don’t know much about those feathers. You don’t know how high theywill go. You don’t know how far they will go. Above all, you don’t know howlong they will stay up. You know canaries in Jamaica end up in Maine oncein a blue moon. They just get swept along for a week in a hurricane. Yetyou know one thing with absolute certainty: Eventually on some unknownflight path, at an unknown time, at an unknown location, the feathers willhit the ground, absolutely, guaranteed. There are situations where youabsolutely know the outcome of a long-term interval though you absolutelycannot know the short-term time periods in between. That is almostperfectly analogous to the stock market.
The international weighting in Gratham’s portfolio is getting lessexpensive than the U.S. and he explained why by saying, “the currency islooking promising. Currency appears to be mean-reverting like everythingelse. The trouble is, it can take so long to revert you die of old age. Thenumbers suggest that the foreign markets are substantially overpriced butmuch less so than the U.S. now. International large-cap value can probablygive a real return of 4%, and U.S. large-cap value only 1.5%. Internationalincludes Europe and Asia but not emerging countries. Emerging countries arequite different. They have had their bloodbath. The index of the wholeemerging equity market trades at a multiple of 8.5 times earnings. Itshould probably be 15 or 16 like everybody else. So sooner or later that isgoing to be 15 or 16 times earnings, just as sooner or later the U.S. isgoing to be 17.
In tomorrow’s message we will view the best valued internationalmarkets recommended by another Wall Street expert Michael Keppler. Untilthen, good global investing and business!