Equities: Sluggish Recovery?

Jeremy Grantham, chief investment strategist of GMO, writes in his latest quarterly letter that the bursting of the two most recent equity bubbles was historically unusual in that stock prices soon recovered to their trend. The next bust, he writes, may not be as forgiving.

http://www.gmo.com/websitecontent/JGLetter_ShortestLetterEver_3Q11.pdf

Another way of looking at the situation is that these two recoveries were bear traps.

Note he called the 2008 crisis before it was fashionable, and he was never someone who was forever and a day prophesying the end is nigh.

What if there is stagnation?

A few days ago, I blogged that were three scenarios for the developed world. Growth — buy equities; inflation — buy property and commodities; and recession — buy government bonds.

Thinking about it again, there is a  fourth scenario: stagnation. There will be shallow recoveries and recessions in quick succession.

In that scenario, one should be looking at buying equities for their dividend yields, and the corporate bonds of super blue chips.

Where be the next winner?

Depending on where the developed world heads, equities, commodities and property, or government bonds could be the investment.

There are three scenarios for the developed world (remember the BRIC and Indonesia etc still are dependent on the developed world to drive their economies). It can

– grow out of its debt burden,

–  inflate the debt away, or

–  fall back into recession, marked by the occasional default.

Each of those outcomes leads to a different portfolio.

Renewed growth would favour equities, but at the moment, this looks too hard to achieve. An attempt to inflate would be good for commodities and property but would be disastrous for government bonds. Selected equities might do well: those that can pass on the cost rises to customers. Those bonds would do best if the developed world goes into a  recession.

Hope this explains the extreme volatility of markets.

Better for gold, worse for stocks

David Ranson of Wainwright Economics:

When gold was up more than 20% over five years, the median return from largecap stocks was 2.1%

When gold was up less than 20%, the median return from stocks was 44.7%

When gold was unchanged, the return was 52%.

When gold fell less than 20%, the return was 68.7%.

When gold fell more than 20%, the median return was 99%.

… the better for gold, the worse for stocks. Which makes the simultaneous strength of gold and equities today look all the odder.

Thanks Buttonwood