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The Downturnaround Is Here

(Photo: Joseph Van Os/Getty Images)

Perhaps I’m primed to believe Shilling’s more negative predictions, but they do seem convincing. While oil has started to climb again, and many analysts warn that hyperinflation is right around the corner, many prices are falling—houses, cars, shoes, handbags. Fabulous time to be a shopper, but as producers, which we all are, in one way or another, we suffer. After talking to Shilling, I feel like recovery in New York will be a slow grind, indeed—like a marathon, but not the kind run by Kenyans. More like the kind run by Vinnie from Queens, puking the last ten miles but eventually crossing the finish line.

Yes, a Recovery Is at Hand, but It’s a Fake!

Illustration by Kevin Christy
Jeremy Grantham

Like Shilling, Jeremy Grantham entered 2008 bracing himself for the worst. Then again, Grantham is what’s known as a “permabear,” so he’s pretty much always braced for the worst. But what separates Grantham from most permabears is that he manages $78 billion (for the Boston-based firm GMO). Which means that he can’t simply indulge his pessimism-porn fantasies.

Grantham, a 70-year-old Englishman, moved to the United States in the sixties to go to Harvard Business School, then worked as an investment manager before cofounding GMO, in 1977. He is a devout believer that markets always, always, always revert to long-term trend lines, which makes him a curmudgeon during boom times, when prices fly off the charts. His quarterly letter for investors has become a must-read of the stock-market intelligentsia: erudite, witty, and often bristling with moral outrage. For years, his favorite whipping boy was Alan Greenspan, the former Fed chairman, whom he saw as putting the U.S. economy on the road to ruin by allowing the housing and finance bubbles to inflate unchecked. This became the conventional wisdom, but Grantham was slagging him when Greenspan was still a wildly popular sage. According to Grantham, Greenspan understood as early as in 1997 that a bubble was forming but did nothing to temper it. Instead, “he became an efficient market advocate suddenly and started talking about ‘Who am I to disagree with tens of thousands of well-informed investors?’ In other words, the market knows best, which is of course the most sublime bullshit possible.”

Grantham saw an era coming to a shattering conclusion. “We’ve had a very sympathetic marketplace for 25 years,” he told me last May, after Bear Stearns failed, but before Lehman Brothers did. “We’ve had inflation coming down, the Russians folding up their tent, China becoming fully fledged capitalists. India finally cutting through a little of their red tape. It’s been a heavenly environment.”

Grantham has a pet theory he calls “the presidential-cycle effect.” Going back 75 years, he discovered that the stock market tends to perform best in the third year of a presidential term—because that’s when incumbent administrations need to demonstrate to voters that they deserve reelection. So they goose the economy with spending while the “independent” Federal Reserve chairman obliges with rate cuts. In the first year of an administration, the stock market typically does least well, because policymakers save their bullets for closer to the election.

The financial crisis, however, has thrown the presidential cycle out of whack. The need to stabilize the economy and calm nerves has turned Obama’s first year into a “year three”–like environment of low rates and megastimulus. That sets up the stock market to do very well, potentially hitting as high as 1,100 on the S&P by the end of the year, which is consistent with Gordon’s outlook.

But whereas Gordon forecasts relative stability from there, Grantham sees a dramatic pullback and then a long muddling-through period that will be a “life-changing shock for hundreds of millions of people,” he wrote in his May 2009 quarterly letter, titled “The Last Hurrah and Seven Lean Years.” “No longer as rich as we thought—undersaved, underpensioned, 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.”

According to Grantham, we have the government bailout to blame for the coming lean years. “If we had let all the reckless bankers go out of business, we would not have blown up our houses or our factories or carted off all our machine tools to Russia, nor would we have machine-gunned any of our educated workforce, even our bankers!” he wrote. “Moral hazard would have been crushed, lessons learned for a generation or two, and assets would be in stronger, more-efficient hands. Real economies are much more resilient than they are given credit for. We allow ourselves to be terrified by the ‘financial-industrial complex,’ as Eisenhower might have said, much to their advantage.”