On Are we in a Bubble?; Emerging Markets for the Long Haul; Healthy Eating and the Brain?

From: aditya rana
Date: Sat, May 9, 2015 at 2:06 PM
Subject: On Are we in a Bubble?; Emerging Markets for the Long Haul; Healthy Eating and the Brain?


With the S&P 500 index hovering around record highs, it is legitimate to ask whether the U.S. stock market is in bubble territory. This question has implications on the vulnerability of the market to a possible rate hike by the Fed later this year. Jeremy Grantham, co-founder of the value manager GMO, provides helpful insights into this issue as well as an update on the long-term trend growth rate of the U.S. economy. To summarise:

-Grantham has argued for several years that the long-term trend growth rate of the U.S. economy has been reduced to 1.5% versus the Fed’s continued optimistic estimate of 3%. The lower growth rate is driven by three key long-term trends: negligible growth in the population, falling man-hours worked and the rise in the oil prices from $16/barrel (100 year trend pre-1972) to the current trend of $75 (with considerable volatility around these long-term trends – $8 to $32 during the pre-1972 era and $37 to $150 around the current trend).

-The IMF, in their annual economic outlook, has also reduced their long-term growth forecast for advanced economies to about 1.5%. However, they and other mainstream economists continue to ignore the crucial limiting resource factor , focusing instead only on the traditional factors – labour, capital and productivity.

-The Fed is likely to continue supporting the stock market until we get a fully fledged bubble – as they did to U.S. growth stocks until 2000 and the U.S. housing market until 2006. These were both three sigma events and the biggest equity and housing bubbles in history.

-We are not at bubble levels yet. GMO estimates (based on historical prices) that a bubble (which they describe as a two sigma event) level for the S&P 500 index would be 2,250 which is about 5-10% higher than current levels. Looking at this from the perspective of the two best measures of value – Shiller P/E and Tobin’s Q – we would need to add another 5-10% to the bubble threshold.

-Subsequent to the Greenspan era (from 1987 and still running in terms of the Fed’s policy to support asset prices to achieve a wealth effect) the Shiller P/E has been an additional 60% higher than previously, implying an even higher threshold (see chart below).

-In addition, and more importantly, the current economic cycle seems only at the mid-way stage due to the continued labour slack as reflected by the relatively low labour participation rates (for males as well as females).

-There is also room for an increase in capital spending, with the current capex level being lower than any level from 1950 until 2007 (see chart below).

-The lower oil prices should also have a larger stimulus effect on growth over time (though not on global growth as highlighted in the previous letter).

-The U.S. housing market has further room for improvement over the next two years, with both prices at long-term fair value and the number of houses being built below the old average.

-The quantity of M&A and co-investment deals are likely to rise to record levels before this cycle ends, due to unprecedented low rates and the low levels of capital spending – which will benefit stockholders but have a negative impact on long-term growth and employment.

-While a modest (and temporary) bear market (a 10-20% fall) is possible given the all global risks which exist, it will only make this bull market lasting until the next elections more likely. It would be unusual to have a Fed-driven cycle to end before the economy is working at full steam – like in 1929, 2000 and 2007 – the biggest equity bubbles of the last 100 years.

-Great insights (as usual) from Grantham and further bolsters the case for the approach suggested in previous newsletters – adding on sharp market corrections and reducing on strong rallies – as the Fed (and global central bank) driven bull markets continue around the globe. While the Fed is likely to raise rates this year, it will the pace of subsequent rate increases which really matter and they are likely to be subdued compared to previous rate cycles.

EM for the Long Haul?

-I have long advocated the value of investing in emerging markets over the long term (multi-decades) as they offer vastly superior returns (in dollars) compared to developed markets. Yes, they are much more volatile, and less liquid than developed markets, but for individual investors who are not affected by short-term volatility and the constraint of index-weighted investing, they offer stupendous opportunities for patient investors. Some fascinating data from the technical analyst firm EWI and from other public sources:

-Since the founding of the Republic of Singapore in 1965, the stock market index increased by 158 times in U.S. dollar terms from until its high in October 2007, compared to only 18 times for the S&P 500. Over the same period, the Hang Seng did even better – increasing by 253 times in U.S. dollar terms (see chart below).


-Since the founding of the Indian Sensex index in 1979, and despite a 86% depreciation in the rupee, the index increased 35 times in dollar terms versus 21 times for the S&P (which included the longest bull run period for the U.S.- from 1982 until 2000)

-Since the launching of the Shanghai Composite Index in 1991, the index has increased 33 times in U.S. dollar terms (with a 15% depreciation of the currency) versus 6.5 times for the S&P index.

-As I mentioned in a recent newsletter, we are likely to be in the early stages of a long-term secular bull market in China – and while it will be rather volatile (given that the market is dominated by domestic retail investors), for patient investors it should ultimately be a very rewarding experience. International institutional investors remain grossly underweight China (at about 2.5% of the global index), versus its stock market being 9.3% of global stock market capitalization and its GDP at 15% of world GDP. As China gradually opens up its capital account (the inclusion of the Rmb in the IMF SDR basket would be an important step), global weighting in the Chinese stock market can only go up.

Healthy Eating and the Brain?

Ayurveda recommends a healthy diet and lifestyle, not just for maintaining a healthy body, but a healthy mind as well. A recent study corroborates this observation:

PRCM May, 2015:

-A healthful diet may reduce your risk for cognitive decline, according to a study published in Neurology. Researchers analyzed diet records and cognitive health tests from 27,860 men and women as part of the ONTARGET and TRANSCEND studies. Those who consumed the most fruits, vegetables, and whole grains had the lowest risk for cognitive decline after a 56-month observation period. This study hopes to shed more light on diet’s potential to curb cognitive decline.

Smyth A, Dehghan M, O’Donnell M, et al. Healthy eating and reduced risk of cognitive decline: a cohort from 40 countries. Neurology. 2015;84:1-8.

Here’s to keeping a healthy mind (in a healthy body) by eating “whole foods, a little less, and mostly plants”!




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