Jeremy Grantham (GMO): Lighten Up On Risk-Taking; QE3 Required To Keep Speculative Game Going

Source: GMO
Jeremy Grantham, co-founder and chief investment strategist of GMO LLC, which manages $108 billion in client assets, released part 2 of his Q1 Investment Letter. He thinks you should "lighten up on risk-taking now and don't wait for October 1 as previously recommended". He did say QE3 could keep the "speculative game going" though, but it is a risky bet.

GMO May 2011 Quarterly Letter: "Time To Be Serious (and probably too early) Once Again"
"With these headwinds, I do not feel the same degree of confidence that I did, which was considerable, that the Fed could carry all before it until October 1 of this year. A third round of quantitative easing would very probably keep the speculative game going. But without a QE3, there seem to be too many unexpected (indeed unexpectable) special factors weighing against risk-taking in these overpriced times. I had recommended taking a little more risk than was justified by value alone in honor of Year 3, QE2, and the Fed in general. Risk now should be more reflective of an investment world that has stocks selling at 40% over fair value (about 920 on the S&P 500) and fixed income, manipulated by the Fed, also badly overpriced."

"The market may still get to, say, 1500 before October, but I doubt it, especially without a QE3, although the chance of going up a little more by October 1 is probably still better than even. And whether it will reach 1500 or not, the environment has simply become too risky to justify prudent investors hanging around, hoping to get lucky. So now is not the time to float along with the Fed, but to fight it. Investors should take a hard-nosed value approach, which at GMO means having substantial cash reserves around a base of high quality blue chips and emerging market equities, both of which have semi-respectable real imputed returns of over 4% real on our 7-year forecast. The GMO position has also taken a few more percentage points of equity risk off the table."

David Einhorn is Still Short St. Joe and Moody's, Buys Yahoo (Greenlight Q1 Letter)

According to David Einhorn's Q1 2011 Investment Letter (released on April 29, 2011 courtesy of DealBreaker.com), Greenlight Capital is still short Moody's (MCO) and St. Joe (JOE), and recently went long Yahoo (YHOO). And now value investor Whitney Tilson, of T2 Partners, has JOE as his largest short position. I'll get into that next. Read Einhorn's amazing report on St. Joe: "Field of Schemes: If You Build It They Won't Come". Per my proprietary valuation models, JOE is worth $7-$15 a share and Yahoo is worth $31-$33 a share. In my next post on Whitney Tilson I'll dig into the longs and shorts in JOE.
"We kept our highest conviction older ideas (including MCO and St. Joe) and our highest conviction newer ideas (including the energy-technology stocks described above)."

House Speaker Boehner on the Debt Ceiling (Economic Club of New York, 5/9/2011)

The $14.29 trillion debt ceiling is officially in play and Congress has to decide whether to raise it again, and under what conditions. I'm going to post different views on the situation (next David Stockman). Below is the video and transcript of House Speaker John Boehner's remarks at the Economic Club of New York on 5/9/2011. Richard Koo, chief economist at the Nomura Research Institute, believes the U.S. could follow the path of Japan if we cut government spending and borrowing too early after the bursting of a nationwide asset bubble (see INET conference and Bloomberg TV videos). However, even Ben Bernanke, the Chairman of the Federal Reserve, has said that the U.S. must address its budget deficit and national debt. From Bernanke's speech in October 2010:

"Over the medium- and long-term, however, the story is quite different. If current policy settings are maintained, and under reasonable assumptions about economic growth, the federal budget will be on an unsustainable path in coming years, with the ratio of federal debt held by the public to national income rising at an increasing pace.2 Moreover, as the national debt grows, so will the associated interest payments, which in turn will lead to further increases in projected deficits. "

Quotes from John Boehner's address to the Economic Club of New York (read the full transcript below if you can't watch the video):

“It's true that allowing America to default would be irresponsible. But it would be more irresponsible to raise the debt ceiling without simultaneously taking dramatic steps to reduce spending and reform the budget process.

“To increase the debt limit without simultaneously addressing the drivers of our debt -- in defiance of the will of our people -- would be monumentally arrogant and massively irresponsible.

“It would send a signal to investors and entrepreneurs everywhere that America still is not serious about dealing with our spending addiction.

“It would erode confidence in our economy and reduce certainty for small businesses. And this would destroy even more American jobs.

“So let me be as clear as I can be. Without significant spending cuts and reforms to reduce our debt, there will be no debt limit increase. And the cuts should be greater than the accompanying increase in debt authority the president is given.

“We should be talking about cuts of trillions, not just billions.

Greece 5Y Credit Default Swaps At 1372; Up From 399 a Year Ago (Greece 5Y CDS Chart)

Greece 5Y CDS (Bloomberg)
Greece 5Y CDSs (credit default swaps) are trading at 1372bps, up from 399bps in January 2010 ("1/30/2010: Pricing of Greek CDS, 10Y Bond Yields Sense Risk (CDS 399bps, 10Y 6.85%"). That is up 243% in a year and three months folks. Did you (or Greece?) scoop some in your retail brokerage account? Ha. Anyone know when CDS will be available for retail consumption? E-mini CDS? Credit default swaps are insurance policies on debt that are priced in basis points per year (the premium or spread). Greece 5Y credit default swaps, similar to CDS on subprime mortgage-backed securities in 2007/8, have been rising for three years now and reflect the country's poor financial health. For more information read announcements made by S&P and Moody's a few days ago. To your left is the 5 year chart of Greece 5Y CDS via Bloomberg.

Recent articles:

Greece restructuring ‘only a matter of time - eFinancialNews

EU and IMF start key Athens visit as Greeks strike - Reuters

EU paymaster Merkel guarded on new aid for Greece - Reuters

Greece will need more aid (Official says Athens hopes for a new $86 billion financing package) - WSJ

Milligan Says `Ultimately' Greece Must Restructure Debt - Bloomberg Video via Washington Post

Roubini’s guide to a Greek debt restructuring - FT Alphaville

Greece taps markets after rating cut, EU mulls help - Reuters
"Greek Prime Minister George Papandreou lashed out at financial markets late on Monday, accusing them of lack of transparency and corruption.

"Profiteering, CDS, derivatives traded without any transparency are threatening to blow up whole countries," he told an anti-corruption conference." /
ouch

S&P Downgrades Greece to B; Moody's Places Greece B1 Bonds On Review For Possible Downgrade; 2-Year Greek Bonds Yield 25%

Source: Wikimedia Commons
Before reading these announcements, look at what Greek bonds are yielding as of May 10, 2011. Click the link for the Bloomberg quote.

3-month Greece Government Bond 8.06% (updated on May 9); 
6-month Greece Government Bond 6.13%;
1-year Greece Government Bond 6.26%;
2-year Greece Government Bond 25.17%;
5-year Greece Government Bond 16.377%,
10-year Greece Government Bond 15.43%,
30-year Greece Government Bond 10.41%.

From Moody's Investors Service yesterday:
"Moody's places Greece's ratings on review for possible downgrade

London, 09 May 2011 -- Moody's Investors Service has today placed Greece's B1 local and foreign currency government bond ratings on review for possible downgrade.

Moody's decision to initiate this review was prompted by:

(1) revisions to fiscal metrics, most notably the significant upward revision of the 2010 general government deficit;

(2) increased uncertainty about the sustainability of Greek sovereign debt in the context of potential delays in the achievement of fiscal consolidation targets; and

(3) concerns about the probability and the implications of a delayed and weaker economic recovery.

Moody's review will focus on the factors that will drive the country's debt dynamics over the next few years.

Moody's says that a multi-notch downgrade is possible if it concludes that there is large risk that Greece's debt metrics are on an unsustainable path. In Moody's view, such conditions would materially increase the risk of debt restructuring over the short to medium term. Under such conditions, euro area policymakers have stated that future loans from the Exchange Stability Mechanism would be extended only if private creditors were to bear some of the losses. If the path of Greek debt-to-GDP were to appear unsustainable, then Greece might itself have an incentive to seek a change in the terms of its debt obligations." [continue reading at Moodys.com]

From Standard and Poor's on May 9, 2011:
"Ratings On Greece Lowered To 'B/C' From 'BB-/B' On Rising Rescheduling Risk; Remain On CreditWatch Negative

Nomura's Richard Koo Warns U.S. Could Repeat Japan's Mistakes! (INET Bretton Woods Video)

Source: Nomura
Richard Koo, Chief Economist at Nomura Research Institute, spoke at the INET Bretton Woods conference on April 6, 2011. Mr. Koo sees similarities between Japan's deflationary experience from 1990 to 2005 and the U.S. today (zero percent interest rates, QE2).

He first compared the US housing market (S&P/Case Shiller Home Price Index) to Japan's housing market when they crashed 14 years apart (2006 in the U.S; 1992 in Japan). I put up a snapshot of the chart. Read his slides while watching the video: The World in Balance Sheet Recession: What-Post 2008 U.S., Europe and China Can Learn From Japan 1990-2005 (Slides).

He strongly believes that once an economy experiences a nationwide asset bubble, the Government must step in to borrow and spend until the private sector recovers (finishes deleveraging balance sheets), or risk an economic crash. So how does the story end in the the U.S.? I'm hearing either Weimar Republic style hyperinflation, Japanese deflation or 70's style stagflation. FYI, according to Clear Capital's Home Data Index, U.S. home prices dipped below the March 2009 low in April (read more).

May 2011 Rail Report by AAR (Link)

The May AAR (Association of American Railroads) Rail Time Indicators report is packed with freight data and economic trends through April 2011. Find the archive here and weekly rail statistics here.

Clear Capital: U.S. Home Prices Dip Below March 2009 Low (4/2011)

According to Clear Capital's "Home Data Index™" (HDI), U.S. home prices through April 2011 dipped below the March 2009 low. Also this can't be good, "‘Underwater’ Homeowners Rise to 28 Percent: Zillow" (Bloomberg). Read the full report at Clear Capital.

Relative Index Value (Source: Clear Capital)
"Clear Capital® Reports National Double Dip

U.S. home prices double dip as West, South and Northeast regions fall prey to the last grip of winter.

TRUCKEE, CA – May 5, 2011 – Clear Capital (www.clearcapital.com) today released its monthly Home Data Index™ (HDI) Market Report, and reports prices have double dipped nationally 0.7 percent below prior lows experienced in March 2009. This month’s HDI Market Report provides the most current (through April 2011) and relevant analysis of how local markets performed compared to the national trend in home prices.

Report highlights include:
  • National quarterly home prices changed -4.9%; while year-over-year national price changes reached -5.0%.
  • National home prices have fallen 11.5% over the previous nine-month period, a rate of decline not experienced since 2008.
  • In a sign of the continued volatility and fragility of home prices, all the major Metropolitan Statistical Areas (MSA) tracked in this month’s report showed quarter-over-quarter price declines.
  • National REO saturation rate reaches 34.5%.

“The latest data through April shows a continued increase in the proportion of distressed sales that are taking hold in markets nationwide,” said Dr. Alex Villacorta, director of research and analytics at Clear Capital. “With more than one-third of national home sales being REO, market prices are being weighed down as many markets have not regained enough footing to withstand the strain of the high proportion of REO sales.

In light of the compounding effects of winter’s seasonal slowdown and increased distressed sale activity, the market now faces the true test of whether prices can rebound in the historically active spring season,” added Villacorta.

As national home prices reached new lows this past winter, hopes remain for a spring revival. Markets have entered uncharted territory, however, as this current home buying season will be the first since 2008 without any tax credit incentive. A note of caution to those looking for a strong end to 2011: The last time no incentives were in place and distressed inventories were this high, home prices fell sharply."

Read more at Clear Capital.

Updates: Gold, Silver, S&P, Treasuries, Munis, Greece, Housing, Fed (5/4/2011-5/9/2011)

Links to articles and videos on gold, silver, equities, munis, Treasuries, housing, Greece, EU rates and Fed governors.

Interview with Jim Rogers: Why Gold Can Go Higher (TheStreet.com) 5/9/2011

Deutsche Bank To Invest $1 Billion In Oil And Gold For John Paulson (ClusterStock) 5/9/2011

Kass: Sell the Rallies (TheStreet.com) 5/9/2011

Treasury Volatility Approaching Four-Year Low as Bonds Rally at End of QE2 (Bloomberg) 5/9/2011

Moody's Mulls Greece Downgrade On Debt, Recovery Concerns (WSJ) 5/9/2011

S&P cuts Greek credit rating to B (Financial Times) 5/9/2011 -EUR/USD is selling off; currently at 1.43581.

EU eyes lower rates for Greece, Ireland amid chaos (Reuters, CNBC Video)

Morgan Stanley Follows Goldman, Downgrades Economy (Zero Hedge) 5/8/2011

BOJ Warns Monetization May Lead To Severe Inflation, Rise In Long-Term Interest Rates; Yet Will Buy ¥350 Billion In Bonds (Zero Hedge) 5/8/2011

*Goldman Sachs Chief Equity Strategist David Kostin kept his 1,500 target on the S&P despite a H2 2011 GDP downgrade by GS economists (click the links to read more at Zero Hedge)