Date: Sat, Nov 26, 2016 at 2:26 PM
Subject: On Grantham's Take on the Current Market; Fat Intake and Diabetes 2!
Hi!,
As long time readers of my newsletter well know, I have long been a fan of Jeremy Grantham (co-founder of the value investment manager GMO) as he has a uniquely insightful perspective on markets, drawing on his 50 plus year investment experience and his deep knowledge about financial history. He writes a quarterly newsletter and the latest one is a masterpiece and provides his perspective on the current market – i.e. whether we are in a classic bubble and how it is likely to play out over the coming years. To summarise:
-Grantham has revised his previous view that we are nearing a classic bubble (2300 on the S&P – about 8% higher than current levels), which would eventually burst in the traditional way (i.e. a 50% or more decline in prices). The previous view was based on his preferred statistical gauge for identifying bubbles – a 2–standard- deviation (2-sigma) move upwards over long term historical averages.
-However, the other yardstick to identify bubbles – "excellent fundamentals irrationally extrapolated" is not present in today's market. Another powerful force which has been playing a critical role is the 35 year decline in interest rates (aided by the Fed and shifts in the global economy over the last 20 years – see chart below) which has reduced the discount rate to value all assets by 2-2.5% compared to previous periods.
-There are three possible market scenarios which could unfold going forward: it crashes over 2 years, falls steadily over 7 years, or "whimpers" sideways over 20 years. However, under all three scenarios the expected returns for long term investors are likely to be a lot lower than those based on history. The most likely scenario is the whimper over 20 years for the following reasons:
-Classic bubbles are characterised by exceptionally favourable fundamentals in areas like productivity, technology, employment, capacity utilization together with a favourable geo-political environment. They are all absent today.
-Bubbles also require investor euphoria, extrapolating good fundamentals into the future. All four modern classic bubbles (1929 US equity bubble, 1989 Japanese equity bubble, 2000 U.S. tech bubble and the 2007 US housing bubbles) have risen at an accelerating pace during the last 2 to 3 years and then fall even faster (see charts below)
-Today the market lacks both excellent fundamentals and the euphoria required to unreasonably extrapolate them. Investors today remain nervous - willing to buy long-term bonds that guarantee zero real returns, cash reserves are high and confidence measures are low. This is reflected in the sideways market over the last two and a half years (see chart below).
-All stock and housing bubbles coincide with credit bubbles (see first chart below of the 1989 Japanese bubble - the US 2000 tech bubble and the US housing boom of 2006 also had a similar feature) but a broad-based credit boom does not exist today (see second chart below).
-So the current market does not exhibit most features of a classic bubble except for one important one – the market is extremely overpriced by historical standards and is almost at bubble levels. Can this apparent contradiction be reconciled?
-The key factor behind this is lthe 2 to 2.5% decline in interest rates over the last 35 years (and in particular over the last 20 years driven by the Fed and other factors) which has forced down expected returns for all asset classes (see table below).
-The dominant factor behind this relentless fall in rates has been a sustained Fed policy (since about 1995) to push down rates , which spread like a virus to longer term government bonds, corporate bonds, high yield stocks and eventually to all stocks, real estate and farming. Other factors like the high levels of Chinese savings, low growth, demographics, inequality are also likely to have played a part.
-While this decline in rates was not a one way trend, as rates did have cyclical periods of increases (they rose by 430 basis points from 2002 until 2006) to counter higher growth and employment, asset prices continued to rise due to the impact of the "Fed put". Investors came to rely on the Fed to bail them out by lowering rates in the event of market downturns, resulting in a downward trend in rates with lower highs and lows.
-Looking forward, there is no reason to believe that rates will regress all the way back to their historical average. What is more likely is a partial regression and that the 1945-2005 era was a golden era of growth which is unlikely to be repeated for at least a few decades. Lower productivity, an aging and slow growing population is likely to lower the demand for capital and thereby lower returns. The current Fed policy of influencing the economy by lowering rates is also unlikely to go away entirely for the foreseeable future. A possible future path for rates is a slow rise back to two-thirds of the historical average over the next 20 years.
-In addition, the relentless rise in corporate margins over the last 20 years seems to be due to slow moving structural reasons and a rapid decline to old averages in unlikely. A possible future path is also a slow trend down over the next 20 years, to two-thirds of historical norms.
-Normal bear markets (drops of 15-20%) can always occur in the interim – but for the purpose of this analysis are short-term noise. Global and domestic political shocks have historically been short-lived , as have been domestic economic shocks.
-With these assumptions, expected returns for US equities over the next 20 year under a "whimper" flight path are 2.8%, 4% for the rest of the developed world and 5.3% for emerging market equities. Remarkably, the other two flight paths (a 7 year slump and a 2 year crash followed by 18 years of full returns) also provide similar expected returns.
-The key to maximising returns in this difficult return environment going forward is to rank the expected returns of different asset classes more correctly than not – this has been an important determinant of their extra returns in previous years as well.
-Brilliant work as usual and further bolsters my longstanding case for EM assets (stocks and bonds). In a low expected return world having a more significant weighting to EM assets (at the expense of DM assets) is likely to be even more critical to eke out the extra performance.
Fat is the Cause of Type 2 Diabetes:
Dr. Michael Greger, November 17th, 2016 http://nutritionfacts.org
-Studies dating back nearly a century noted a striking finding: If you take young, healthy people and split them up into two groups—half on a fat-rich diet and half on a carbohydrate-rich diet—we find that within just two days, glucose intolerance skyrockets in the fat group. The group that had been shovelling fat in ended up with twice the blood sugar. As the amount of fat in the diet goes up, so does one's blood sugar. Why would eating fat lead to higher blood sugar levels? It would take scientists nearly seven decades to unravel this mystery, but it would end up holding the key to our current understanding of the cause of type 2 diabetes.
-The reason athletes carb-load before a race is to build up the fuel supply within their muscles. We break down the starch into glucose in our digestive tract, it circulates as blood glucose (blood sugar) and is taken up by our muscles to be stored and burnt for energy.
-Blood sugar, though, is like a vampire. It needs an invitation to come into our cells. That invitation is insulin. Insulin is the key that unlocks the door that lets glucose in the blood enter muscle cells. When insulin attaches to the insulin receptor on the cell, it activates an enzyme, which activates another enzyme, which activates two more enzymes, which finally activates glucose transport.
-What if there was no insulin? Blood sugar would be stuck in the bloodstream banging on the door to our muscles, unable to get inside. With nowhere to go, sugar levels in the blood would rise and rise. That's what happens in type 1 diabetes: the cells in the pancreas that make insulin get destroyed, and without insulin, sugar in the blood can't get out of the blood into the muscles, and so blood sugar rises. But there's a second way we could end up with high blood sugar.
-What if there's enough insulin, but the insulin doesn't work? The key is there, but something's gummed up the lock. This is insulin resistance. Our muscle cells become resistant to the effect of insulin. What's gumming up the locks on our muscle cells? What's preventing insulin from letting glucose in? Tiny droplets of fat inside our muscle cells, so-called intramyocellular lipid.
-Fat in the bloodstream can build up inside the muscle cell, creating toxic fatty breakdown products and free radicals that block the insulin signalling process. No matter how much insulin we have in our blood, it's not able to sufficiently open the glucose gates and blood sugar levels build up in the blood. And this can happen within three hours. One hit of fat can start causing insulin resistance, inhibiting blood sugar uptake after just 160 minutes.
-This mechanism by which fat induces insulin resistance wasn't known until fancy MRI techniques were developed to see what was happening inside people's muscles as fat was infused into their bloodstream. That's how we found that elevation of fat levels in the blood causes insulin resistance by inhibition of glucose transport into the muscles.
-We can also do the opposite experiment. Lower the level of fat in people's blood and the insulin resistance comes right down. If we clear the fat out of the blood, we also clear the sugar out. That explains the finding that on the high fat, ketogenic diet, insulin doesn't work very well. Our bodies become insulin resistant. But as the amount of fat in our diet gets lower and lower, insulin works better and better—a clear demonstration that the sugar tolerance of even healthy individuals can be impaired by administering a low-carb, high-fat diet. We can decrease insulin resistance, however, by decreasing fat intake.
-The most concerning downside of low-carb diets, though, is heart health. This is the first of a 3-part series on the cause of type 2 diabetes, so as to better understand dietary interventions to prevent and treat the epidemic
Here's to naturally cutting down on fat intake by eating more grains, plants and fruits!
Regards,
Aditya
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