I always enjoyed reading the well written and erudite Interest Rate Observer by Jim Grant. It certainly had its share of miscues but it was always quite logical and it stimulated one’s thinking in an unconventional way. Barron’s interviewed Grant this weekend.
For the past 33 years, Grant’s Interest Rate Observer has chronicled the ups and downs of financial markets, its elegant prose and opportunistic investment ideas rendering it a must-read for countless investment professionals. Its founder and proprietor, James “Jim” Grant, 70, is a Navy veteran and an amiable bear who has prospered during the lengthy bull markets in equities and bonds, despite his avowed skepticism.
Grant inaugurated Barron’s Current Yield column in the 1970s—an era of inflation, monetary disorder, and upheaval in interest-rate markets, as he has observed. He founded Grant’s in 1983, and is viewed by many on Wall Street and elsewhere as one of the most astute market analysts around. Indeed, a presidential hopeful once called Grant his likely candidate for chief of the Federal Reserve.
Disorder and upheaval could also become the legacy of today’s disquieting trends, from explosive money growth in Japan to potential bank bailouts in Europe to populist politics that hint at greater government spending. The very thought put us in a mind to check with Grant about what might lie ahead.
Barron’s: Until recently, sub-zero was a brand of refrigerator. Now it is an interest-rate regime. Will it succeed in reviving national and regional economies?
Grant: No. It’s an experiment, isn’t it? I called up Dick Sylla, co-author of that page-turner titled A History of Interest Rates, which chronicles 5,000 years of interest-rate history. I said, “Dick, did you come across any examples of negative yields?” He said no. We are living in a unique time. Negative rates aren’t a naturally occurring phenomenon in finance but a creation of our ingenious central bankers. Furthermore, they seem to defy common sense. Interest rates exist because we want things now rather than later. That’s the nature of human desire. Negative interest rates turn that on its head. So they are a sign not of constructive policy making, but of trouble.
On the subject of policy making, you invented the term Ph.D. standard—not to be confused with the gold standard. What does it mean?
The Ph.D. standard is the regime of discretionary monetary management by former tenured economics faculty. Not much is new under the sun in finance, except for this regime of improvisation by college professors trying stuff because it looks good on a blackboard. What it means for investors is thrills and chills. Richard Feynman, the wonderful physicist who was such a wit and so wise about much in life besides physics, talked about cargo cult science, in which things have the appearance of scientific rigor but not the substance. That’s what characterizes the body of knowledge we know as macroeconomics. The people who deploy it are very well intended but very dangerous.
Where will it lead?
We’ve seen low rates beget lower interest rates, and radical policy making beget more radical policy making, because it doesn’t work. So we need something else, which seemingly invariably is a more intense form of price administration. You know interest rates are critical prices. They help us understand and measure in price risk, set investment hurdles, and discount future cash flows. These prices are increasingly under the thumb of government functionaries—the ones we call central bankers—and because that’s the case, asset prices have become distorted and the standard signposts of valuation have been twisted and turned.
We’re on the long, winding road to confetti—to the discrediting of fiat currencies. That is the end game. Adam Smith cautioned against being excessively bearish. One shouldn’t be dogmatic about when things will happen. But we’re on the road to an important perception that central bankers don’t have the answers and are in fact in the process of discrediting the very money they are meant to protect. I would be short the Ph.D. standard, long the periodic table.
In our previous conversation, in 2011, you were bullish on gold at $1,800 an ounce, near the top. You are still bullish today, with gold at $1,321. Do you have a forecast?
From the guy who loved it at $1,900, I’ll shut up. It’s a provocation to the market gods to stick a number up there. I’m very bullish on the metal, bullish on miners. Bears on credit finally get paid in gold. At the end of the road to confetti, gold will reclaim some position as an active monetary asset, not a crank’s asset. It is now a relatively high-yielding asset, yielding, as it does, nothing.
The gold stocks have come a long way [from a recent bottom]. But many were priced for bankruptcy, notably Barrick Gold [ticker: ABX], an encumbered mining company priced at $6 at the bottom, as if its debt would not be paid. Now the stock is $20. I personally own Newmont Mining [NEM], Goldcorp [GG], and New Gold [NGD], which is more speculative, but that I like in part because [Canadian businessman] Pierre Lassonde is involved. We are also bullish on silver. It is the crazy uncle in the attic of monetary assets. It is as volatile as Donald Trump. It has industrial uses as well as monetary ones, which will come to the fore as the gold bull market progresses. In June, we recommended Pan American Silver [PAAS] and long-dated, out-of-the-money call options on the silver exchange-traded fund iShares Silver Trust [SLV].
In 2011, when the euro was at $1.40, you called it confederate money and said it should fetch around $1.10 instead. Good call. Do you have a new forecast for the euro?
I don’t. I wasn’t born yesterday. However, we all know about the centrifugal political forces that are coursing through the world, not least in Europe. There is always risk of one kind or another. The question is whether you’re being paid to bear it. Europe offers no such compensation. Big-cap stocks on the Continent change hands at more than 22 times earnings. Ten-year Italian sovereign debt yields 1.2%. German government bonds yield—after a nasty selloff—exactly nothing. Italian banks interest me a little because they are among the most despised assets on Earth. The euro doesn’t interest me in the least.
The Spanish bank Banco Bilbao Vizcaya Argentaria [BBVA] did well for itself during the terrifically deep and troubling Spanish recession. It has a $1 billion euro, 8.875% junior subordinated perpetual bond. The yield was recently quoted just below 9%. We think that’s a pretty good value. It’s much safer than Deutsche Bank [DB], for example, and is yielding much more than the comparative Deutsche issue.
Will low yields prevail for the rest of your career?
You are talking to a guy who lived through all but three months of the bond bear market of 1946 to 1981. In the spring of 1946, a long bond yielded about 2.25%, and it ended in 1981 at 15%. Everyone was looking backward to the credit experience of the 1930s and the early ’40s, not anticipating they were about to be treated to a generation-length bear market in interest rates. That was 35 years in the making. And almost 35 years ago, the great bond bull market began that may, or may not, be ending right now. Since the 19th century, the cycles in interest rates are very long-lived. They have ranged from 20-odd years in this country to 85 years in 19th century Britain. So you can’t dogmatize on the timing. At Grant’s, we are very bearish on bonds.
Where are the opportunities for people seeking yield?
I am stumped. One can shop for manufactured yields, and there are plenty available in the shape of real estate investment trusts and mortgage REITs, and they’re all levered and attempt to make something of nothing.
Speaking of real estate, you have been negative on luxury residential real estate in Manhattan. Separately, you were early to buy a town house in Brooklyn Heights, back in 1994. So, is Brooklyn over, too?
Not long ago, [BlackRock CEO] Larry Fink was talking to investors in Singapore and said the two things you had to own were super-high-end real estate in the world’s destination cities and contemporary art. With respect to super-high-end real estate in Manhattan, the top was actually 2014. There aren’t enough billionaires to go around, and maybe fewer still if the bond market does what we think it ought to do.
As for Brooklyn, in May friends of mine bought a condo in the neighborhood called Boerum Hill. They bought a parking spot at the same address, for which they paid $60,000. Today, it’s worth $90,000. House prices peaked around Brooklyn Heights probably as early as 2014. But there is still an arbitrageable difference with Manhattan. You could sell your $10 million brownstone in Manhattan and buy a $6.5 million brownstone in Brooklyn. Or maybe just sell your place in Manhattan. Brooklyn may be soft, but it isn’t cheap.
You are less well known for the excellent work you do on individual stocks. Let’s have some names.
All kudos go to Evan Lorenz, who has been with the firm more than five years and is one of the best security analysts I’ve ever worked with or heard about. One idea that hasn’t worked yet is being bearish Big Food, like Campbell Soup [CPB] and Kraft Heinz [KHC]. Both are indicative of one form of excess, reaching for yield in equities. Campbell is trading for 23 times trailing net income, and Kraft is 46 times. Both are battling new trends in eating.
Then there is the question about the consumer environment generally: Campbell admits that shoppers are making more frequent trips [to the grocery store] than a year ago but purchasing less per trip. These stocks aren’t safe. They are standing on tiptoes, figuratively speaking, with regard to their valuation. Target recently redesigned its center-display offerings. They are getting rid of dry grocery items and displaying items like organic, gluten-free, and other such things, which isn’t good news for ketchup or canned soups. The stocks are priced as if for growth, but we don’t see organic revenue growth or margin growth.
I’m also bearish on United Rentals [URI], which rents construction and industrial equipment: forklifts, aerial work platforms, excavators—you name it. It leads the American equipment-rental industry with an 11% market share. The stock looks cheap—just 12 times trailing net—and earnings are strong. What could go wrong? Well, in early 2008, the ratio of debt to assets was 46%. Today, it’s 65%. Ex-goodwill, liabilities exceed assets by almost $1.8 billion. If you liquidated all the equipment on the balance sheet, United Rentals couldn’t pay off the debt. Insiders are net sellers. Shrewd investors, I’d say.
What do you like aside from gold stocks?
When I look back to 2007, I really wish we hadn’t reached for long ideas simply because we felt we had to have them. I’m not going to try to find what can’t be found.