AI 15: Climate change a threat to growth, says Grantham
As part of our 15th anniversary celebrations, AsianInvestor asked Jeremy Grantham, co-founder of GMO, the Boston-based partnership, to give us his predictions about the global trends that will shape the next 20 years. The first part of this interview was published yesterday.
We’ve talked about population and resources. How does climate come into this?
It’s deteriorating even faster than Al Gore prophesised. Scientists who warned about climate change understated it. It’s not just about changing temperatures, which we all notice. It’s the instability of the weather, which is a death for farmers. Water vapour in the atmosphere has increased, but it has been badly distributed: it’s much higher now in the two Englands – the England where I grew up, and New England where I now live. But it has declined in California.
So the two Englands are a whole lot wetter: this winter, Boston got 109 inches of snow. More water vapour means colder temperatures and more snow.
What does that imply for agriculture?
Flood and droughts are dangerous for farmers. Floods do a lot of damage. As precipitation rises, it probably takes the form of heavy downpours. I’ve seen estimates that the UK summer will see four times as many downpours by the end of the 21st century as it does today.
The real issue is soil. It turns out that erosion is a power law on heavy rain. The one or two worst storms account for about half of the rainfall over a year. Heavy downpours accelerate soil erosion from its 1% annual pace to 2%. That means more downpours erode fertility.
Heat and drought impacts productivity and puts huge pressure on underground water. That’s happening in China and the American Midwest.
On top of this, we face rising sea levels – which is disastrous for places ranging from Bangladesh to Miami – and the acidification of water, which has nothing to do with climate change but is another threat to the productivity of the oceans.
You’ve outlined big problems. How do you put these into some system of urgency?
The least of our problems is the decline in the world’s economic growth rates, because it means less stress on the other variables. The challenge of this century is developing an economic theory without steady conventional growth.
What about for today’s investors?
We are operating with a drag on growth and rising costs. If you have oil in the portfolio, yes, the price of oil is going to rise, but the rise in costs of finding new oil is remorseless. Since 2000, the cost of finding oil has risen 8% per year. This is the end-game for oil companies; we’re enjoying a last, glorious run as we consume this surplus and cashing in on low-cost returns.
But it is the end-game: in 2005 the oil majors spent $50 billion on exploration and extraction; in 2013 they spent $250 billion to find the same amount of oil. And with costs rising 8% per annum, we’re enjoying the end of the investment lifecycle.
Oil companies are buying back stock and not over-expanding. It can be profitable for shareholders, but investors need to be aware of the background, and reconcile ourselves to a different future growth rate.
Is India too late to the party? Or is it reinventing itself as the next great economic power?
Indian equities may be today’s hero, but they can’t repeat a China-like surge. India’s too big and the world can’t deal with that pressure on resources – and nor can India, for that matter; its urban pollution is already worse than China’s. Last year China used less coal than it had in 2013, the first time it had a year-on-year decline. So no wonder coal prices hit the dust. India’s choking; it will have to go solar. It can’t grow at 10% each year for a decade, but it might do 5%. China will probably do less than that.
The US Fed is expected to begin raising interest rates. But there are plenty of institutions that have little choice but to keep buying sovereign bonds. Will this change market dynamics?
Three steps and stumble, that’s the old saying. The first expected increase hasn’t stopped a bubbly market. This doesn’t mean the market won’t take a hit from a rate hike, not with such a jittery mob, but it will regroup. I expect the Fed will try to ensure the market peaks close to the presidential election [in November 2016]. In the past 12 months, the [S&P500] stock market rose 12% and earnings are up 5%, but retail investors haven’t yet poured into mutual funds, we haven’t gotten to that mania level.
Are you expecting a mania?
In the short term the Fed is the most important force in the market, and it’s trying to keep things going. Markets are up despite geopolitical turmoil. I’m backing King Fed to win this one. All the final great moves [in market direction] become impressive bubbles, and I don’t see why this one wouldn’t. US equities, and equities worldwide, will keep going up despite the negatives. We’ll experience a classic euphoria, and the whole thing will go over the edge in a few years’ time.
The full interview with Jeremy Grantham can be read in the current (May 2015) edition of AsianInvestor.