(GMO) Jeremy Grantham - Q2 letter - Summer Essays

Bubbles Again: Setting Up for a Deal Frenzy

Despite a shocking 2.9% setback in first quarter GDP (quarterly decline at annualized rate), the extent of which was
forecast by no one, and despite a substantial decline in NIPA corporate earnings, the market has climbed slowly
but steadily in recent months. Market volatility has declined to very low levels despite these setbacks and despite
Middle Eastern problems. (The negative January Rule this year has, for that matter, also been ineffective so far.)
So, all is apparently well, as we have arrived within three months of the dreaded (by bears) Presidential third year.
Accordingly, my recent forecast of a fully-fledged bubble, our definition of which requires at least 2250 on the S&P,
remains in effect.
What is worse for us value-driven bears, a further bullish argument has struck me recently concerning the probabilities
of a large increase in financial deals. Don’t tell me there are already a lot of deals. I am talking about a veritable
explosion, to levels never seen before. These are my reasons. First, when compared to other deal frenzies, the real
cost of debt this cycle is lower. Second, profit margins are, despite the first quarter, still at very high levels and are
widely expected to stay there. Not a bad combination for a deal maker, but it is the third reason that influences my
thinking most: the economy, despite its being in year six of an economic recovery, still looks in many ways like
quite a young economy. There are massive reserves of labor in the official unemployment plus room for perhaps a
2% increase in labor participation rates as discouraged workers potentially get drawn into the workforce by steady
growth in the economy. There is also lots of room for a pick-up in capital spending that has been uniquely low in this
recovery, and I use the word "uniquely" in its old-fashioned sense, for such a slow recovery in capital spending has
never, ever occurred before. The very disappointment in the rate of recovery thus becomes a virtue for deal making.
Previous upswings in deals tended to occur at market peaks, like 2000 and 2007, which in complete contrast to today
were old economic cycles already showing their wrinkles. Worse than being in full swing, they were usually way over
capacity. Thus, 2000 was helped along by the bubble in growth stocks to over 60 times earnings, allowing companies
like Cisco, possibly correctly, to believe they were dealing with a near-zero cost of capital in making deal after deal
for their massively overpriced stock.
In 2007 the housing bubble led to an extra one and a half to two million houses being built, with all the usual
accoutrements of furniture sales and more jobs for realtors, bank officers, and Goldman Sachs designers of ingenious
new ways to be of service to real estate speculators. Now that the smoke has cleared, the 2007 economy at its peak
looks to have been 2% or so above trend capacity (allowing, incidentally, for the overstating of the U.S. long-term
growth capability, a misjudgment that is still hanging around).
GMO Quarterly Letter – Second Quarter 2014 7
If I were a potential deal maker I would be licking my lips at an economy that seems to have enough slack
to keep going for a few years. Also, individuals and institutions did feel chastened by the crash of 2009 and
many are just now picking up their courage. And as they look around they see dismayingly little in the way of
attractive investments or yields. So, the returns promised from deal making are likely to appear, relatively at
least, exceptional. I think it is likely (better than 50/50) that all previous deal records will be broken in the next
year or two. This of course will help push the market up to true bubble levels, where it will once again become
very dangerous indeed.
My final thought on this issue is the following point, which I failed to make in my bubble discussion last
quarter: perhaps the single best reason to suspect that a severe market decline is not imminent is the early-cycle
look that the economy has. And even Edward Chancellor last quarter conceded that there was as yet no sign of
a bubble in the quantity of credit that was being created.

WSJ : Goldman Sachs: Here Are 25 Small-Cap Stocks to Buy

While Goldman Sachs is cautious on small-cap stocks due to valuation concerns, the firm still finds some pockets of opportunity among individual names within the group.
Goldman strategist David Kostin identified 25 small-cap stocks (companies with market capitalizations of less than $4 billion) that could offer at least a 25% upside to the Goldman price target over the next 12 months.
The list skews heavily toward consumer discretionary and tech stocks, including RetailMeNot Lumber Liquidators and Office Depot

Here’s a look at Goldman’s buy-rated Russell 2000 stocks that have significant upside over the next year.


Agios Pharmaceuticals Inc. AGIO Health Care 39 55 66
Axiall Cop. AXLL Materials -5 61 36
Boise Cascade Co. BCC Materials -12 38 47
Cornerstone Ondemand Inc. CSOD Information Technology -28 55 43
Darling Ingredients Inc. DAR Consumer Staples -7 25 29
Granite Construction Inc. GVA Industrials 1 47 35
GT Advanced Technologies Inc. GTAT Information Technology 64 22 54
Infinera Corp. INFN Information Technology -9 11.5 30
Lumber Liquidators Holdings Inc. LL Consumer Discretionary -47 77 40
Marketo Inc. MKTO Information Technology -33 41 64
MGIC Investment Corp. MTG Financials -8 11 42
Nimble Storage Inc. NMBL Information Technology -46 34 38
NPS Pharmaceuticals Inc. NPSP Health Care -11 40 48
NuVasive Inc. NUVA Health Care 0 43 32
Office Depot Inc. ODP Consumer Discretionary -5 7 40
Polycom Inc. PLCM Information Technology 12 16 27
Proofpoint Inc. PFPT Information Technology 1 42 26
Qlik Technologies Inc. QLIK Information Technology -21 28 33
Radian Group Inc. RDN Financials -8 18 39
RetailMeNot Inc. SALE Consumer Discretionary -17 $44.00 85
Ryland Group Inc. RYL Consumer Discretionary -13 48 27
Steven Madden Ltd. SHOO Consumer Discretionary -9 46 37
Synageva BioPharma Corp. GEVA Health Care 10 126 78
Universal Display Corp. OLED Information Technology -16 44 52
Vitamin Shoppe Inc. VSI Consumer Discretionary -19 60 42

>>> Banco Espirito Santo could sell non-core assets including 10% stake in Portu

Banco Espirito Santo could sell non-core assets including 10% stake in Portugal Telecom as part of restructuring

Banco Espirito Santo (BES)'s restructuring plan could include sale of non-core assets including its 10% stake in Portugal Telecom (PT), reported Jornal de Negocios. Sources familiar with the situation told the business paper that BES is working with financial advisors on a plan to bolster its solidity, which should conclude by September.

Offloading some BES assets like shares in PT, insurer BES Vida, toll highways operator Ascendi and car park operator Empark is among a range of possible asset disposals under consideration by the bank's new management team led by CEO Vitor Bento, the same sources said.


Source Jornal de Negocios

>>> Holcim/Lafarge assets sale attracts more than 100 interested parties

Holcim/Lafarge assets sale attracts more than 100 interested parties 

More than 100 parties have registered an interest in assets to be sold by cement groups Holcim and Lafarge, Tagesanzeiger reported.

The Swiss daily cited Holcim Chief Executive Bernard Fontana as saying that potential buyers include investment groups and other cement companies. Talks are due to begin in August.

Fontana said in the report that a spin-off or an IPO for units is also possible.


Source Tagesanzeiger

(BFW) Croda 2Q Rev. GBP263m, Est. GBP268m; Confirms 2014 Forecast

Croda 2Q Rev. GBP263m, Est. GBP268m; Confirms 2014 Forecast
2014-07-22 06:16:45.241 GMT


By Chiara Remondini
July 22 (Bloomberg) -- Croda 2Q rev. GBP263m, est. GBP268m.
* Adj. pretax profit GBP60.1m vs restated GBP68.1m
* Adj. operating profit GBP63.6m vs restated GBP71.2m
* FX had “significant impact” on results
* Currency translation reduces 1H sales by GBP38.3m (6.8%)
* FX, transaction costs cut operating profit by GBP11.4m
* Interim div. 29.5p, BDVD est. 30.5p
* Outlook: repeats 2013 pretax profits to come in below 2013,
sees underlying profit progress this yr
* Says visibility remains limited
* Sees adverse FX effects in 3Q at similar level vs 2Q
* Sees underlying sales, profit progress in 2H and beyond
* NOTE June 24: Croda cut 2Q pretax profit outlook, saw it to
drop 8% q/q vs previous forecast of similar to 1Q
* Still expected to achieve underlying profit progress in
2014, saw pretax profit drop vs 2013; said M/T targets
unchanged, confident in L/T strategy
Statement

For Related News and Information:
First Word scrolling panel: FIRST<GO>
First Word newswire: NH BFW<GO>

To contact the reporter on this story:
Chiara Remondini in Milan at +39-02-8064-4241 or
cremondini@bloomberg.net
To contact the editors responsible for this story:
James Ludden at +44-20-7673-2645 or
jludden@bloomberg.net
Jurjen van de Pol

>>> What to look at today - 22/07/2014

US Market Closed lower, but not on lows even with more tension about potential new Russians sanctions. we saw some "Buy-the-dip" activity but volumes were still low at 530mil shares vs Average of 658mil, the health care (-0.4%), utilities (-0.1%), consumer staples (-0.4%), and telecom services (-0.3%) sectors all finished lower, only sector up where Energy (+0.2%) following crude prices higher ($104.89 +1.7%)...the Russell 2000, which fell as much as 1.0% early in the day, recouped a good portion of its losses and ended the session down 0.4%...VIX @ 12.81 +6.22%...After Hours NFLX higher on Earnings, CMG +10% on ERN & Guid.... Six Dow components are reporting today KO, DD, MCD, TRV, UTX & VZ...China June economic assessment from Conference Board increased at the highest rate in 7 months. Resident economist said the June pickup "is unlikely to be fully felt until the final quarter of the year...the PBoC skipped its regular repo drain for the first time in 7 scheduled operations in spite of the high lending volume reported last month, China Banking Regulatory Commission (CBRC)'s Yan Qingmin called for mainland banks to accelerate bad loans write off, expressing concern over the possibility of rising NPLs...Japan govt cut its economic projection for real GDP in FY14/15 to 1.2% from
1.4% as had been speculated in local press. Fin Min Aso put the blame on lagging exports amid soft demand from emerging economies. Meanwhile, a Sankei survey revealed disapproval rating for PM Abe's cabinet climbing 6pts to a record high above 40%. Econ Min Amari also reiterated the govt will not make a decision on another sales tax hike until this December...Nikkei +1.03% Hang Seng +1.32% Shanghai +0.90%

Eur$ 1.3523 S&P +0.10% Eurostoxx +0.39% FTSE +0.27% Dax +0.38% SMI +0.43%

Macro
- France Prepared to Cancel Warship Sale to Russia, Hollande Says
- M&A Deals in Emerging Markets Show ’Home Bias’, Citigroup Says

Keep an eye on :
- ACX SM : Acerinox 2Q Net EU51 Mln; Analyst Est. EU44.9 Mln
- ATLN VX : Actelion 2Q Drug Sales Rise; Sets ’Higher’ Base for 2015, CEO Says Co. Hasn't Had Any M&A Approaches
- AI FP : Air Liquide to Supply Natgasoline Oxygen for Methanol Plant
- BBVA SM : BBVA to Buy Catalunya Banc for EU1.19b, FROB Says
- CA FP : E. Leclerc Half-Year Sales Rise 3.5%, Leclerc Tells Figaro
- CSGN VX : Credit Suisse 2Q Core Pretax Loss CHF370m, Says to Exit Commodities Trading Business
- DAI GY : Mercedes Aims to Sell More Than 300,000 Units in China in 2015
- DLG GY : Dialog Semiconductor, AMS Terminate Merger Talks {NSN N93N5P6S972C<Go>}
- EDF FP : EDF Cuts Electricity Prices for French Industry’s Biggest Users,
- ENG SM : Enagas 2Q Net EU110.2M; Analyst Est. EU109.8M
- GET FP : Groupe Eurotunnel 1H Ebitda In Line, Sales Beat Estimates
- FCT IM : Fincantieri 1H Ebitda EU142m vs EU140m Y/Y
- GEC FP : Gecina Confirms Forecast for Stable Recurrent Net Income in 2014
- LI FP : Klepierre Raises Full-Year Net Current Cash Flow Forecast
- KPN NA : America Movil cuts KPN Satke to 22.6% from 24.8%
- FOI FP : PAI to Buy Half of Labeyrie Today, Les Echos Reports
- NHY NO : Norsk Hydro 2Q Profit Misses Estimates on Prices, Power Output
- PHIA NA : Philips could close, slim down or sell traditional lighting plants - Het Financieele Dagblad
- PUB FP : Publicis 2Q Revenue Drops, Damps 1H; 3Q Expected to Be Better
- RNO FP : Renault Sales in Russia Fell 13% in June, Les Echos Says
- SPM IM : Saipem sales process likely to be launched after summer
- SAN SM : Santander Says It Wasn’t Contacted By Bank of Portugal on BES
- SGO FP : Saint Gobain Will Keep Investing in Russia, Les Echos Says
- SRT3 GY : Sartorius 2Q Sales Rise 11%; Ebitda Up 7%; Reiterates Outlook
- SUN SW : Sulzer 1H Orders, Operating Income Drop; Sales Miss Estimates
- TRELB SS : Trelleborg 2Q Op. Profit Beats Est.; Sees Flat 3Q Demand
- UHR VX : Swatch 1H Operating Profit Misses Estimates; 2H Outlook ’Good’
- VIV FP : Vivendi considering relaunching GVT sale or merger with Tim Brasil; Moelis could be advising - La Lettre de l'Expansion
- ZO1 GY : Zooplus 2Q Revenue Rises 28%; Raises 2014 Sales Outlook

>>> Brokers Upgrades & Downgrades

>>> Up
*ATRESMEDIA RAISED TO BUY VS NEUTRAL AT GOLDMAN
*JULIUS BAER GROUP RAISED TO HOLD VS SELL AT BERENBERG
*SARAS RAISED TO NEUTRAL VS SELL AT UBS

>>> Down
*ABERTIS CUT TO NEUTRAL AT MACQUARIE
*MEDIASET ESPANA COMUNICACION CUT TO SELL VS HOLD AT BERENBERG
*MORGAN ADVANCED MATERIALS CUT TO HOLD VS BUY AT JEFFERIES
*ROTORK CUT TO HOLD VS BUY AT JEFFERIES
*STADA ARZNEIMITTEL CUT TO NEUTRAL VS OVERWEIGHT AT JPMORGAN

>>> PT Change


>>> Initiation


>>> Call
>> Sector
* Bernstein Cuts Steel, Iron Ore, Coking Coal Price Estimates {NSN N93E9F6TTDSF <go>}