Jeremy Grantahm: Still Holding Back
In a recent interview with Barron’s, Jeremy Grantham cautioned that the biggest mistake might be buying too soon. He co-founded Boston-based GMO, an investment house overseeing $120 billion in assets, in 1977.
In July this year Grantham said: “Ironically for a ‘perma bear’, I underestimated in almost every way how badly economic and financial fundamentals would turn out. Events must now be disturbing to everyone, and I for one am officially scared!” In terms of strategy, he summarized his view with what he believes should be investors’ motto: “Don’t be brave, run away. Live to fight another day.”
Although his warnings go back a number of years, Grantham was eventually right. It was therefore with keen interest that I read in Barron’s his latest views on the fallout from the financial crisis and what investment opportunities he sees.
Barron’s: How much will the recent $700 billion bailout plan approved by Congress help stabilize the economy and the financial markets?
Grantham: It certainly doesn’t hurt. It is an amazingly complicated situation. But I do believe we have passed the point where we have to worry about moral hazard. When Bear Stearns was in trouble, I used to worry about moral hazard.
What is your sense of how this crisis has been handled by those in charge?
Everyone is shaking in their boots. The awareness of risk has come back with a terrifying surge, and it is not going to go away too quickly.
With the Fed and other central banks lowering rates last week, are you worried about inflation?
What was at the core of what got the financial system into this crisis?
At the center of this crisis was a bubble in risk-taking. The risk premiums dropped off the cosmic scale, the lowest ever recorded. On our seven-year forecast data, we reckoned that between June of ’06 and June of ’07, people were actually paying for the privilege of taking risk. Our constant theme for the last three years was avoid risk, avoid risk, avoid risk.
How much further do we have to go to get through this downturn?
This was not only a monetary event, but it coincided with the first truly global bubble in all assets. You had inflated housing in almost every country in the world, except for Japan and Germany. You had overpriced stocks in every country in the world. And you had too much money and too-low interest rates. I was confident about very little, but I was confident that this would be different from anything we had seen before, and potentially more dangerous. It should have been treated with more care.
Is this crisis playing out the way you thought it would?
But this is much worse than I thought. All the fundamentals are turning out worse than I thought they would. All the competencies of the senior people at the Fed, Treasury and [firms like Merrill Lynch and Lehman Brothers] have turned out to be much less than I had expected; that’s very disappointing.
And, therefore, how could one’s confidence that the senior people would get us through the storm be very high? Prior to three months ago, we were investing in emerging-market equities. Then we battened down the hatches, and I changed my view from avoid all risk except emerging markets to avoid all risk, period.
The terrible thing – after all this pain – is that the U.S. equity market is not even cheap. You would imagine that, given the amount of panic, that it would be. But it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.
What about equities outside the U.S.?
The problem, though, is that we have so much downside momentum, so many financial problems and so many interlocking relationships, that it is hard to imagine this crisis subsiding because stock prices are digging in their heels and approaching fair value.
What happens to hedge funds in the wake of this crisis?
I also said that at least one major bank will fail. I got a lot of grief for that, and now it looks like I could have said at least a dozen major banks will fail.
As for the broad, typical opinion that we would muddle through this crisis, it just shows you what a dangerous optimistic bias the advisory business has built into it.
Do you think we will learn anything from all of this turmoil?
Let’s talk about your asset allocations
What about looking ahead in terms of asset allocation?
But the next move will be buying, and we are encouraged that there are a few pockets that are cheap on an absolute basis. We are not encouraged that they will rally immediately. But we will be looking to buy the cheap pockets of global equities as our next move some time in the next several months.
Why emerging markets and small-cap international value?
The great trap is to buy too soon and, in the big move, to sell too soon. I’ve been saying since ’98-’99 that my next major-league error will be buying too soon – but we will not buy quite yet. But when we do, I suspect it will be too soon again.
What do you see ahead for commodities?
What about some other trades?
Why are you shorting the euro?
The U.K. housing market was dreadfully overpriced. I felt nearly certain that the U.K. housing market would come back to a more normal multiple of family income, which is a very big decline of 40% if you did it in a hurry – or you can sit back for many years and wait for income to catch up. But you should really count on that market coming down over a couple of years painfully.
Do you have any closing thoughts about how we got into this financial state?
I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained – but we end up with an army of left-brained immediate doers.
So it’s more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored.
If you look at the people who have been screaming about impending doom, and you added all of those several dozen people together, I don’t suppose that collectively they could run a single firm without dragging it into bankruptcy in two weeks. They are just a different kind of person.
So we kept putting organization people – people who can influence and persuade and cajole – into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don’t have those skills.
Where do you see all of this going?
Source: Lawrence C Strauss, Barron’s, October 13, 2008.
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