It is extremely difficult to sit out a party. Do so and you lose both clients and assets. Invest in unloved and undervalued assets and you do even worse?
But what is the alternative? Get drunk like everyone else?
I have to admit (again, and again actually), this market has gone further, faster, than I thought possible. Bubbles of the current magnitude have never been blown back-to-back in such a short timeframe.
I am not the only one who see things that way. John Hussman has been preaching essentially the same message, and so has Jeremy Grantham.
“Over Next Seven Years, Market Will have Negative Returns”
I strongly encourage you to read an interview of Jeremy Grantham, by Stephen Gandel, senior editor of Fortune, entitled The Fed is Killing the Recovery.
The entire article is well worth a read. But here is one snip that caught my eye.
Fortune: Are you putting your client’s money into the market?
Grantham: No. You asked me where the market is headed from here. But to invest our clients’ money on the basis of speculation being driven by the Fed’s misguided policies doesn’t seem like the best thing to do with our clients’ money. We invest our clients’ money based on our seven-year prediction. And over the next seven years, we think the market will have negative returns. The next bust will be unlike any other, because the Fed and other centrals banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before. Assets are overpriced generally. They will be cheap again. That’s how we will pay for this. It’s going to be very painful for investors.
Again, It’s well worth reading the entire interview. Of course I am biased. It supports my own view about market valuations and the Fed.
Jeremy Grantham 1999
Grantham is one of few who saw things correctly in 1998 and 1999. While others were partying like no tomorrow, Grantham sat things out. In the process, he lost 60% of his asset base, simply for not acting like a drunken fool, like nearly everyone else.
Please consider this Forbes Interview of Jeremy Grantham, by Steve Forbes, from 2009. The section of most interest to me pertains to 1999
Steve Forbes: Well thank you, Jeremy, for joining us today. First, since you have bragging rights in this situation, what made you a bear, [a] great skeptic? Between 1999 until about a couple of months ago, you were saying, “Stay out.”
Jeremy Grantham: Well, really very simple. Not rocket science. We take a long-term view, which makes life, in our opinion, much easier.
Steve Forbes: Well everyone says it, but you certainly practiced it.
Jeremy Grantham: We actually do it. Well, we tried the short-term stuff and it was so hard; we thought we’d better do the long-term. We just assume that at the end, in those days, of 10 years, profit margins will be normal and price-earnings ratios will be normal. And that will create a normal, fair price. And more recently, we’ve moved to seven years, because we’ve found in our research that financial series tend to mean revert a little bit faster than 10 years–actually about six-and-a-half years. So we rounded to seven
And that’s how we do it. And it just happened from October ’98 to October of ’08, the 10-year forecast was right. Because for one second in its flight path, the U.S. market and other markets flashed through normal price. Normal price is about 950 on the S&P; it’s a little bit below that today.
And on my birthday, October the 6th, the U.S. market, 10 years and four trading days later, hit exactly our 10-year forecast of October ’98, which is worth talking about if only to enjoy spectacular luck. The P/E was a little bit lower than average and the profit margins were a little bit higher, so they beautifully offset. And given our methodology, that would mean that on October the 6th, the market should have been fairly priced on our current approach. And indeed it was–that was even more remarkable–950, plus or minus a couple of percent.
Steve Forbes: And what did you see during that 10-year period that made you feel–other than your own models–that this was something highly abnormal, that this couldn’t last?
Jeremy Grantham: Well, first of all, the magnitude of the overrun in 2000 was legendary. As historians, you know we’ve massaged the past until it begs for mercy. And we saw that it was 21 times earnings in 1929, 21 times earnings in 1965 and 35 times current earnings in 2000. And 35 is bigger than 21 by enough that you’d expect everyone would see it. Indeed, it looks like a Himalayan peak coming out of the plain.
And it begs the question, “Why didn’t everybody see it?” And I think the answer to that is, “Everybody did see it.” But agency risk or career risk is so profound, that even if you think the market is gloriously overpriced, you still have to get up and dance. Because if you sit down too quickly–
Steve Forbes: Famous words of Mr. Prince.
Jeremy Grantham: If you sit down too quickly, you’re likely to get yourself fired for being too conservative. And that’s precisely what we did in ’98 and ’99. We didn’t dance long enough and got out of the growth stocks completely, and underperformed. We produced pretty good numbers, but they’re way behind the benchmark. And we were fired in droves.
I think our asset allocation, which is the division I’m now involved in, we lost 60% of our asset base in two-and-a-half years for making the right bets for the right reasons and winning them. But we still lost more money than any other person in that field that we came across, which is a fitting reminder that career risk runs the business.
Grantham did not lose money, at least client money. He lost accounts and assets. Clients who stayed with him did quite nicely.
Unfortunately, it’s a sad state of affairs that investors (speculators really), time and time again chase managers with a current hot-hand rather than invest prudently.
I do not know when this party ends, nor does Grantham, nor anyone else. Actually, it matters not, at least in the long run.
Stocks in general are poised for negative returns for seven years once again. If the party lasts a lot longer, seven might turn into eight or ten, but that will not change the ultimate outcome.
Mike “Mish” Shedlock