Jeremy Grantham warned in January 2000 that U.S. equities were “more overpriced than at any time in the last 70 years due to the massive overpricing of technology and especially dot-com stocks.”
By the end of 2002, the Standard & Poor’s 500 Index had fallen 40 percent and technology shares were down 73 percent. The forecast didn’t help his firm, Grantham Mayo Van Otterloo Co., because he’d been bearish since 1997. Assets declined 45 percent in the late 1990s as customers sought out better- performing mutual funds that liked the technology stocks Grantham disdained.
Grantham said in an interview that his negative calls are often so early that investors who acted on them gave up gains before prices peaked. He recommended avoiding Japanese stocks more than two years before they started falling at the end of 1989. While his timing doesn’t deter fans like former Harvard University endowment manager Jack Meyer, it requires a delicate balancing act by GMO, which oversees $107 billion.
“We lost business like it was going out of style,” the 71-year-old Grantham said of his dot-com prediction at a Jan. 28 speech to investment advisers in Boston, the home of GMO, which he co-founded in 1977.
GMO’s funds usually don’t fully adopt his recommendations, or hedge their bets, underscoring the difference between being a star strategist and successful money manager. That’s true for the fund Grantham works most closely with, GMO Global Balanced Asset Allocation, which oversees $3.1 billion.
Setting Off Alarms
The tension between acting on a long-term vision and keeping clients happy in the short run is a fact of life for all money managers, said Charles Lieberman, chief investment officer at Advisors Capital Management LLC in Hasbrouck Heights, New Jersey, which oversees about $190 million. “The issue is: Are you willing to stick your neck out and how far?” he said in a telephone interview.
The tension is heightened at GMO, where Grantham’s warnings of investment bubbles have at times sent customers packing for firms with a more upbeat view of the markets.
“If we are too aggressive, and we don’t get it right, we run the risk of being fired,” Ben Inker, GMO’s head of asset allocation, said in a telephone interview.
Two of Grantham’s most recent forecasts were right -- and timely.
Emerging Markets
In 2007, he wrote in his newsletter that all asset classes were overvalued and it was time to sell high-risk securities. GMO’s $2 billion Emerging Country Debt Fund, which held high- yielding securities from countries such as Venezuela and Argentina, decided to stick with those investments in 2008.
“Every bet we made turned out to be wrong,” Thomas Cooper, the fund’s co-manager, recalled in an August interview, pointing out that investors sought out safer securities during the financial crisis. The fund lost 33 percent in 2008, and the following April GMO was fired by the Massachusetts state pension system as manager of $230 million in emerging-market debt.
The fund bounced back, returning 50 percent in 2009. Its 14 percent annual return over the past 10 years made it the best performing bond fund, according to Chicago-based Morningstar Inc.
“Jeremy has been a great long-term investor,” said Meyer, who ran Harvard’s endowment for 15 years until 2006, when he left the Cambridge, Massachusetts, university, to start Convexity Capital Management LP, a Boston-based fund manager. Grantham was ahead of the pack in the 1990s identifying the value of emerging-market stocks, inflation-adjusted securities and timber, Meyer said in a telephone interview.
‘No Justice’
In March 2009, when the S&P 500 index bottomed out at 676, Grantham wrote that fair value for the benchmark of the largest U.S. stocks was 900, or 33 percent higher. By July, with the index above that mark, Grantham concluded U.S. stocks had become too expensive again.
“After 20 years of more or less permanent overpricing, we get five months of underpricing,” he told newsletter readers. “There is no justice in life.”
The fair value of the S&P 500 today is 850, 23 percent below yesterday’s close of 1103.94, said Grantham. He arrives at that valuation by assuming a long-term average price-to-earnings ratio of about 15 for U.S. stocks and applying it to a long-term average for profit margins.
Grantham is chief investment strategist at GMO, whose assets have risen almost fivefold since 2000. Its more than 40 mutual funds usually require a minimum investment of $10 million and are aimed mainly at institutions such as pension funds and endowments, according to the firm’s Web site. The firm also acts as a sub-adviser on several retail mutual funds.
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Current Outlook
Grantham’s favorite asset class today is high-quality U.S. stocks, companies defined by high, stable returns and low debt. The allocation fund had 31 percent of its money in that category at year-end, sometimes called blue chips, according to the GMO Web site. In the interview, he said he expects such stocks to return an average of 6.8 percent a year over the next seven years, compared with 1.3 percent for all large-cap U.S. stocks.
Emerging-market stocks may rise about 4 percent annually in the next seven years, as investor enthusiasm for economic growth in developing countries carries the stocks to unsustainable levels, Grantham said.
“Why not go along for the ride?” he said. The MSCI Emerging Markets Index returned an average of 22 percent in the past seven years, compared with a gain of 5.5 percent by the S&P 500 index.
U.S. government bonds will return 1.1 percent a year over the seven-year period, according to the latest GMO forecast. The Bank of America Merrill Lynch U.S. Treasury Master Index rose 4.3 percent from 2003 through 2009.
Grantham said he expects a difficult, not disastrous, period for the economy and investments.
“It will feel like the 1970s,” he said. “One step forward, one step back.”
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No ‘Permabear’
Grantham dismisses his “permabear’” label, saying that in 2000 he was bullish on emerging-market stocks, real estate investment trusts and inflation-adjusted bonds. GMO data show that the three asset classes returned between 4.9 percent and 8.1 percent a year in the 10 years ended Dec. 31. The S&P 500 lost 1 percent a year over the same stretch.
Looking back on more than 40 years in the investment business, Grantham summed up his career this way: “We win all the bets but we are horrifically early,” he said.
I have benefited immensely by reading Grantham's writings and, to an extent, following his calls. My personal IRA accounts are much the better for it.
The man knows his "weaknesses". You can chart his calls against the market (as I have done) and discover that he is sometimes as much as three years (!) early with his calls. An investor would give up a portion of those gains if he switched equity exposure to bonds but -- and here is the important point-- he would sidestep large declines. This strategy isn't for everybody but it works for me.
As always, consult with your advisor if you wish to take this further.
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