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Grantham's words of wisdom: Part II - Views on News from Equitymaster
 
 
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  • Apr 5, 2013

    Grantham's words of wisdom: Part II

    This is the second part of our three-series article. on Jeremy Grantham's thoughts as revealed on the Charlie Rose show. The write-up would focus on Jeremy Grantham's uncanny knack in spotting 'market bubbles' and in navigating safely through them.

    Grantham believes that it is not very difficult to spot market bubbles. However, it requires a lot of courage to admit these and take the necessary course of action. This is because there is an enormous pressure in the investment business to deliver good news. The stock-brokers are very adept in avoiding talks about over priced markets, lest they get fired. Grantham discusses more on the tech-bubble, the bubble in Japan and finally the sub-prime crisis. These are illustrated below:

    Tech bubble: Grantham did not shy away in admitting that it was very painful to lose half of their fund-book, just before the onset of the tech-bubble. His firm decided to return money to the investors in 1998-99. During those years, the US markets were trading at a PE range of 21-35. Interestingly, the US markets had traded at a multiple of 21 times just before the start of The Great Depression of 1929. The internal forecasts of GMO in 1998-99 projected a long term earnings growth, which was much lower than what was getting reflected in the prevailing multiple. This prompted them to return money to the investors.

    The bubble in Japan: Grantham started narrating his experience with the bubble in Japan by stating that it was the 'mother of all bubbles'. While it was a common rumour at that point in time that the land underneath the Japanese emperor's palace was worth more than the state of California, Grantham's team at GMO actually took time to find out if that was true. Their research showed that the rumour was indeed true! The effects of the real estate market percolated into the stock market, which started trading at 65 times. The historical PE of the Japanese stock market before that period had never crossed 25. Grantham and his team at GMO believed that while people saw a disaster coming on their way given the heated markets, it was a case of 'willing suspension of disbelief' and they lacked the courage to take contrarian action, which was not the case with GMO. GMO sold all their Japanese holdings and for a total of seven years they maintained a zero holding, which was 60% off-benchmark. And what was the end-result? GMO's funds underperformed by 10 percentage points a year for three years. However, when the bubble burst, all their losses were recouped. Grantham acknowledged that GMO's clients support during those heated years helped them in maintaining their contrarian position.

    Sub-prime crisis: According to Grantham, the US housing price surge before 2008 was really a result of the surge in debt. And, the surge in debt could well be attributed to the loose monetary policy since the Greenspan era. GMO's research further revealed that such irrational growth patterns occur in every 10,000 years. The housing debt pile accumulated in all US banks books reflected a huge disconnect when compared with the paying capacity of the borrowers. It was this simple rationale, which prompted Grantham to announce that a housing crash was inevitable. And, GMO altered their funds' holdings accordingly.

    Grantham added flavour to the discussion by emphasizing that markets can be crazily inefficient from time to time. Any pretence to the contrary is really in defence of some elegant economic theory. Elegant economic theories simply fail to work in a normal world! He also did not hesitate to add that while an economy may look dismal, a portfolio of carefully picked stocks based on their fundamentals can do very well.

    Investors can thus take lessons from Grantham's views and pay proper heed to a company's strategy, growth prospects and of course valuations before picking stocks.

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