Monday, July 17, 2017

Interview With Jeremy Grantham: The Rules Have Changed for Value Investors

This is from April 24, we're a bit tardy in getting to it but I'll probably be referring back so  here we go.
One quick note: We think Mr. Grantham is too gloomy and in some specific situations e.g. phosphorus (phosphate) and potassium (potash) running out, is just plain wrong.
See, for example 2012's "Vaclav Smil Takes on Jeremy Grantham Over Peak Fertilizer".

If one had acted on Grantham's shortage ideas by buying Potash Corp. or the Cargill fertilizer spinoff Mosaic back in 2012, one would have had one's head handed to one.
In the last five years POT has declined from $45 to $18 and MOS is down from $59 to $24.
During a big bull market.

This relative performance will of course change, and we think we'll be on top of it when it does but we'll be late, simply because trying to time the turn can be very costly if you're early.

That said Grantham is a sharp guy and very, very experienced so we pay attention when he speaks.

The past few years haven’t been kind to value investors like Jeremy Grantham, founder of money manager GMO (Grantham Mayo Van Otterloo), who rose to fame after calling the stock market crash of 2000.

He says the mean reversion principles that accurately guided investors from 1935 until about 2000 have been circumvented since then. What has changed is that since 1998, price-earnings ratios and profit margins have outstripped their historical averages, giving the advantage to growth investors. That change stems largely from the massive monetary easing implemented under Federal Reserve Chairs Alan Greenspan, Ben Bernanke and Janet Yellen from the late 1990s until now, Grantham says.

This doesn’t mean the cupboard is bare for GMO’s portfolio managers. Going forward, Grantham, 78, sees investment opportunities in agriculture and clean energy, thanks to climate change and resource constraints. He finds emerging markets appealing too.

Grantham recently chatted with Wealth about these topics and his views on financial advisors. What are the most interesting changes you’ve seen in the investment business since you began in 1968?

Jeremy Grantham: The market was extremely well-behaved from 1935 until 2000. It was an orderly world in which to be a value manager: there was mean reversion. If a value manager was patient, he was in heaven. The market outperformed when it was it cheap, and when it got expensive, it cracked.
Since 2000, it’s become much more complicated. The rules have shifted. We used to say that this time is never different. I think what has happened from 2000 until today is a challenge to that. Since 1998, price-earnings ratios have averaged 60 percent higher than the prior 50 years, and profit margins have averaged 20 to 30 percent higher. That’s a powerful double whammy.

Diehard Ben Grahamites underestimated what earnings and stock prices would do. That began to be a drag after 1998.

In 2000, there was a classic bubble driven by the technology sector and eventually it blew up, leaving us well-positioned. In the Greenspan-Bernanke-Yellen era, the market rallied on housing, and then there was the first truly global bubble in 2007, creating another opportunity to ply our trade. But underneath the surface things started to change.

WM: How so?

JG: The price-earnings and profit margin increases. Corporations got more monopoly power and more power in government. The current market era doesn’t feel like a bubble — it’s not euphoric yet like the housing bubble of 2005. It’s more that we have been climbing the wall of worry.

So why have prices risen so high without a hint of euphoria — at least until very recently — or a perfect economy? My answer is that the discount rate structure has dropped by two percentage points. The yield on stocks is down by that amount and bonds too. The market has adjusted, reflecting low rates, low inflation and high profit margins.

With value investing and mean reversion, you have to be careful with saying this time is never different. Things do change. I was really lucky in that the first 30 years of my career were similar to the prior 30 years. But 1997 was very bad preparation for the next 20 years....MUCH MORE
We have dozens and dozens of links on Mr. Grantham and GMO, use the 'search blog' box if interested.
Three from around the time of the above interview were:
April 2
GMO: The Deep Causes of Secular Stagnation and the Rise of Populism
May 2
Grantham Mayo Van Otterloo First Quarter Letter
June 15
Grantham Mayo: "Whiplash: On Value, Growth, and Ignoring the Fundamentals"