Saturday, March 15, 2014

Barron's Interview: "Jeremy Grantham: Learning to Live With a Stock Bubble " (Quick, Hire a Kid!)

Mr. Grantham may want to hire a kid.*
From Barron's:

Famed strategist Jeremy Grantham views the market as 65% overvalued, but still sees some pockets of attractive investments. 
For Jeremy Grantham, founder and strategist at GMO, a Boston-based money manager that oversees about $120 billion, it hasn't been easy watching equity markets rack up huge gains. As of Dec. 31, GMO was forecasting an annual real return of minus 1.7% for large-cap U.S. stocks over the next seven years. Grantham and his colleagues don't see much hope for bonds, either. Still, Grantham, 75, says the current stock boom has a much different feel than the tech bubble of 1999 and 2000. Back then, "there were clients who not only wanted to fire us, but who didn't want to ever see us again," he recalls. "It was personal." GMO runs various strategies, including its benchmark-free allocation funds, which aim for 5% annual real returns over a market cycle. The Wells Fargo Advantage Absolute Return fund (ticker: WARAX), which GMO subadvises, returned 9.65% last year. Grantham, whose market view is marked by an inherent bearishness and skepticism, is an engaging speaker. His passions include financial history, climate change, and other environmental issues.Barron's recently visited him at his office overlooking Boston Harbor.

Barron's: How frothy does the U.S. stock market look?
Grantham: There are two good standards for a bubble. One is boring statistics, and the other is an exciting behavioral frenzy, on which so many good books have been written. And based on the boring statistics, the data is really very clear: We are not even that close to a bubble. With the S&P 500 at around 1860 recently, we are at about a 1.4- to 1.5-sigma event. Another way to say that is that we are between one and two standard deviations outside the normal distribution of stock-valuation levels. A two-sigma event would put the S&P 500 at 2350. So using the standard definition, it has to go up another 30% from here to get to a bubble. But you don't know when an ordinary market move is a bubble; you only know that in hindsight. As for the second test, which is euphoria, I like to joke that in 2000 here in Boston, Celtics replays were displaced at lunchtime at the greasy spoons by talking heads on TV. You would go to one, and they would be touting the latest Internet stock. But I've noticed recently that they are still playing the sports highlights on the televisions in the pubs here.

What else are you seeing in terms of sentiment?
There is a high level of enthusiasm from the financial professionals, hedge funds in particular. This time you have a very high level of confidence from the professionals—but not a very high level of confidence from the individual investors. The individuals are a bit more down to earth. They felt the pain of 2009 longer than the institutions did, and they have been slow to come back into stocks when you look at net buying of mutual funds. There has never been a bubble where individuals were not flooding into the market at the very end, though sometimes they are pretty late to the game. By the end of a real bubble, individuals are gung-ho, and they are not gung-ho yet. That says a lot.

What's brought about the discrepancy?
The belief in the Greenspan-Bernanke-Yellen put gets greater and greater each time there's a crisis. So we start in '94 with a bond crisis and a very successful bailout. Then we have the Long-Term Capital Management blowup in 1998. There's a bailout, which is very successful again. We have the Y2K bailout, which was a little unnecessary. And then we have the 2000 bubble and the ensuing collapse—the biggest bubble in American equity history. Uniquely, the stock market does not go below trend, even though the market is down 50%.

In 1929, it crashed through the trend line and stayed there for 20-odd years. The Nifty Fifty crashed through the trend line in 1973 and stayed down there until '86-'87. What is not typical is a bubble like the one in 2000. The market tumbled over three years, but it didn't even reach trend. And the cavalry comes over the hill with enormous stimulus and moral hazard, the kind of implicit promise that they would bail investors out in a crisis, which they did. And the market, never having hit even fair value for a minute, then doubles. I described it as the greatest sucker rally in history.

So that turned out to be a prescient call.
That was a lucky call, as much as anything else, because it took the breaking of the housing bubble in 2007 to end that rally....MUCH MORE
*We've mentioned the story a few times, here's the 2012 iteration:
"Transports, Small Caps Hit New Highs" (Quick! Hire a kid!)

There's an interesting dichotomy developing in the markets, one that we've seen before.
The old pros are cautious, befuddled and a bit scared. Folks with less than a decade at the market are making money.

Adam Smith noted it in the 'sixties bull market (The Money Game via Contravest, January 22, 2000):
There is one wonderful chapter where the consummate pragmatic speculator, the Great Winfield, is lamenting his performance problems in a wildly speculative bull market.
“My boy,” said the Great Winfield over the phone. “Our trouble is that we are too old for this market. The best players in this kind of a market have not passed their twenty-ninth birthdays. Come on over and I will show you my solution.”
So Adam Smith goes over and finds three new faces in the Great Winfield’s office. 
My solution to the current market,” the Great Winfield said. “Kids. This is a kids’ market. This is Billy the Kid, Johnny the Kid, and Sheldon the Kid.” The three Kids stood up without taking their eyes from the moving tape, shook hands, and called me “sir” respectfully.
“Aren’t they cute?” the Great Winfield asked. “Aren’t they fuzzy? Look at them, like teddy bears. It’s their market. I have taken them on for the duration.”
Winfield then describes how much money Billy the Kid is making in computer leasing stocks like Leasco Data Processing and Randolph Computer that he has heavily leveraged with bank borrowing....
And the really spooky bit, for me anyway, SHALE:
...Sheldon the Kid waved his hand for recognition.

“This one will really take you back,” said the Great Winfield. “Sheldon’s Western Oil Shale has gone from three to thirty.”

“Sir!” said Sheldon. “The Western United States is sitting on a pool of oil five times as big as all the known reserves in the world – shale oil. Technology is coming along fast. When it comes, Equity Oil can earn seven hundred and fifty dollars a share.

It’s selling at twenty-four dollars. The first commercial underground nuclear test is coming up. The possibilities are so big no one can comprehend them.”

“Shale oil! Shale oil!” said the Great Winfield. “Takes you way back, doesn’t it. I bet you can barely remember it.”

“The shale oil play,” I said dreaming. “My old MG TC. A blond girl, tan from the summer sun, in the Hamptons, beer on the beach, ‘Unchained Melody,’ the little bar in the Village.”

“See? See?” said the Great Winfield. “The flow of the seasons. Life begins again. It’s marvelous. It’s like having a son! My boys! My Kids!”

The Great Winfield had made his point. Memory can get in the way of such a jolly market, that malaise that comes with the instantly gone, flickering feeling of déjà vu. We have all been here before.

“The strength of my kids is that they are too young to remember anything bad, and they are making so much money they feel invincible,” said the Great Winfield.

“Now you know and I know that one day the orchestra will stop playing and the wind will rattle through the broken window panes, and the anticipation of this freezes us. All of these kids but one will be broke, and that one will be the multi-millionaire, the Arthur Rock of the new generation. There is always one, and maybe we will find him.”
In late 2006 both Bloomberg and Raymond James' Jeff Saut were reminded of the above:

Bloomberg, Aug. 3, 2006
Go Short, Mildred -- the Kids Are Taking Over: Susan Antilla
Saut, Nov. 20, 2006
“A Kid’s Market?!”