As I write this Monday morning, stocks are up quite a bit on the day, with the S&P 500 pushing even closer to a new all-time high. The headline on Google Finance reads “U.S. Stocks Advance Amid Deals on Optimism Over Economy,” and all seems right with the world.
What’s Jeremy Grantham’s take?
The most interesting thing I read last week was Looking for Bubbles, Part One, by Jeremy Grantham, founder of asset management firm GMO and one of the smartest investors in the world. He and his firm are famous for their seven-year asset class return forecasts, which have been amazingly successful, and almost as famous for a determined adherence to a value-based investment style that often leaves them sitting as the only onion in the fruit salad. I respect him a lot (my nickname is Eeyore, after all), and his quarterly letters are must-reads.
Despite the firm’s below-consensus forecasts for returns, despite his own conviction that the market is overvalued, Grantham predicts (with lots of grains of salt) that the S&P 500 might rise past 2,250, an increase of almost 19 percent. Hooray, we all shout! But the follow-up is sobering: “the market bubble will burst, as bubbles always do, and will revert to its trend value, around half its peak or worse . . . ”
The other day I wrote about mistakes I’ve made over the past several years, a major one being that I was too slow to recognize the market recovery. My takeaway was to acknowledge that, while fundamentals tell us where we’re going, technical factors tell us when we’re leaving to get there.
Grantham’s piece is a different spin on what I was saying there. He singles out many simple factors—the Presidential election cycle and statistical pictures of previous bubbles, among others—and applies them to the current market, in much the same way I’ve been trying to do. (As you might guess, I derive a lot of comfort from being in company this distinguished.)
A new perspective on value investing
Grantham argues that, as a value investor, his firm must simply suffer through underperformance while the market runs up, rather than try to outguess the inevitable decline. This position has credibility; it’s what GMO did during the tech bubble—hold tight and suffer—until it was eventually vindicated.
For my part, I view the melt-up of 2013 as the real key to my error. My idea was to be a Grantham-like value investor, which doesn’t necessarily serve the needs of clients and advisors. As a result, I’ve shifted my perspective and my research to focus more on participating in the upside, while recognizing the eventual downside.
This isn’t to say that I’ve abandoned the value approach; I haven’t. For many investors, however, participating in the upside is just as necessary to staying in the game as avoiding the downside, and some higher degree of eventual downside risk may be a good trade for more upside participation.
So yes, the market probably will go higher in the short to medium term, but at some point we will face a correction—potentially a very severe one. Investors have a decision to make: do you want to assume higher risk in trying to capture all that upside, or do you recognize that longer-term signs are discouraging and wait for a better opportunity with lower risk?