Jeremy Grantham: The Market is Gloriously Inefficient

By on February 26, 2012

Jeremy Grantham - Grantham, Mayo, Van OtterlooJeremy Grantham has released his latest investment letter which he dubs, “The Longest Quarterly Letter Ever.”  In it, he blends philosophy with sage investment observations.  It is definitely one of the superior reads in the world of investing.

Grantham opines early on,

The market is gloriously inefficient and wanders far from fair price but eventually, after breaking your heart and your patience (and, for professionals, those of their clients too), it will go back to fair value. Your task is to survive until that happens. Here’s how.

Grantham goes on to describe his core investment creeds including the dangers of leverage, the importance of diversification and patience, the advantage individual investors have over professionals, being skeptical of excessive optimism and the enthusiasm of crowds, taking advantage of market outliers, the surprisingly simple truths about investing that professional investors find too hard to implement, and the importance of investors realizing their limitations and investing appropriately.

Grantham displays a telling chart showing the results of GMO’s 10 year forecast for 11 asset classes from December 31, 2001. The actual ranking of returns 10 years later showed a stunningly accurate 94.5% correlation to their projection.

In Act II of the current letter, Grantham comments on the Financial Times recurrent articles on capitalism’s deficiencies. He laments the current state of affairs where corporate senior officers “earn” 600 times what an average worker makes, as opposed to the Eisenhower era ratio of 40-1. Grantham also goes into great depth regarding the future burdens born by society for the growth at any cost mantra and states, “seen through a corporate discount rate lens, our grandchildren really do have no value.” He ruminates on the finiteness of natural resources:

You don’t have to be a PhD mathematician to work out that if the average Chinese and Indian were to catch up with (the theoretically moving target of) the average American, then our planet’s goose is cooked, along with most other things. Indeed, scientists calculate that if they caught up, we would need at least three planets to be fully sustainable. But few listen to scientists these days.

In Part III, Grantham gives his view on the current investing climate and expectations for the coming year. He considers U. S. stocks moderately overpriced, but on balance, asset classes are not providing any great opportunities for asset allocators. The only “opportunities” he sees are avoiding long-term “duration” fixed income and underweighting most of the U. S. stock market.

Grantham does believe equities offer an effective inflation hedge along with serious resources – oil, copper, forestry and farmland, and offers a couple of correlation charts as proof.

Grantham takes humorous offense to being labeled a “notorious bear” by a journalist recently. He was actually bullish on emerging market equities over a decade ago which was absolutely the correct stance.

Source: GMO Quarterly Letter – February 2012

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