My Review of Jeremy Grantham's "The Making of a Permabear:........."

Regression to the Mean?

 

I met Jeremy Grantham of GMO fame on several occasions many years ago and I had a working relationship with Dick Mayo, the M in GMO. Thus, it was a pleasure to read Jeremy’s autobiography written with the help of Edward Chancellor. Grantham is a value investor’s value investor and as such numerous times in his career he was out of step with a raging bull market, hence the title “Permabear." In the interest of full disclosure, I would characterize myself as a value investor.

 

Grantham was born in Yorkshire, England in 1938, just at the onset of the war that would kill his father. His background was middle class and he attended Sheffield University, a far cry from the Oxbridge of the elite. However, the future Nobel Laureate John Hicks read one of his papers. Nevertheless, by the dint of his efforts and natural intelligence he ended up at Harvard Business School and ultimately into investment management.

 

He broke off from Keystone, a prominent mutual fund manager in the early 1970’s to form Batterymarch Financial where he was a pioneer in the nascent index fund industry. He left them to form his own firm, and Dick Mayo soon joined him. The mid-1970’s was a heyday for value managers as the once exalted nifty fifty cratered and practically everything else moved higher. Simply put, value was having the sale of the century.

 

Like most value managers, Grantham believes that stock valuations and profit margins are mean reverting. Simply put, when the market’s price/earnings ratio gets down to around 7 or 8, the market as a whole is a buy and when the ratio is well into the 20’s on normalized earnings, the market is a sell. Grantham backed up his investment analysis with serious quantitative research that covered international markets as well.

 

The dot.com boom of the late 1990’s tested Grantham like no other. Valuations went to the sky from 1998 to early 2000 leaving GMO’s performance in the dust. Nearly half of its assets when out the door. Here Grantham is very astute in talking about business risk and career risk. Being bearish in a bull market brings with it enormous risks to investment managers and their principals. Trust me, as a sell-side equity strategist at Salomon Brothers I felt the brunt of career risk. Nevertheless, Grantham stuck to his guns and was buying REIT stocks that were yielding up to 9% at the time. I had the same instinct at the time and built a personal portfolio holding a basket of REITs. I later became the REIT analyst at Lehman Brothers. In early 2000 the dot.com boom crashed and burned, but unlike in the mid-1970’s the overall stocks market did not get really cheap.

 

In the early 2000’s GMO recovered dramatically, but by mid-decade Grantham blew the whistle on the unsustainable housing boom. Yet again he was early, but dead right. Although stocks suffered from a vicious bear market in 2008-2009, the averages only stayed cheap for a few short months by Grantham’s reckoning.

 

As I write this Grantham is again calling out what he perceives to be the outlandish valuation of the U.S. stock market. Profit margins are at an all-time high and the cyclically adjusted price/earnings ratio is just a touch away from its 2000 peak. What’s going on? Perhaps, the economy has changed so much that it is now dominated by a few highly profitable tech monopolies that are skewing aggregate profit margins. Furthermore, the emphasis has shifted from tangible capital to intangible capital. That was true until last year when the tech behemoths started to massively spend on data centers to support artificial intelligence. The big question is whether or not those investments will be sufficiently profitable to support today’s valuations.

Grantham, through his foundation, is a very active environmentalist. He almost went to jail in opposition to the Keystone XL pipeline. He rightly worries about climate change and chemical pollution. In his private life he attacks the major oil companies, but my guess is that as a value manager he holds the stock in those very same companies. In his environmental hat he applauds the decline in population growth, but as a money manager, he realizes that might have negative consequences for future profit growth.

 

To sum up, Jeremy Grantham is quite the character. and it comes through in his book. For those readers interested in the stock market, its contrarian take is well worth the read and if you are of value bent, like me, it will gird you for the market that lies ahead.