Why Jeremy Grantham Changed His Mind

If people had paid attention to veteran investor Jeremy Grantham over the past two years, their investment portfolios would be looking much better than they likely are. While many investors were caught up in bull-market euphoria in 2007, Grantham, who oversees $85 billion for Boston-based institutional money-management firm GMO, told anyone who would listen there was a global bubble: “It’s everywhere, in everything.” Then, in early March of this year, when the market looked its worst, he wrote that people needed to get over their fears and invest, because U.S. stocks were cheap and foreign stocks even cheaper.

Grantham’s disregard for the conventional wisdom has brought him grief at nearly every point of his 40-plus-year investing career. But more often than not, the often grumpy Grantham, 70, has been right over the long term. The irony of all his remarkable forecasting is that few ordinary investors can invest with him. The funds GMO runs are mostly geared toward institutions, such as pension funds or school endowments, although the Evergreen Asset Allocation fund invests exclusively in funds managed by GMO. GMO investors lost money last year because many of its funds dictate a substantial degree of stock holdings even when the boss is decrying the market. Still, GMO’s U.S. stock funds lost only about half what the S&P did during the crash, and some other GMO funds did much better.

Grantham, 70, has an opinion for everyone about the best investment strategies in these uncertain times. Sitting in his office lined with giant Buddhas and relics of civilizations long gone, Grantham talked to SmartMoney about the stock market and the current financial mess.

SmartMoney: In 2007 you were worried the global financial market could fall apart, and you said a market downturn was probably coming. Okay, say it: “I told you so.”

Jeremy Grantham: That seems so long ago. I felt like saying that a few months ago, but now onward and upward, and wait for the next unexpected twist.

SM: Why were you so certain things were going to get so ugly?

JG: There wasn’t a whole lot of doubt where I was coming from. I thought the fair value of the S&P was 925; the S&P went to 1500. And by 2006 the housing bubble was at a 100-year peak. This was the 32nd asset bubble that we’ve tracked, and all but the U.K. housing bubble have popped.

SM: Why didn’t you just put all the money in GMO’s funds into cash?

JG: Every quarter, we do our best to tell our clients the truth. We were comfortable with telling our clients there was a major bubble in every asset class, everywhere. Then they go to investment committees and decide what to do with their money. They don’t want to do anything that looks eccentric and costs them their jobs. It’s a miracle that any of our advice perks up the pipeline.

SM: Why did your own funds lose so much money when you were confident the market would fall apart?

JG: Most of our mandates require us to be nearly 100 percent invested. But even when you had to be at least 45 percent equity, then you couldn’t help but to go down. There was nowhere to hide. Everywhere and everything got hit.

SM: Yet now, for the first time in years, you like U.S. stocks.

JG: We think a fair price for the S&P 500 index is 900. By sheer divine intervention we bought into the market on Mar. 6, the day it hit the recent low of 666. It’s likely, but far from certain, that we’ll go back and make a new low. You aren’t going to get to buy at the absolute low unless you have a time machine.

SM: Anything else besides U.S. stocks?

JG: U.S. stocks were nicely cheap, and frankly, the rest of the world was even cheaper. In early March, when we bought, we invested only in stocks we thought would have a 10 to 14 percent average annual return after inflation. That’s magnificent. We haven’t seen anything like that in 20 years. It was somewhat disappointing that prices moved up so fast in just a couple of weeks. The odds are a bit more than 50-50 that we will go back and test that low.

SM: So you’ve made a quick buck. Now what?

JG: You have a set of possibilities. First, if the market nosedives, it’s easy: You buy. The second is confusing, when the market just goes sideways, between 700 and 800. The market is irritatingly cheap then, but not supercheap. The longer that goes on, the less probability we will set a new low, so we’ll ultimately put money each month into the market.

SM: What if stocks keep rallying?

JG: If the market goes higher, above 950, and then starts moving sideways, between 950 and 1050, we probably do very little. Then the market is moderately overpriced.