Jeremy Grantham: Lessons from 60 Legendary Years of Investing

0:00I don't think of it as timing the market. I think of it as getting out of clearly overpriced stocks and concentrating always on the ones that are cheap. And every time you buy a small stock, you could say, oh, you're timing the market, you're timing that stock. Are you or are you just in the long run always going to win eventually if you own the cheaper stocks? And so do not stand your ground in badly overpriced stock markets unless eventually you want to take it on the chin. And of course, in the meantime, other people are outperforming you. But in the longer run, you win. Has there ever been a more dangerous environment on every level as we began to talk about?

0:48Every level. Population bust, climate change, geopolitics, trade war. actual live war in two or three places. And things can get really bad in a real hurry. And how does the market reflect this? I'll tell you. By having one of the two or three highest priced markets in the history of business. And if you think the future looks one of the two or three best futures that we have ever had in the last 100 years. You're smoking dope, right? This is a fraught, dangerous, growth-limiting world.

1:37Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders, and politicians in the world, giving you, our listeners, The Edge. The Master Investor Podcast is sponsored by LSEG, Interactive Brokers, the World Gold Council and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes. My guest today, Jeremy Grantham, is a true investment legend.

2:19He founded and led GMO for many decades and remains their long-term strategist. At his peak, they managed a staggering $150 billion in AUM and oversaw some consistent extended periods of enormous outperformance during his 60-year investment career. Famously, Jeremy, of course, predicted all of the major stock market bubbles of his six-decade investment career and often the corresponding rallies as well. Jeremy, welcome back to the Master Investor podcast. This is our fourth interview. We did two on CNBC, one obviously on the podcast so far. It's great to see you in person. Nice to be here. And welcome back to the podcast.

3:06And I have to object to predicting. I didn't predict the bubbles. I said that they had arrived when they arrived. But they hadn't burst yet. If I could predict them coming out of nowhere, that would be very handy. All I can do is wait until they appear. They always seem pretty darn obvious. And say, look, there it is. and you're absolutely right to correct me there and I'm sure you're going to be correcting me a lot through this which is what I look forward to so we can share in your wisdom and I wanted to begin Jeremy by getting into your mindset as a person and how that led to the type of investor you are I've so enjoyed reading the making of a perma bear the perils of long-term investing in a Short-Term World, which was published in January this year.

3:59And I've learned a lot about you personally in it that I didn't know before. You're a pre-war baby born in 1938. Your family were Quakers and you're a Yorkshireman. And I love how all of those things together you point to gave you the appreciation for finding good value. You wrote that every Yorkshireman worth his salt is born with the natural understanding that cheap is better than expensive. I think that's fair to say. You also talk about your butterfly effect, how your ideas and thoughts flit around the garden like they have no concentration. Tell me what you mean by that and why that is important and why you were such a great investment thinker.

4:46Well, it's probably self-justification. I have a hard time spending too long on a given topic and tend to move on much to the irritation of my colleagues usually onto a slightly different topic or a completely different topic. But the thing is I'm quite persistent. So after a little bit, I come back. And anyone who's got any interest in gardening will notice that that is exactly how butterflies work. You think they're just here and gone, but they're not. They can stay around for a day or two. and they're constantly coming back to the same flowers. And then off they go. They don't spend long on a given flower, but they keep coming back.

5:26And I have found that that is exactly the way that brainstorming should proceed. If you hammer away too earnestly, which is a tendency, oh, stay on topic, stay on topic. And in fact, what happens is you just get stale, you're beating your head on the wall, and it's no good to anybody. The worst thing you can do is stay on topic. you know what the topics are take some time out wander around the periphery a bit come back to the original and when you come back your brain is a little open you have an insight maybe with any luck and and just do not hammer away it's seen as a virtue and i think it blocks the creative juices you also wrote in the book very hard work does get in the way of thinking because you're so busy shoveling in new data, you have little time to really think.

6:19Do investment professionals today spend too long in the Excel spreadsheets or perhaps in the AI building models today? But rather than what do you mean by really think? It's not it's not typing numbers into a spreadsheet. No, it's walking across Boston Common and having a shower before you go there and just thinking, where are we? What's going on? What am I working on? Let the brain travel at a convenient walking speed and see where it goes. I used to reckon that by the time I'd arrived at work in the good old days, of which there were maybe about 30, I would have had two or three ideas. Mostly, according to my colleagues, pretty silly ideas.

7:08And I was blessed with a colleague, Chris Darnell, who was the only human being who could persuade me that an idea was idiot in about 20 seconds. Ben Inker can do it in 10 minutes or an hour, and no one else can do it, period. I'm very hard to convince. But Chris could do it so fast that I'd hardly got my brilliant new idea out. Then I was, oh, how obvious. And that combination is absolutely formidable, by the way. have someone who's got lots and lots of ideas, mostly ridiculous or superficial, and one guy who is an idea destroyer who just looks through, points out the fatal fallacy, and you move on.

7:54And we would go through 10 or 20 ideas to find one to put into the pile for further research. And on that note, you say, again, another quote, I'm going to throw lots of your great quotes from your book, Jeremy, at you during this interview, I hope you don't mind. another one saying getting the big picture right is everything one or two good ideas a year are enough we'll come to some of the scale of your outperformance in a moment but it's really just one or two a year that leads to that investment legendary status yeah and there's plenty of years i would have settled for one um i didn't get it but um if the idea if the level you're thinking on is fairly high level, you know, are small cap going to win this year?

8:41You don't need to hit too many. Just knowing that small cap are on a roll might be a single idea that will power you through three or four years of outperformance. And when you get it right, it doesn't even that difficult. You can't really implement it badly enough not to win if you get the big ideas, right?

9:33In terms of narrowing down, and there's too often generalizations used and labels used in investing, but narrowing down the type of investor you were, the real winner, if I'm right, for you was basically a dividend discount model with your adaptations that you guys made to it. But that was at core what you focused on? Yeah, I wouldn't call that an idea. It was just how we measured the quality of our other ideas. Every stock would have a dividend discount ratio. What ratio of fair value was it? 0.79, you were 21 % cheap. 1.12, you were 12 % overpriced. And then we'd add them all together. And it turned out that the sum of all the small ones was very cheap.

10:25The sum of all the big ones on average was very expensive and so on. And it gave us a measuring kit to test whether our instinct was right and very handy. And clearly, therefore, you weighed up the value and that was much more your focus than was other factors like growth and momentum. But I guess you had an appreciation for the importance of those other factors. I kind of, you had quite a long set of chapters on this part of the book, which I really enjoyed. And stepping back from it all, it was almost as if you begrudgingly accepted that momentum was a significant factor. No, actually, I have a sneaking respect for anything that works, however ludicrous it may be.

11:19And of course, momentum is a pretty simple-minded inefficiency. It really shouldn't work. And it's worked pretty well, I'm sure, all my investment career and a lot before. And it still works in many forms. And it just says, you know, a body in motion tends to stay in motion for a while. And I remember when the market efficiency guys were saying, there is no information in pricing alone. And random walk down Wall Street guy, Burton Malkiel. And if the day he said that, you had looked back 20 years and you had asked the profound quantitative question, hands up who did best last year, and you took the 10 % best, they outperformed by three or four points the following year.

12:06Information in pricing alone. He was completely wrong and provably wrong for the last 20, 30 years before he said it. But academics can be like that. I think the biggest inefficiency was always quality. You know, quality has less debt, higher returns, more stability, goes bankrupt less. However you torture the data, you can't persuade anyone that quality is a risk factor. The higher the quality, the lower the risk. And yet, quality outperformed. It's outperformed forever. And it should be minus a point, right, a year. The AAA bond underperforms, you know, the B bond by about a point a year. and the AAA stock should do the same for the same reason, less risk.

12:52And it didn't. It outperformed by about half a percent a year. So there was a freebie return and an inefficiency of about 1.5 % a year. You were paid for the privilege of owning the big, high-quality stocks. And the academics went for decades without picking that up and making a fuss about it. So you referenced there they went for decades without picking that up. um so have markets gotten more efficient over time has your job gotten harder or not no as my career went on i tended to gravitate to bigger and bigger issues starting with stocks and then sectors and then markets and so on just because i i found them a bit different and more interesting and the critical critical question is are the are the magnificent inefficiencies the bubbles where ridiculous meme stocks go up six times in a year.

13:54Are they more now than they were? I would say, if anything, a little worse than they ever were. In terms of your investment approach, this quote jumped out to me. We never made tons of money without taking painful losses beforehand. You need to have the confidence to hold your positions when it moves against you and to increase your weighting as it gets more attractive. Value gives you that confidence. I mean, we'll come to some of the more painful bits of your underperformance in a moment, but if you've done the work and you're confident in your position, I guess you can see through those moments in time, but it must have been very tough.

14:35No, it is tough. And you do have to believe the data. And the catch-22, really, is that if you want to have a three sigma bubble, the super colossal bubbles that have occurred once or twice in 100 years, you don't get there overnight. You get there via a pretty substantial bubble of the kind that you see every 30 years. And you don't get there overnight. You get there via, yeah, it's a bubble. It's a two sigma event, the kind that occurs every 15 years. And if you want to make real money, you have to go from overpriced to very overpriced to, oh my God, extremely overpriced. And from that point, you make a fortune.

15:24But by that point, you have taken a lot of grief. You know, you bought it when it was cheap. The market moved against you by 50%. You're now cosmically cheap. And it's from those points, 1929, 2000, that you go down a lot and you outperform the market by an amazing amount if you're in the right place. In 2000, there were plenty of places to hide. The market went down 50%. Our portfolios were up quite nicely over the three years. Well, kudos to you to seeing it through as you did so many times against, you know. Well, there are not many when you think about it. You know, three or four. Three or four.

16:03Well, I've been in the business for 60 years. That's true. That's true. But, you know, particularly in the run up to the dot-com ball of buffing, you describe in the book, you know, losing a lot of the clients, some personal positions as well that you had that caused pain. Another couple of quotes before we get on to some moments in history to reflect on just on your broad investment style. And I love this because, you know, so many people say it's impossible to time the market. And, you know, I think it kind of is on any individual stock. But again, I love the sort of bold positions you take.

16:41And you say market timing, in my view, is a disparaging tag used by some buy and hold investors to put down anything that involves using your brain. These are the same people who watch the locomotive coming down the tracks and in the name of discipline get run down. And I mean, so timing the market is something for those big asset allocation decisions in particular, once a decade or so rather than daily on an individual stock you believe you have to try and do. No, I don't think of it as timing the market. I think of it as getting out of clearly overpriced stocks and concentrating always on the ones that are cheap.

17:23and every time you buy a small stock, you could say, oh, you're timing the market. You're timing that stock. Are you or are you just in the long run always going to win eventually if you own the cheaper stocks? And so do not stand your ground in badly overpriced stock markets unless eventually you want to take it on the chin. And of course in the meantime, other people are outperforming you. but in the longer run you win um on that note your performance throughout as we know those of us that are in the business or study the business know was was outstanding the scale of it across a couple of the decades i had underappreciated so six out of the eight years when you're at battery march outperformed one of them was in line one of them was behind and then your first nine years at gmo after founding it, you outperformed every single year with an annual outperformance of 8 % per annum.

18:29Yeah. That's right, 8 % per annum. 8 % per annum. So that run of performance, which was, you know, the 16 years. Would double your money, by the way. Eight, nines, and 72. Rule of 72. So that run, those years I just outlined was up to 1987. Was that the best moment? there were some great moments but that is 8 % per annum for 9 years is unheard of in a way, no it isn't unheard of, Warren Buffett has done 9 % for a whole lot longer and that actually it's that statement that makes me realise how good that sucker is I mean, that in our best 8 years out of 60 years of trying I'm sorry, best 9 years we couldn't quite equal his 45 or 50 year average.

19:20That's pretty dismal. Wait a minute, it's 35, 40, 60 years, jeepers creepers. 60 years of averaging 9 % and we can muster 9 years of adding 8. It's not dismal. No, it's not dismal. It's just a recognition of how remarkable Warren Buffett's record has been. Whilst you mention, is he the greatest of all time?

19:47Why is he so good? In terms of adding percentages to basically a buy and hold portfolio, yeah I guess he has no rivals that I can think of. I'd have to say there are other measures out there who has been the most useful. Of course it's Jack Bogle because he gritted his teeth and kept driving that idea of indexing through 30 years of little interest. And then finally, the internal logic, there's a power of the logic of that idea begins to take over. And to have an organization whose Christmas bonuses depend on how much money you save investors, this is a pretty far cry from what everyone else was doing.

20:39So yeah, Warren Buffett gets the medal for making money. A simple, entertaining goal. But Jack Bogle gets the medal for doing the most useful thing in the investment business, saving millions of people, billions of dollars, perhaps even more. But Jack Bogle credits you, which I was holding my hands up unaware of, the impact. You came up with the idea of indexing before him. Yeah. And he gives you that credit. Yes, he does. Together with Dean LeBaron.

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21:48Hey guys, Wilf here. I wanted to flag Jim Mellon's upcoming Master Investor Show on the 25th of April in London in person. It's always a fabulous event with 5 ,000 investment enthusiasts like you expected to attend loads of panels and speakers, including me on the main stage at lunchtime interviewing Jim Mellon. Visit masterinvestorshow.com to register or check the show notes for a special link and discount code to register for free.

22:20I wanted to now focus, Jeremy, on a couple of particular moments in history and bubbles that were formed. Starting with 1999, you are talking about how a client was giving you a lot of grief because you guys had identified the bubble early and taken a more anti-risk approach and therefore were underperforming for a number of years. Although making decent money, by the way, beating the long-term pension fund targets, perhaps as much as 7 % a year, but the market was 13%. Right. So you were identifying that. And And this is what you said you were pushing back to the client by saying. You said, I went over the pitch.

23:06I described how cheap some of the nooks and crannies of the market were, how inflation-linked bonds yielded 4%, how regular bonds yielded handsomely. Value was off the scale and as cheap as it had been in 1974. REITs sold at a discount to their NAV and so on and so forth. Could you apply all of that to today as well? No. 2000 was wonderful because it gave you many places to hide. The REITs, real estate sold at a discount to building the building. REITs sold at a discount to the properties they had bought. The 9%, you must be joking, right at the top of the market when the S &P was down to a yield of 1.6, which had never seen such a low level even in 1929.

23:57And there it was. I mean, small cap was cheap. And then you have other markets, like the housing bubble of 2007, almost nowhere to hide. That was a risk bubble. Everything risky was overpriced. There were no obviously cheap assets in 08. Now this one is in the middle. This is

24:32happily quite like 2000. So you have half the bubbles have great alternatives to the US market. half of them do not. Half of them represent a general tendency to all go together and some of them do not. And this one, I remember at the beginning of last year saying in a podcast that we had nothing against non-US equities. We wouldn't touch the US equity market. But the rest of the world, emerging markets, European stocks, Australian, Canadian, the rest of the world's equity markets were extremely reasonable. In terms of one sort of similarity to 1999, I guess it was another decade where a lot of people were talking about the potential boost in productivity and with it the potential boost in GDP that might come from a new technology, the internet then, AI this time around.

25:39Talk to me why that was a foolish point of view to have, because in all of the work you've done, GDP growth itself and productivity growth itself doesn't in fact necessarily correlate with strong equity returns. Yeah, there's been no easy relationship in the past between high-priced markets and and the growth in the future. And that's what it gets down to, right? And in every bull market, they say the future must be wonderful, otherwise the market wouldn't be so high priced. And it's quite the reverse. If you say, what are the three or four terrible times? They are not randomly distributed. They are precisely following the great bubbles.

26:25So the Great Depression precisely follows the famous 1929 peak. And Japan's last 10 years, last 20 years, precisely follows that amazing 65 times earnings in 1989. There's no example of a high PE predicting higher profits, higher growth, higher productivity in history. What they do predict is tough times. And if ever there was likely to be a case of that, it's now. You know, everything has been done wrong. We've taken wonderful post-war growth in international trade and done our best to mess it up with tariffs and trade war. And done our best to destabilize geopolitics. Our relationships with Russia, China, and so on.

27:23I'm sure they've been worse with one or the other several times. But to have both of them at the same time, this is distinctly uncomfortable. And then we have the long-term climate change, which up until two years ago was something you talked about, but no one listened. And now in the last two years, the billion-plus damages, floods and droughts and fires are so thick and fast that they may be knocking half a percent off global GDP. And they're getting worse all the time. Then you have the population beginning to decline. In some countries, Japan, South Korea, China, all dropping like a stone.

28:07And they're going to do it as far as the eye can see. So the world is going to have to get used to slower growth in the workforce. The declining populations, it's a factor we talked about at length in our first episode, and I refer people back to that and the bonus episode in particular. where we touched on a lot of your long-term risks.

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28:54you mentioned there the worst thing geopolitical situation which brings me to one other comparison i wanted to to touch on this you wrote about the 1970s um talking about 1973 in particular market the market hates high inflation and weak profit margins you wrote when those two factors become extreme the market should sell at seven or eight times earnings and it did at the trough, the S &P 500 was down 55%. Again, talking about the 70s there, 1973 specifically. I picked that out just because of the situation of the last six weeks. Are you reminded of some of the challenges of the 1970s as the Iran war has kicked off and the obvious impact on oil prices and inflation?

29:37Yes, I think we as a species have a tendency to think happy thoughts. We do wishful thinking extremely well. I believe it's a survival characteristic. I think that pessimists, that this was not a good survival characteristic for 150 ,000 years. And so we've kind of bred out the real pessimists mainly. And so we're a very happy thinking species. And certainly if you studied the stock market now and forever, you'd conclude that. Given half a chance, we will generously interpret the future and say how good things will be. If the economic data is bad, we say whoopee, this will give an excuse for the Fed to cut rates and the market goes up.