“‘Enron-itis’ is to blame for the sluggish economic recovery,” according to Jeremy Grantham. “If Enron hadn’t existed,” he says, “I’m almost sure the market would be up 15%.”
Grantham, chairman and co-founder of the Boston money management firm Grantham, Mayo, Van Otterloo & Co. LLC (GMO), will appear at the Morningstar Investment Conference, scheduled to run June 24-26 in Chicago, where he will discuss his economic recovery predictions and emphasize the importance of “price before investing.” Staff Editor Megan Fowler caught up with the traditional bear on his cell phone just before he caught an afternoon flight out of Boston.
You’ve said there are lots of alternatives to U.S. stocks and that the overall stock market will go nowhere for the next seven years. Can you tell me what those alternatives are? If you can think outside the box and not worry about what other people are doing, you can build an unconventional and respectable portfolio that can make good money. We love emerging equity in our portfolio. So we are looking for an earnings recovery and P/E recovery. Small-cap value, both U.S. and international, also look very attractive. REITs have gone up 35% and Treasury bonds have done beautifully with a handsome yield and a handsome gain.
All of those areas that we loved two years ago we only like now. They moved from very cheap to a little cheap, and now they are merely less expensive and less attractive. But they still collectively represent a good haven. Because of this, we have been able to deliver a positive return in 2001 and 2002. For example, our global fund has delivered positive returns throughout its eight-year history, including this year at a 6.5% positive return.
Do you still think Treasury Inflation Indexed Securities (TIPS) are a good investment outlet? I still think that TIPS are reasonable, but they are not cheap. They yield about 3.4% above inflation, which is close to what they should be, in our opinion. So they’re a fairly priced asset–with very very low risk–in a world where the biggest assets (the S&P 500) are very overpriced.
We encourage our readers to pick investments for clients that are low cost and that meet the client’ goals. Any particular suggestions for our readers? Yes, don’t spend so much time worrying about what typical advisors are doing. Just focus on price: Avoid [investments] that are above average. Resist the temptation to come up with some fancy new system, [to think] that this time is different. And force yourself to buy [asset classes] that are cheap. Of course they will be unpopular, that is why they are cheap. So if you go with price, you are buying out-of-favor asset classes and selling in-favor asset classes.
The S&P 500 now institutionally is the worst of all possible worlds, it’s an unfashionable, unfavorable, overpriced asset class. In fact, a recent group of endowment and foundation managers voted the S&P 500 at the very bottom of nine asset classes, even below Japan, which was pretty shocking. In first place were junk bonds, which we don’t do, and in second place were emerging country equities, which is remarkable. You only have to go six months back and emerging equity was incredibly unpopular, and now it is second on the list.
How do you think REITs fit into the everyday investor’s portfolio? I think if they are priced attractively, they belong in everyone’s portfolio; and if they are priced unattractively, they belong in nobody’s portfolio.
At the moment they are priced pretty attractively, yielding 6.5%. They are certainly fairly priced and even may be a tiny bit cheap on an absolute basis. Two years ago they were very cheap and now they are somewhere between a little bit cheap and fairly priced. Again, the competition is so overpriced that they jump in the portfolio.
As advisors, we would own basically as much as the client could stand. We would still try to stuff the portfolio full of REITs and Treasury bonds, a little emerging country equity, a little emerging country debt, small-cap value U.S., and if we had some good hedge funds–good risk control hedge funds–this is a good time to add them. They are different and keep the risk level down in a dangerous market.
To preview the Morningstar Conference: do you think tech stocks will rise again? Do you see an economic rebound any time soon? I write a quarterly letter to our clients and last June and October I wrote, “Of course there will be a recovery and it will be preceded by a stock market rally.”
In the first quarter I expected a recovery, but I believe Enron-itis has more than upset the spectacularly surprising strength of the economy. If Enron hadn’t existed, I’m almost sure the market would be up 15%.
Also there was substantial overpricing of blue chips and pricing is everything. Ignore any arguments that if the S&P goes down, so will small caps. History suggests that often in declines small caps go down, but when they are very cheap, the cheapness is a more powerful variable. When they are very cheap, they don’t fall, and they have never been cheaper relative to blue chips than now.
You have been categorized as a bear. Is that accurate? Whenever I go to a conference someone always makes that comment. I suppose I am what I am.