“The Longest Quarterly Letter Ever” is the aptly titled February release from delightfully pessimistic Jeremy Grantham, (below right) co-founder and chief investment strategist of Grantham Mayo Van Otterloo, a Boston-based asset management firm.
Weighing in at 14 pages (15 with appendices that list “Hamlet, Act I, Scene III,” among others) the three-part newsletter includes sub-heads like “Investment Advice from Your Uncle Polonius” and “Your Grandchildren Have No Value (And Other Deficiencies of Capitalism),” before thankfully wrapping up with a market review.
For individual investors setting out on what he sees as “dangerous investment voyages,” Grantham offers 10 points of advice (in just the first section). They are:
- Believe in history. “All bubbles break, all investment frenzies pass away,” Grantham writes. “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.”
- “Neither a lender nor a borrower be.” If you borrow to invest, it will interfere with your survivability, Grantham notes, before adding “Unleveraged portfolios cannot be stopped out, leveraged portfolios can.”
- Don’t put all of your treasure in one boat. “This is about as obvious as any investment advice could be,” he lectures.
- Be patient and focus on the long term. “Wait for the good cards,” Grantham writes. “If you’ve waited and waited some more until finally a very cheap market appears, this will be your margin of safety.”
- Recognize your advantages over the professionals. He believes this is by far the biggest problem for professionals in investing is dealing with career and business risk: protecting their own job as an agent.
- Try to contain natural optimism. From someone like Grantham, it’s a no-brainer.
- But on rare occasions, try hard to be brave. “You can make bigger bets than professionals can when extreme opportunities present themselves because, for them, the biggest risk that comes from temporary setbacks–extreme loss of clients and business–does not exist for you,” he advises.
- Resist the crowd: cherish numbers only. Hard advice to follow, as “keeping up with the Joneses” and the enthusiasm of a crowd is hard to resist.
- In the end it’s quite simple. Grantham offer up encouraging data (no, really): “GMO predicts asset class returns in a simple and apparently robust way: we assume profit margins and price earnings ratios will move back to long-term average in seven years from whatever level they are today.”
- “This above all: To thine own self be true.” To be at all effective investing as an individual, Grantham concludes, you must know your limitations as well as your strengths and weaknesses.
“Doomsayer” Grantham then begins a lengthy diatribe against what he sees as the deficiencies of capitalism, specifically taking on the Supreme Court’s recent Citizens United ruling.
“Today’s version of U.S. capitalism has died and gone to heaven on this issue,” he writes. “A company is now free to spend money to influence political outcomes and need tell no one, least of all its own shareholders, [who are] the technical owners. So, rich industries can exert so much political influence that they now have a dangerous degree of influence over Congress. And the issues they most influence are precisely the ones that matter most, the ones that are most important to society’s long-term well-being, indeed its very existence.”
Grantham exhausts himself further by railing against the quality of education and “the tyranny of the discount rate,” before ending the second part of the newsletter with “capitalism does admittedly do a thousand things better than other systems; it only currently fails in two or three. Unfortunately for us all, even a single one of these failings may bring capitalism down and us with it.”
After a market review of 2011, including the crisis in Europe, the bond rally, and other factors, as well as a look ahead to 2012, Grantham concludes with the following recommendations:
- Heavily underweight U.S equities, but not the high quality quartile, which is almost fair price. Non-quality equities, in contrast, have a negative imputed seven-year return after their handsome rally in the last three months through to mid-February.
- Slightly overweight other global equities, which are almost fair price, down from a little cheap at year end.
- In total, be about neutral in global equities. Yes, there is more than our normal fair share of potential negatives lurking around, but on our data: a) most of the negatives are reflected in stock prices; and b) all fixed income duration is dangerously overpriced. This last situation is, of course, engineered by the Fed, which hopes to drive us all into taking more risk, notably by buying more equities. I hate to oblige, but at current equity prices it just makes sense to do what they want. As mentioned earlier, equities are also good long-term hedges against inflation.
- Underweight as much as you dare long-term bonds, especially higher-grade sovereign bonds.
- In the long term, resources in the ground, forestry, and agricultural land are attractive, but come with the usual caveats of the risk of short-term over pricing, so average in.