Jeremy Grantham: AI Mega-Bubble Meets a Dangerous Global Backdrop

"Every bubble in a major stock market always went back to trend," he says. "That's mean reversion."

His first book, "The Making of a Permabear: The Perils of Long-term Investing in a Short-term World," co-written with Edward Chancellor, was released in January. It is revealing and instructional, taking the reader from Grantham's childhood in England through GMO's ups and downs from its 1977 inception.

What has stayed constant is a disciplined investing philosophy.

"Look at the numbers; play the numbers," Grantham maintains. "No room for excitement, a very bad idea. No room for super-pessimism either. Just analyze the data."

In the interview, Grantham, who the past several years has been focused on climate change — "The most important problem we face in the long term," he offers — also discusses the implications of artificial intelligence ("Everything is changing," he says) and his long-term forecast for the global economy (bearishly realistic).

Here are highlights of our conversation:

THINKADVISOR: Are you really a permabear?

JEREMY GRANTHAM: No, no. That's inaccurate. I voted for putting permabear in quotations [as the book's title] because it's what they call me.

THINKADVISOR: You write that investing shouldn't be driven by excitement because "it will always end badly." What should drive investments, then?

GRANTHAM: You should be driven by cold-blooded, hard-headed analysis. Warren Buffett is like me, dead-against excitement. Excitement is just another way of saying you're beginning to lose your standards. It's the very opposite of sensible, long-term analysis.

Look at the numbers; play the numbers. No room for excitement, a very bad idea. No room for super-pessimism either. Just analyze the data.

THINKADVISOR: How would you further describe your investing philosophy?

GRANTHAM: I don't like stock prices when they're above the long-term average. I dislike them when they're way above. When they're spectacularly above, I hate them.

I understand how bubbles work. We've found a lot of them — over 200 — in various asset classes.

Every bubble in a major stock market always went back to trend. That's mean reversion. The problem is some did it quickly, some slowly, some started tomorrow, some started 2 1/2 years later, by which time they had gone from a decent-sized bubble to a spectacular one of the top two or three in history.

In that long wait, as they went from overpriced to hellishly overpriced, a bear is likely to lose business [clients] and take a lot of grief. We're a very unpopular group.

THINKADVISOR: You write that "a major stock market bubble is one of the most dangerous things that can happen to an economy." What's going on with the bubble that's in the market now? How big is it?

GRANTHAM: It's one of the biggest ever. There are really two bubbles this time: We've had a great surge of AI.

In 2000, the U.S. tech bubble went to 35 times earnings for the whole market. The one now is not necessarily bigger, but the environment in which it's happening is more dangerous by far because we have wars, the politics, the trade wars and the effect on business that declining foreign trade will have.

Simultaneously, we have a workforce in which the growth rate is becoming negative. That will feed through the system as far as the eye can see. From now on, we'll have a much more limited growth rate in the workforce, and that goes directly through to GDP growth and makes it less.

THINKADVISOR: But what about all the potential of AI?

GRANTHAM: AI promises, rather vaguely, enormous increases, potentially, in some areas of productivity. So the struggle we're facing is like the irresistible force and the immovable object.

I don't pretend to know how that will work out. But I guarantee there'll be more uncertainty, more volatility and more surprises than we're used to.

THINKADVISOR: Reversion to the mean has "dominated" your career, you write. Why do you consider that the most important principle?

GRANTHAM: It says that history is a decent guide, that if a trendline has been going for 100 years, it probably represents a fairly stable economic truth. Then the question becomes, has that truth changed? Of course it's changed, and that will affect the future economy.

In a sense, this time is different: We had that great surge of AI, one of the most important inventions ever. Everything is changing. It's going to cost a lot of jobs. Maybe some old-fashioned industries will cease to exist; others will spring up.

It's precisely ideas that are huge and obviously important around which bubbles form.

THINKADVISOR: "The financial crisis revealed how Wall Street ethics had deteriorated over the years," you write. What's an example?

GRANTHAM: My favorite example is Goldman Sachs. Back in the golden era of Goldman Sachs, the 1960s and '70s, they would never trade against their customers. But they morphed into a culture using trading data of their clients to trade against them, to rip their hearts out and make as much money as they possibly could.

That's a pretty big shift in from protecting your clients to using them as an asset in which you can make as much money as you can.

THINKADVISOR: What's your outlook right now for the market and U.S. economy?

GRANTHAM: Quite long-term, the growth rate of the economies of the developed world will be substantially less than we're used to. Even in the U.S., which is the champ, the growth rate has been slow. We have a higher and higher level of monopoly, which is wonderful for profits but tends to hold growth rate back.

THINKADVISOR: "The most important problem we face in the long term" is climate change, you hold. "If we fail at this, everything else we achieve will be for nothing." Therefore, "green investing is an existential necessity," you write. Please elaborate.

GRANTHAM: We're using up finite resources at a shocking rate. That has a profound effect. [President Dwight D.] Eisenhower said in his retirement speech that we must not plunder the resources of our grandchildren. I mean, holy cow, that was so advanced!

THINKADVISOR: Your foundation is investing in geothermal energy and grease-proof paper. Earthquakes are triggered by geothermal energy. Your thoughts?

GRANTHAM: Fracking is going to produce 50 times more earthquakes than geothermal because it's drilling hundreds of times more wells.

If they continue to make breakthroughs in geothermal, we'll be able to drill a really large percentage of big chunks of territory and produce power where we need it.

That, in some cases, will go on forever and won't be accompanied by the same production of carbon dioxide [as fracking does].

THINKADVISOR: What should be done to control the issues of climate change?

GRANTHAM: It's obvious that you need at least a decent measure of government regulation to help push people in the right direction. That needs to be encouraged.

But a lot of people hate the very concept of government intervention of any kind even though without regulations, society would disintegrate very quickly.

THINKADVISOR: Generally, Wall Street "hasn't told the unvarnished truth," you write. If it weren't so bullish, what would happen to the stock market?

GRANTHAM: There would be less pain and less action for the stockbrokers; less money would be made [by them]. So from their commercial point of view, that would be a bad idea.

But the same money would be made in the market. It's just a reflection of how well the underlying companies do. Whether it goes up a lot and comes down a lot doesn't affect the corporate system underneath.

The reality is very stable. But the stock market's reflection of that is very unstable.

No big company will ever tell you to get your tail out of the market.

Courtesy photo