Monday, March 17, 2014

Jeremy Grantham: Learning to Live With a Stock Bubble

For Jeremy Grantham, founder and strategist at GMO, a Boston-based money manager that oversees about $120 billion, it hasn't been easy watching equity markets rack up huge gains. As of Dec. 31, GMO was forecasting an annual real return of minus 1.7% for large-cap U.S. stocks over the next seven years. Grantham and his colleagues don't see much hope for bonds, either. Still, Grantham, 75, says the current stock boom has a much different feel than the tech bubble of 1999 and 2000. Back then, "there were clients who not only wanted to fire us, but who didn't want to ever see us again," he recalls. "It was personal." GMO runs various strategies, including its benchmark-free allocation funds, which aim for 5% annual real returns over a market cycle. The Wells Fargo Advantage Absolute Return fund (ticker: WARAX), which GMO subadvises, returned 9.65% last year. Grantham, whose market view is marked by an inherent bearishness and skepticism, is an engaging speaker. His passions include financial history, climate change, and other environmental issues. Barron's recently visited him at his office overlooking Boston Harbor. 
Barron's: How frothy does the U.S. stock market look? 
Grantham: There are two good standards for a bubble. One is boring statistics, and the other is an exciting behavioral frenzy, on which so many good books have been written. And based on the boring statistics, the data is really very clear: We are not even that close to a bubble. With the S&P 500 at around 1860 recently, we are at about a 1.4- to 1.5-sigma event. Another way to say that is that we are between one and two standard deviations outside the normal distribution of stock-valuation levels. A two-sigma event would put the S&P 500 at 2350. So using the standard definition, it has to go up another 30% from here to get to a bubble. But you don't know when an ordinary market move is a bubble; you only know that in hindsight. As for the second test, which is euphoria, I like to joke that in 2000 here in Boston, Celtics replays were displaced at lunchtime at the greasy spoons by talking heads on TV. You would go to one, and they would be touting the latest Internet stock. But I've noticed recently that they are still playing the sports highlights on the televisions in the pubs here. 
What else are you seeing in terms of sentiment? 
There is a high level of enthusiasm from the financial professionals, hedge funds in particular. This time you have a very high level of confidence from the professionals—but not a very high level of confidence from the individual investors. The individuals are a bit more down to earth. They felt the pain of 2009 longer than the institutions did, and they have been slow to come back into stocks when you look at net buying of mutual funds. There has never been a bubble where individuals were not flooding into the market at the very end, though sometimes they are pretty late to the game. By the end of a real bubble, individuals are gung-ho, and they are not gung-ho yet. That says a lot.