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Irrational Exuberance - The Thinking of Financial Analyst Jeremy Grantham

Advisers to Investing

Readers will know that we often comment on the motivations of those that advise on where to invest, and what to invest in. They have their motivations and it is essential for investors to understand why your investment adviser recommends an investment and why a media pundit touts some stock or other.

An article published in the Guardian has many insights that mirror our views on how to invest, so we essentially reprint it here, with some minor editing. The article is by John Elkington and it discusses the views of financial analyst Jeremy Grantham. It follows:

For those who haven't come across Jeremy Grantham, he is perhaps the most interesting financial analyst worldwide. He was a co-founder of GMO back in 1977, a firm that now employs more than 500 people and at the end of last year managed $97bn in client assets. Grantham is known for his trenchant views on long-term "value" investing. The idea: whatever the market may say, there are fundamental valuations of businesses that are ignored at the investor's peril.

If you want to make long-term returns, he says, remember that "all bubbles burst, all investment frenzies pass away. You absolutely must ignore the vested interests of the [financial] industryand the inevitable cheerleaders who will assure you that this time it's a new high plateau or a permanently high level of productivity, even if that view comes from the Federal Reserve itself." Then he corrects himself, adding: "No. Make that especially if it comes from there."

The point is that "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," he advises would-be long-term investors, "is to survive until that happens." GMO assumes that whatever the market thinks today, "profit margins and price earnings ratios will move back to the long-term average in seven years."

Jeremy Grantham warns that investors ignore the long-term at their descendants peril. People who struggle to get their brains around long-term sustainability find it easier to grasp if they think about their children or grandchildren. But the capitalist system thinks otherwise. Jeremy Grantham's message is that if we proceed on current capitalist lines, "the planet's goose is cooked."

Grantham calls for foresight, patience and a reining in of analysts' natural optimism - noting that "successful people are probably more optimistic than average." This can lead to irrational exuberance, a problem compounded by the fact that for most financial analysts there is an irresistible temptation to over-manage, driven by the need "to be seen to be busy, to be earning your keep."

An example is the Law of Unintended Consequences. The problem with most of today's variants of capitalism is that they produce unintended consequences on a planetary scale. They ignore key externalities (particularly things like species loss and climate change), assuming that growth can continue almost indefinitely. Worse, Grantham warns, some of the most damaging forms of capitalism, and some of the worst industries, have the money to buy influence, a lot of it.

"Today's version of US capitalism has died and gone to heaven on this issue," Grantham warns. "A company is now free to spend money to influence political outcomes and need tell no one, least of all its own shareholders, the technical owners." And, grotesquely, some parts of the industrial complex fight "to increase the inherent weaknesses of capitalism," aggravating its blind-spots and its addiction to unsustainable forms of growth.

Translation of the Foregoing into Sensible Investment Policy

In our last post, we talked about how the economic world, and especially the Capitalist world, rotates around ever repeating cycles of boom and bust, or prosperity and despair. In order to put the words of Grantham into understandable form, we now repeat some of our comments of our last post.

The Panic Investment Cycle

The panic investment cycle is a migration in emotion from optimism to excitement, then thrill, and then virtual euphoria about how well things are going. Unfortunately, in the absence of the proper risk management tools, this emotion usually morphs into anxiety once an investment begins to break down. That anxiety then becomes denial, and it is at this point that the fear factor invades. Soon after the fear comes the panic selling, and it is at this capitulation point, when nearly everyone is despondent, that the real opportunity for income investors presents itself."

Buy Low, Sell High

Another description of this phenomena is the old adage Buy Low Sell High. You often hear this truism, and yet people miss opportunity after opportunity to follow this basic and simple way to invest. People are always jealous of others who have either bought at an opportune moment, or sold at an opportune moment. Yet investors fail to follow this very simple and basic rule of investing.

Why don't people buy low and sell high - because people have a basic instinct to follow the crowd. When there is fear in the land, history is ignored and fear takes over.

How to Make Money in this Tidal Wave of Fear

Ignore the experts. Ignore the media. Remember the truism that has stood the test of time over hundreds of years. Stocks are depressed currently. They are at low points. Multiples of p/e are low. Companies are increasing cash reserves rather than investing. This is when stocks are low. Buy now. Sell when the frenzy of the next cycle hits its height.

The bargains that are available now, come around once in a decade. If you miss this opportunity, the next one wont come for many years.

Buy good value stocks, with good management, with no debt, and with valuable unrecognized assets. Then sit back and wait. Wait patiently.


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