Friday, April 20, 2012

Jeremy Grantham's Latest Quarterly Letter: Tortured Logic of Rational Expectations

From Jeremy Grantham's latest quarterly letter:

"It is simple to see what is necessary, but not easy to be willing or able to do it. To repeat an old story: in 1998 and 1999 I got about 1100 full-time equity professionals to vote on two questions. Each and every one agreed that if the P/E on the S&P were to go back to 17 times earnings from its level then of 28 to 35 times, it would guarantee a major bear market. Much more remarkably, only 7 voted that it would not go back! Thus, more than 99% of the analysts and portfolio managers of the great, and the not so great, investment houses believed that there would indeed be 'a major bear market' even as their spokespeople, with a handful of honorable exceptions, reassured clients that there was no need to worry."

Price action in the short run (and even longer) will almost always be driven by the mood of the herd, not fundamentals. If price of something happens to be near fair value at any time it's likely mere coincidence.

I suppose no one is entirely immune to the influence of crowd behavior. Yet, it seems those who can mostly ignore what others are doing, judge value consistently well, buy what they understand at a discount (margin of safety or price versus value discipline), and have a bias toward owning what they like for a very long time seem to do more than okay.

Simple? Maybe.


Not so much.

Check out the quarterly letter in its entirety.


* ...the efficient-market hypothesis requires that agents have rational expectations; that on average the population is correct (even if no one person is) and whenever new relevant information appears, the agents update their expectations appropriately. - Wikipedia