Friday, December 30, 2016

Grantham on Bubbles Revisited

From Jeremy Grantham's 3Q 2016 letter:

"We have been extremely spoiled in the last 30 years by experiencing 4 of perhaps the best 8 classic bubbles known to history. For me, the order of seniority is, from the top: Japanese land, Japanese stocks in 1989, US tech stocks in 2000, and US housing, which peaked in 2006..."

Grantham goes on to explain something each of these bubbles have in common. It essentially comes down to euphoria combined with widespread belief in the unbelievable. Things like:

- That "land under the Emperor’s Palace" should equal the combined value of all California real estate.

- That the Japanese stock market, at 65x earnings, was supposedly cheap.
(Apparently Solomon Brothers at the time thought that valuations should be more like 100x.)

- That U.S. tech stocks could also be considered cheap at 65x while Internet stocks had, at least in aggregate, negative earnings yet many sold at high multiples of their loss generating sales.

More from Grantham:

"...Greenspan (hiss) explained how the Internet would usher in a new golden age of growth, not the boom and bust of productivity that we actually experienced. And most institutional investment committees believed it or half believed it! And US house prices, said Bernanke in 2007, 'had never declined,' meaning they never would, and everyone believed him. Indeed, the broad public during these four events, two in Japan and two in the US, appeared to believe most or all of it. As did the economic and financial establishments, especially for the two US bubbles. Certainly only mavericks spoke against them."

So how does the current environment compare? Well, according to Grantham, it just doesn't stack up.

"How does that level of euphoria, of wishful thinking, of general acceptance, compare to today’s stock market in the US? Not very well. The market lacks both the excellent fundamentals and the euphoria required to unreasonably extrapolate it."

This hardly makes for a wonderful investing environment. Grantham points out that the market these days economically and psychologically "is closer to an anti-bubble than a bubble. In every sense, that is, except one: Traditional measures of value score this market as extremely overpriced by historical standards."

He then adds...

"None of the usual economic or psychological conditions for an investment bubble are being met" though valuations are "almost on the statistical boundary of a bubble."

Investing well necessarily requires not only sufficient margin of safety to protect against unforeseeable outcomes (along with inevitable mistakes), it requires sufficient compensation considering ALL risks and understood alternatives.

High valuations make meeting these requirements nearly impossible.

During the financial crisis -- and actually for quite a long while after the crisis -- lots of equity bargains could be found.

These days...not so much.

Instead, in way to many instances, more than full valuations prevail these days even if there may naturally be the odd exception when it comes to such a generalization. Charlie Munger once said:

"Our system is to swim as competently as we can and sometimes the tide will be with us and sometimes it will be against us. But by and large we don't much bother with trying to predict the tides because we plan to play the game for a long time."

Unfortunately, valuation reveals little or nothing about what market prices might do in the near-term or even longer.

Judging how price compares to the intrinsic value of a business is a very different game than guessing how the "tides" might impact market prices.

The former is difficult yet not impossible while the latter activity is, at least for me, something destined to be ignored from the sidelines with great enthusiasm.


Related posts:
Isaac Newton, The Investor
Grantham om Bubbles
Charlie Munger: Snare and a Delusion

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