A voice in the wilderness who won’t be quiet

Posted by ProjectC 
By Chris Taylor
February 19 2008

Jeremy Grantham does not take any pleasure in watching world markets melt down. Well, perhaps just a little.

This is because back in mid-November, the chairman of the Boston-based money manager GMO was feeling pretty foolish. He had just read in the Financial Times that corporate profit margins were taking a hit from the economic slowdown, and the news sent him into in a rare panic.

The 69-year-old investor had long thought those margins were the last leg propping up a shaky US economy, and if they collapsed, many other things would follow.

And so that day he barged into his offices along the Boston wharves “completely hysterical”, he remembers, as though the firm had only minutes to shift its assets around before a total market blow-up. “And then, nothing happened. Two or three days, nothing. A month, nothing. I was very embarrassed in front of our younger troops, and felt like a complete idiot.”

Not for long, though. As Mr Grantham took a break on the beaches of Mexico with his family over the holidays, the markets digested all the dire economic data coming in and finally began to convulse. Suddenly January became “one of the more exciting months in my investing career”, he says. “By some measures, I had never seen the likes of it.”

It was all rather as Mr Grantham had predicted. Last July, when the credit market collapsed but equities remained almost impervious, he said: “As yet the equity market seems totally unaffected, with volatile and risky stocks still making the running. Although the brontosaurus has been bitten on the tail, the message has not yet reached its tiny brain, but is proceeding up the long backbone, one vertebra at a time.”

He was proved right, but it was far from the first time. Some of Mr Grantham’s “greatest hits” are as follows: the technology-stock implosion of 2000; the insane Japanese valuations of the late 1980s; the emerging-markets run of the last few years; and the plunging housing market we are experiencing at present.

In retrospect, all obvious. But at the time, before these massive booms and busts, he always seems to be a lonely voice in the wind.

“I remember when Jeremy made a stand against tech stocks in the late ’90s, and was in the wilderness for what must have seemed like 50 years,” says Jim Grant, founder and editor of Grant’s Interest Rate Observer, who has known Mr Grantham for 15 years. “He lost many clients during that time, but he’s a fighter, and just doesn’t back down from a deeply held conviction. I think the British army lost a talented field general when Jeremy migrated to the States and took up finance.”

It was to Harvard University in particular that Mr Grantham migrated, for his MBA, subsequently founding GMO with Richard Mayo and Eyk van Otterloo back in 1977. The firm now boasts $154bn in assets, infused with a risk-conscious outlook and propelled by number-crunching with a side of common sense. In short, a rational player whenever the world loses its senses, which is frequently.

To wit, Mr Grantham now houses two statues of Buddha in his office, as part of his growing collection of ancient stone, radiating calm and solidity. “Anyone who visits me has to sit right between them,” he jokes. “If they lie to me, they vaporise.”

This “middle way” is why Mr Grantham seems to thrive in more extreme times, when other investors are either euphoric or despairing. When subprime mortgage debts began to blow up, housing was plunging and credit risks were spreading into new corners of the economy, the markets just shrugged it all off. To Mr Grantham it made no sense, and he said so.

“He takes it very personally when the market sticks a thumb in his eye,” Mr Grant says. “He takes off his coat, forgets he’s a Quaker, and starts ‘showing leather’, as they say in boxing.”

Indeed, there are many things Mr Grantham is not afraid to say. Consider his “Greenspan Prize”, awarded to economic titans who offer the most boneheaded observations. This is in honour of the revered former Federal Reserve chairman Alan, of course, who once posited that you cannot recognise bubbles before they pop.

Other distinguished winners, and targets of Mr Grantham’s withering commentary, include Hank Paulson, the Treasury secretary, for saying last spring that subprime troubles were “contained”, and Ben Bernanke, the Fed chairman, for riffing that inflated housing values merely reflected a strong economy.

Mr Grantham prefers to pay attention to hard numbers, instead of the misinformed musings of public officials. He is a “quant” at heart, collecting reams of data and discovering what it all has to tell him – with a few crucial modifications, though.

For in the latest market crisis, the quants and their mathematical trading models were humiliated in dramatic fashion. If an unforeseen, outlying event takes place – a “Black Swan”, as the best-selling book terms it – the vaunted model often does not know how to react.

That is where real live human beings come in, to “override” the system every once in a while, Mr Grantham says.

Quant models had not calculated how to deal with a housing decline of 25-30 per cent, for instance, or a credit crisis of global proportions. “If you find yourself at a cliff, a quant says ‘there is no cliff here’, and marches right off,” Mr Grantham quips. “A more traditional investor would say, ‘Hey, that looks like a cliff!’ So the next generation of quantery will combine discipline with actually using your brain.”

Without the benefit of sophisticated quant models to run, though, what is an individual investor to do in volatile economic times? “The mattress is good,” Mr Grantham says, only half-joking. After all, boring cash – the “good, old-fashioned” kind of short-term government instruments – is at least a safe harbour, despite negligible returns.

And other places to consider stashing assets during a storm, for more aggressive investors? Half in the “bluest blue chips you can find”, and the other half in solid emerging-market equities. Even though emerging markets have enjoyed a multi-year run of outperformance, Mr Grantham still likes them, given the stunning global growth story.

As for the current market nightmares, do not think they are over quite yet. It is a little bit like Alien, Mr Grantham’s favourite horror movie: equal measures terrifying and thrilling, and the enemy threat is never truly exterminated. Every minute is something you have to watch “through your fingers” – and that is just the way Mr Grantham likes it.

“In this business, I am in constant dread of being bored to death,” he explains. “So this credit crunch is completely intellectually challenging and exciting. If you like to have real problems, this is absolute heaven.”

Copyright The Financial Times Limited 2008