Jeremy Grantham on 'The Curse of the Value Manager'

Jeremy Grantham of GMO has released Part I of his Q3 letter (.pdf, dated October 17, 2008). Here's how Grantham describes the challenge of timing and his current buying in this market:

We at GMO have a strong value bias, and our curse, therefore, like all value managers, is being too early. In 1998 we saw horribly overpriced stocks that at 21 times earnings equaled the two previous great bubbles of 1929 and 1965.  Seeing this new “peak,” we were sellers far, far too early, only to watch it go to 35 times earnings!  And as it went up, so many of our clients went with it, reminding us that career risk is really the only other thing that matters. 

The other side of the coin is that only sleepy value managers buy brilliantly cheap stocks:  industrious, wide-awake value managers buy them when they are merely very nicely cheap, and suffer badly when they become – as they sometimes do – spectacularly cheap.  I said as far back as 1999, while suffering from selling too soon, that my next big mistake would be buying too soon.  This probably sounded ridiculous for someone who was regarded as a perma bear, but I meant it. With 14 years of an overpriced S&P, one feels like a perma bear just as I felt like a perma bull at the end of 13 years of underpriced markets from 1973-86.  But that was long ago. 

Well, surprisingly, here we are again.  Finally!  On October 10th we can say that, with the S&P at 900, stocks are cheap in the U.S. and cheaper still overseas.  We will therefore be steady buyers at these prices. Not necessarily rapid buyers, in fact probably not, but steady buyers.  But we have no illusions.  Timing is difficult and is apparently not usually our skill set, although we got desperately and atypically lucky moving rapidly to underweight in emerging equities three months ago.  That aside, we play the numbers.  And we recognize the real possibilities of severe and typical overruns.  We also recognize that the current crisis comes with possibly unique dangers of a global meltdown. 

We recognize, in short, that we are very probably buying too soon.  Caveat emptor.  

Comments

[Michael Comeau:]

I've been slowly getting long via covered calls and short put positions. However, I think where I've seen a few value investors go wrong is that they were buying stocks in clear downtrends while earnings estimates were also coming down.

It is extremely difficult to when all the bad news is priced in the market let alone any particular stock. Within 6 months, I believe value will be THE place to be as far as style categories go, but for now cash is better than the average stock.

2008 Oct 21 06:11 PM

[MarvinMBA:]

This seems like a very risky time to be making market calls...in my opinion we have not seem the worst of the decline among all sectors. As earnings come out for the next few quarters its going to scare the pants off of investors. Business layoffs are just starting in my opinion...unless M! starts moving higher who is going to take us out of this downdraft and start job formation and a baseline to the Real Estate downdraft. I really think you are a couple of years premature in your comments because the problems are going to get significantly worst on main street...MarvinMBA

2008 Oct 21 07:59 PM

[herbert hoover:]

If they are cheap at 900, what will they be when the S&P sits around 700?

2008 Oct 21 09:24 PM

[T. Myers:]

Comon guys, please note the phrase "strong value bias". Grantham is not necessarily looking at the slope of the change in earnings, the RSI or momentum. Value bias generally means that he will be buying for sustainable earnings, or earnings power, for the strength of the business model and for the competitive advantages the company has developed. This theory is almost entirely contrary to momentum of any sort. Even if Mr. Grantham is even a few years ahead of schedule, he has surely explained that he is creating value for the long term. By the rule of 72 and the record for the best value investors he should be doubling his money roughly every 5 years or 14.5% pa. Please look at his record and his methods. And as for the S&P at 700, he will not be buying the S&P 500 or Spyders - that is the broader market and its not what he is paid to do.

Then there is cash. A wonderful asset. Unfortunately, in the US it is losing its value at around 8.5% annually as per Shadow Govt Stat's read on the pre-Clinton CPI. In the long run, strong brands with pricing power are the best way to retain and create value.

2008 Oct 21 11:02 PM

[Captain Thomas:]

Small domestic oil companies have the most bang for the buck. Oil is cheap, HK is down from $54 to $17 hit $8 at the bottom earning are going up and just wait for the next Middle East War. Remember Osama is on the side of US onshore domestic production, Opec will bail out and price problems in the future

2008 Oct 22 09:01 AM

[bbowen7:]

Thanks for carrying the Grantham articles - high credibility for good reason.

2008 Oct 22 12:10 PM

[mkreisel:]

Lots of small oil/gas companies have loaded themselves with debts (CHK for example). During a credit crunch and the resulting deflation, they will be annihilated. Even the greedy Aubrey McClendon got himself wiped out.

2008 Oct 23 03:20 AM

[fjpenney:]

Timing isn't easy but getting out simply because the market is expensive or getting in simply because the market is cheap can be a recipe for poor performance. A good timer will keep you in the market until after a peak and keep you out of the market until after a trough.

2008 Oct 23 10:57 AM

[Stone Fox C...:]

true, a good money manager should recognize the valuation in the market and hence be prepared to act in that direction. Simply saying stocks were expensive in 1999 and therefore selling is not wise. Having your finger on the sell signal as soon as the momentum ends is the key. Just like now. We all know stocks are cheap. Its just a matter if when to join the party.

2008 Oct 23 05:13 PM