Jeremy Grantham: Hold Cash, Not Stocks

In his latest quarterly letter to shareholders, legendary manager (and longtime bear) Jeremy Grantham of Grantham, Mayo Van Otterloo addresses the Minsky Meltdown, describing the current situation as the most important U.S. financial crisis since World War II. The letter was written January 12, and as Grantham astutely points out, it may certainly have been overtaken by more recent events. Key excerpts:

2007 Eggs-on-Face Awards

My first Greenspan prize goes to Chuck Prince for enthusiastically continuing to ‘dance’ the expanding credit polka into the summer; a most unfortunately timed demonstration of chutzpah. The second Greenspan prize – for “incomprehensible misreading of obvious data by an apparently well-informed source” – goes appropriately enough to Ben Bernanke for his late 2006 comment that, “U.S. housing prices merely reflect a strong U.S. economy.” In humble third place I have to put Hank Paulson for his view in the Spring that the subprime troubles were “contained.”

Minsky Meltdown

About 2 years ago I was introduced to Hyman Minsky’s argument on the development of credit bubbles. Remarkably, ‘stability is unstable’ really captures his point. Investors, when confronted with an apparent reduction in risk, will seek to return to their normal or desired risk by leveraging up. This attitude becomes contagious and reinforcing – risk is ignored and debt levels soar until at the peak capital gains are needed to merely pay the carrying costs. Then something, it doesn’t really matter what, goes wrong; the risk in the environment is seen to return to more normal levels. Many players are caught with risk levels far above their desired level and are forced to cut back on leverage and risk in general, which puts pressures on the prices of what they own and so on. It has a simple and powerful logic. Well, the Minsky Meltdown has clearly arrived, and one shoe after another of the market centipede drops onto the floor, and we are waiting for many more. This is the most important U.S. financial crisis since World War II: it is of course far more global than previous crises, with tentacles reaching everywhere, and it coincides with broad overpricing of assets.
... Stocks meanwhile, relative bystanders last year, are overpriced, particularly at the risky end of the spectrum. And profit margins are spectacularly above average precisely for companies at the riskier end of the spectrum. Margins are declining now and the markets are finally getting the point that all risk is dangerous. Markets are well into a massive repricing of both risk and asset prices but it has far to go outside the original subprime area, where repricing may have already run its course.

Recommendations for 2008

I’m afraid cash is the ugly answer that no one ever wants to hear. For the first time, in many bear markets, traditional value stocks are unlikely to help much and may even hurt, as they entered the decline badly overpriced. And, once again, if you literally cannot resist buying some stocks, we recommend a mix of the highest quality U.S. blue chips and emerging markets. The bigger the fundamental problems, the more quality stocks are likely to outperform.

Comments

[Alpha Seeker:]

Another bear mumbles for attention, dusting off its crappy mediocre returns and hoping to get into the spotlight. Sometimes I wonder why we give outlet to these privileged come-late-to-party blue blood dudes to waste our time? Where was he in the summer, where was he in October when the market topped? Now, he is pointing to the winter and telling me " It snows". Obviously his firm has some heavy shorts, that's all. The third award for " late for the party" goes to Grantham, and yes I may step into your office and tell you why Ken Heebner has outperformed you for almost every year in the last 20 years.
Rob
WallastonInvestments.c...

2008 Jan 23 05:16 PM

[HarMegiddo:]

there also needs to be an award for angelo mozilo who's tan became darker the more CFC stock price fell.


if its that bad you can buy short ETFs now, i don't see why he says there is nothing to buy. how about the DBA, i don't see food deflating anytime during my life.
it's "ok" AS don't worry. articles like this one get all the late shorts in, they will be the ones that cause the next rally.

2008 Jan 24 12:05 AM

[Myron Shlapak:]

How much of the current meltdown is due to the recent exposure at Societe Generale?

There seems to be an Imelda load of shoes still to drop.

2008 Jan 24 07:14 AM

[Jim Brown 1776:]

Do you jokers even have any idea what an absolute investment stud Jeremy Grantham is? Honestly, you guys shouldn't even be allowed to comment on his articles. And to be even more honest, I find it slightly offensive that Seeking Alpha publishes his stuff because I'd say odds are overwhelming likely that he did not give you permission to publish his stuff, nor have you ever even had any contact with him whatsoever. But, whatever...

Apr 20 11:05 AM