My boss told me to serve expensive wine because the more the financial experts I was hosting drank, the more they were likely to speak candidly. So I pulled out the corporate card, ordered grand cru Chablis, and told the waiter to pour liberally. As it turned out, Jeremy Grantham did not need alcohol to loosen his tongue. Before the fish was even served, Grantham had compared a popular investment theory to a vampire that won't die, implied that a fellow diner's gains were the product of luck, not skill, and made seemingly outlandish statements about the stock market. With his clipped English accent he sounded like a scolding professor.
This was November 2002, the aftermath of the tech bubble. I'd gathered a few of Wall Street’s leading lights at New York’s “21” to address a pressing question: Was the bear market finally over? Most strategists were cautiously optimistic, predicting the S&P 500 index would end 2003 north of 1,000. If anything, they were overly cautious. When the ball dropped in Times Square 12 months later, the index was at 1,111.
Grantham, co-founder of Boston money manager Grantham, Mayo, Van Otterloo, had refused to offer a one-year prediction, declaring that short-term movements of the market are impossible to predict (he’s correct). But, he said, markets always revert to their long-term averages. By his calculations, that would take the S&P down to 670 in seven years.
It’s hard to overstate how insane that prediction sounded at the time. The stock market was slowly crawling its way back after getting cut in half, and this Brit in an Hermès tie wanted us to believe that in 2009 my 401(k) was going to be more than 20% lower? “At GMO, we hero-worship reversion to the mean,” he said, by way of explanation.
Nearly seven years later, on March 9, 2009, the S&P hit an intraday low of 666 and closed at 676. It was at that point I began to hero-worship Jeremy Grantham. His prediction was so uncannily accurate, it seemed more like a Vegas magician’s trick than a market forecast. And it wasn't a one-off. For the decade, he called for emerging markets to return 7.8% a year. They logged 8.1%. He said U.S. small-company stocks would return 2.5%; in fact, they returned 2.3%. You get the picture.
It’s important to understand that nobody else does this. Not Goldman Sachs, not Warren Buffett, not George Soros. Academics will tell you it’s not possible, and Wall Street doesn’t have the patience to look that far ahead anyway. Hell, most traders close out their positions before cocktail hour. In fact, in the late ’90s, Grantham paid dearly for being correct. He saw the Internet bubble inflating and kept GMO’s clients out of tech stocks. They were so pissed that they were missing out on all those hot IPOs (RIP pets.com) that they pulled 60% of their money out. They regretted the move.
On March 10, 2009, the day the market turned around, Grantham published a letter to investors under the headline “Reinvesting When Terrified,” announcing it was time to buy stocks. Four and a half years later, the market was up about 160%.
So, the obvious question: What is Grantham recommending today?
For the most part, Grantham and his team believe that financial assets have climbed so far they’re overpriced. The only area of the stock market where GMO is predicting generous returns during the next seven years is emerging markets, which had a rough 2013. GMO predicts annual returns of 6.5% after adjusting for inflation—or around 8.7% when you add in the firm’s assumption that inflation will eventually revert to 2.2%.
The best way to own emerging-market stocks is through the Vanguard Emerging Markets Fund (VEIEX). An index fund, it charges rock-bottom fees of 0.33%. Its biggest positions include Taiwan Semiconductor, Russia’s Gazprom, and Brazil’s Banco Bradesco. The stockpickers at Harding Loevner Emerging Markets (HLEMX) have outpaced the index in the past three, five, and 10 years. But you’ll pay 1.49% per year to bet they can continue to do so. Their top two holdings are Samsung and Chinese search engine Baidu.
Grantham, a staunch environmentalist, is a longtime fan of timber as an investment, as am I. Should inflation return, it will be good to own hard assets like gold, oil, and wood because if the dollar loses value, well, such things are just worth more dollars. When the economy is booming, wood, like other commodities, is in demand. But wood is also nice to own when demand dries up because, unlike gold or oil, trees keep growing. GMO estimates timber will return 5.9% a year after inflation during the next seven years.
The tough part is finding a way to invest. GMO, which has more than $100 billion under management, just goes out and buys forests. For the rest of us, one imperfect but decent proxy is Plum Creek Timber (PCL), which owns and manages forests. It's structured as a real-estate investment trust and pays a decent 3.6% dividend. It’s not cheap by conventional measures, however.
U.S. high-quality stocks
This is a subjective category, and Grantham declines to offer much of a definition. He and others at GMO, however, have described Coca-Cola, Microsoft, Procter & Gamble, and Johnson & Johnson as quality companies. GMO says this category is priced to return 3.3% a year after inflation. If that sounds lame, keep in mind the after-inflation caveat: It feels better if you think about it as 5.5%.
Here are two ways to get exposure: The Jensen Quality Growth Fund ( JENSX) is a picky mutual fund that gets a gold rating from Morningstar. Without getting into the nitty-gritty of its stock selection, it's so demanding that fewer than 200 companies (out of 10,000) have a good enough track record to even merit consideration. And among its 28 holdings are Coke, Microsoft, and P&G. Another option: Buy shares of Warren Buffett’s company, Berkshire Hathaway. Buffett collects quality companies like John Mayer collects ex-girlfriends, and he owns Coke and P&G.
Not much else looks good to Grantham. He expects international stocks will return less than 2% a year and bonds will return close to nothing. The scary part: He sees U.S. stocks (excluding the aforementioned quality companies) racking up negative returns during the next seven years.
To be sure, there’s no guarantee GMO is right this time. Even if the firm’s methodology is on target, the unprecedented efforts of the Federal Reserve and other central banks around the world to stimulate the economy could cause markets to act in unpredictable ways.
So rather than betting your life savings that the firm nails it again, just tweak your investments to benefit if Grantham is right. There’s no need for speed, either. Add to your holdings the next few years through dollar-cost averaging, and if the market dips, you’ll be buying cheaper. Who knows, your returns may even outpace Jeremy Grantham’s.