Thursday, March 26, 2009
REINVESTING WHEN TERRIFIED
It was psychologically painful in 1999 to give up making
money on the way up and to expose yourself to the career
risk that comes with looking like an old fuddy duddy.
Similarly today, it is both painful and career risky to part
with your increasingly beloved cash, particularly since cash
has been so hard to raise in this market of unprecedented
illiquidity. As this crisis climaxes, formerly reasonable
people will start to predict the end of the world, armed
with plenty of terrifying and accurate data that will serve
to reinforce the wisdom of your caution. Every decline
will enhance the beauty of cash until, as some of us
experienced in 1974, ‘terminal paralysis’ sets in. Those
who were over invested will be catatonic and just sit and
pray. Those few who look brilliant, oozing cash, will not
want to easily give up their brilliance. So almost everyone
is watching and waiting with their inertia beginning to set
like concrete. Typically, those with a lot of cash will miss
a very large chunk of the market recovery.
There is only one cure for terminal paralysis: you
absolutely must have a battle plan for reinvestment and
stick to it. Since every action must overcome paralysis,
what I recommend is a few large steps, not many small
ones. A single giant step at the low would be nice, but
without holding a signed contract with the devil, several
big moves would be safer. This is what we have been
doing at GMO. We made one very large reinvestment
move in October, taking us to about half way between
neutral and minimum equities, and we have a schedule
for further moves contingent on future market declines. It
is particularly important to have a clear defi nition of what
it will take for you to be fully invested. Without a similar
program, be prepared for your committee’s enthusiasm
to invest (and your own for that matter) to fall with
the market. You must get them to agree now – quickly
before rigor mortis sets in – for we are entering that zone
as I write. Remember that you will never catch the low.
Sensible value-based investors will always sell too early
in bubbles and buy too early in busts. But in return, you
may make some important extra money on the roundtrip
as well as lowering the average risk exposure.
For the record, we now believe the S&P is worth 900 at
fair value or 30% above today’s price. Global equities
are even cheaper. (Our estimates of current value are
based on the assumption of normal P/Es being applied to
normal profi t margins.) Our 7-year estimated returns for
the various equity categories are in the +10 to +13% range
after infl ation based on an assumption of a 7-year move
from today’s environment back to normal conditions.
This compares to a year ago when they were all negative!
Unfortunately it also compares to a +15% forecast at the
1974 low, and because of that our guess is that there is still
a 50/50 chance of crossing 600 on the S&P 500.
Life is simple: if you invest too much too soon you
will regret it; “How could you have done this with the
economy so bad, the market in free fall, and the history
books screaming about overruns?” On the other hand,
if you invest too little after talking about handsome
potential returns and the market rallies, you deserve to
be shot. We have tried to model these competing costs
and regrets. You should try to do the same. If you can’t,
a simple clear battle plan – even if it comes directly from
your stomach – will be far better in a meltdown than none
at all. Perversely, seeking for optimality is a snare and
delusion; it will merely serve to increase your paralysis.
Investors must respond to rapidly falling prices for events
can change fast. In June 1933, long before all the banks
had failed or unemployment had peaked, the S&P rallied
105% in 6 months. Similarly, in 1974 it rallied 148% in
5 months in the UK! How would you have felt then with
your large and beloved cash reserves? Finally, be aware
that the market does not turn when it sees light at the
end of the tunnel. It turns when all looks black, but just a
subtle shade less black than the day before. - Jeremy Grantham
Disclaimer: The views expressed are the views of Jeremy Grantham through the period ending March 4, 2009, and are subject to change at any time based on market
and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. Any forward looking statements
are based on the reasonable beliefs of GMO and are not a guarantee of future performance. Nothing in this article should be considered investment advice.
Copyright © 2009 by GMO LLC. All rights reserved.
money on the way up and to expose yourself to the career
risk that comes with looking like an old fuddy duddy.
Similarly today, it is both painful and career risky to part
with your increasingly beloved cash, particularly since cash
has been so hard to raise in this market of unprecedented
illiquidity. As this crisis climaxes, formerly reasonable
people will start to predict the end of the world, armed
with plenty of terrifying and accurate data that will serve
to reinforce the wisdom of your caution. Every decline
will enhance the beauty of cash until, as some of us
experienced in 1974, ‘terminal paralysis’ sets in. Those
who were over invested will be catatonic and just sit and
pray. Those few who look brilliant, oozing cash, will not
want to easily give up their brilliance. So almost everyone
is watching and waiting with their inertia beginning to set
like concrete. Typically, those with a lot of cash will miss
a very large chunk of the market recovery.
There is only one cure for terminal paralysis: you
absolutely must have a battle plan for reinvestment and
stick to it. Since every action must overcome paralysis,
what I recommend is a few large steps, not many small
ones. A single giant step at the low would be nice, but
without holding a signed contract with the devil, several
big moves would be safer. This is what we have been
doing at GMO. We made one very large reinvestment
move in October, taking us to about half way between
neutral and minimum equities, and we have a schedule
for further moves contingent on future market declines. It
is particularly important to have a clear defi nition of what
it will take for you to be fully invested. Without a similar
program, be prepared for your committee’s enthusiasm
to invest (and your own for that matter) to fall with
the market. You must get them to agree now – quickly
before rigor mortis sets in – for we are entering that zone
as I write. Remember that you will never catch the low.
Sensible value-based investors will always sell too early
in bubbles and buy too early in busts. But in return, you
may make some important extra money on the roundtrip
as well as lowering the average risk exposure.
For the record, we now believe the S&P is worth 900 at
fair value or 30% above today’s price. Global equities
are even cheaper. (Our estimates of current value are
based on the assumption of normal P/Es being applied to
normal profi t margins.) Our 7-year estimated returns for
the various equity categories are in the +10 to +13% range
after infl ation based on an assumption of a 7-year move
from today’s environment back to normal conditions.
This compares to a year ago when they were all negative!
Unfortunately it also compares to a +15% forecast at the
1974 low, and because of that our guess is that there is still
a 50/50 chance of crossing 600 on the S&P 500.
Life is simple: if you invest too much too soon you
will regret it; “How could you have done this with the
economy so bad, the market in free fall, and the history
books screaming about overruns?” On the other hand,
if you invest too little after talking about handsome
potential returns and the market rallies, you deserve to
be shot. We have tried to model these competing costs
and regrets. You should try to do the same. If you can’t,
a simple clear battle plan – even if it comes directly from
your stomach – will be far better in a meltdown than none
at all. Perversely, seeking for optimality is a snare and
delusion; it will merely serve to increase your paralysis.
Investors must respond to rapidly falling prices for events
can change fast. In June 1933, long before all the banks
had failed or unemployment had peaked, the S&P rallied
105% in 6 months. Similarly, in 1974 it rallied 148% in
5 months in the UK! How would you have felt then with
your large and beloved cash reserves? Finally, be aware
that the market does not turn when it sees light at the
end of the tunnel. It turns when all looks black, but just a
subtle shade less black than the day before. - Jeremy Grantham
Disclaimer: The views expressed are the views of Jeremy Grantham through the period ending March 4, 2009, and are subject to change at any time based on market
and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. Any forward looking statements
are based on the reasonable beliefs of GMO and are not a guarantee of future performance. Nothing in this article should be considered investment advice.
Copyright © 2009 by GMO LLC. All rights reserved.
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