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On Jeremy Grantham's Latest

Slow start, fast finish.

John Rekenthaler, 11/20/2013

Brave Talk
GMO's irrepressible Jeremy Grantham is at it again. In his third-quarter 2013 letter to shareholders, reprinted on Morningstar.com, Grantham takes aim at, among other things, economists, the Nobel Committee, Eugene Fama, the Efficient Market Hypothesis, and the condition of today's stock market.

It's entertaining stuff, made more entertaining by Grantham's delivery, which suggests that he has received his word directly from the Lord. Grantham knows what his audience wants. Investment managers comfort their shareholders when they are direct and confident. It's unbecoming for a guru to show uncertainty.

For me, Grantham overestimates his abilities in the first part of the letter, when he attacks economists and the Nobel Committee. He's on much firmer ground later on when assessing the stock market.

No Bells for Nobels
Grantham isn't fond of economists, who practice a "soft science" that is guilty of "physics envy." As "economics has been more or less threadbare for 50 years," the Nobel Committee should stop handing out so many economics prizes. Instead of three awards per year, as has been the recent fashion, the Committee should instead make the award once every three years.

That's a fun section, but not credible. The number of people who understand physics, literature, medicine, chemistry, and economics (I'm setting peace aside--not sure what to do there) well enough to judge the amount of excellence exhibited by each field must surely be very small. It's unlikely that one of those people would be an investment manager who is paid to evaluate asset prices, not to measure, say, the quality of contributions from modern physicists.

Grantham isn't much more convincing with his criticism of one of this year's Nobel Laureates, Gene Fama. Grantham demolishes the Efficient Market Hypothesis, which Fama helped to develop, by pointing to various market bubbles. In 1991, Grantham writes, the land underneath the Japanese Emperor's Palace was worth more than the value of the land in the entire state of California. The boom in U.S. stock prices during the New Era of the 1990s, and then the growth in housing prices in the 2000s, also strike Grantham as being indefensible.

With this section, I fully agree with Grantham, down to his mocking of the "12 reasons that were given as to why the 22% drop in one day" of Monday, Oct. 19, 1987, was a "rational economic response." I recall an editorial in The Wall Street Journal claiming that news that arrived over the weekend of Oct. 17 and 18 justified a change in the discount rate used for valuing stocks, and therefore justified the 22% daily loss in stock prices. I also remember believing that couldn't possibly be right. It was not. But it was a required line of thought for those who felt the need to defend the EMH. 

That said, the EMH has been useful.(1) Defending the extreme form of EMH is a losing proposition--a proposition, admittedly, that Fama himself has sometimes made the mistake of supporting--but in its milder form the thesis has been accurate. It has served as a useful guide for understanding the performance of mutual fund managers, few of whom have been able to beat a static benchmark consistently. Indeed, of GMO's three large-company stock funds with 15-year records (U.S. Core Equity GMRTX,  U.S. Equity Allocation GUSAX, and U.S. Growth GMGWX), two trail the Wilshire 5000 for the time period.

is vice president of research for Morningstar.

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