As I’ve noted previously on Investorazzi.com, legendary money manager Jeremy Grantham has been buying equities. Yet, how did the chairman of Boston-based investment firm GMO decide now is the time to start buying stocks? Well, Steven Goldberg, writing for Kiplinger.com, provided some insight yesterday as to how Grantham might have come to this conclusion. Goldberg wrote:

In making his forecasts about U.S. stocks, Grantham worships at the altar of “reversion to the mean” — the notion that valuations eventually return to their long-term averages. He calls it “our single big truth.” Over the long term, he notes, the stock market’s average price-earnings ratio is about 15. When stock prices are higher than those long-term medians, he turns bearish. And vice versa.

Grantham also pays attention to profit margins. The long-term average net-profit margin for S&P 500 companies is 5.6%. Currently, Grantham thinks profit margins are way too high. As the recession deepens, he believes margins will fall much lower — back to their historical averages. That’s a negative for stocks. But because of the bear market, P/Es have fallen so far that he sees stocks as good buys now.

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Goldberg also pointed out what the British investor is buying these days. The investment adviser wrote:

What is he buying now? Grantham’s favorite stocks are high-quality U.S. and foreign blue chips. He’s also turned bullish on emerging-markets stocks — they have been pummeled even worse than U.S. stocks during the bear market.

Grantham is negative on stocks of small U.S. companies and real estate investment trusts.

Source:

“A Bear Turns Bullish”
Steven Goldberg
Kiplinger, November 19, 2008

Today, a guest post of mine appears on “MarketClub Trader’s Blog” from INO.com:

“Investing Legends Buying Up Stocks”

Legendary investors Jeremy Grantham and Warren Buffett recognize stock investors are in a panic, and are taking advantage of the situation by actively acquiring equities.

Here are the latest plays by legendary investors Warren Buffett, Jeremy Grantham, Mark Mobius, and Jim Rogers:

Warren Buffett

Equities:

(GurusFocus.com, October 13)

Warren Buffett has been one of the most notable buyers. After cutting an amazing deal with Goldman Sachs and watching shares of Berkshire Hathaway (NYSE:BRK-A) fall about 30% in the last month, he’s making plenty of other moves. Berkshire was perfectly positioned as it entered September with a $40 billion cash.

The bid to take over Constellation Energy Group (CEG) still stands. Berkshire has also agreed to put $3 billion into 10% preferred shares of General Electric (GE). Also, $6.5 of Berkshire’s dollars were committed as part of the Wrigley (WWY) LBO led by Mars.

His latest move is probably the timeliest. In order to capitalize on the Bull Market in Volatility, Berkshire is starting to write put options more aggressively. This week Berkshire disclosed it has written put options on Burlington Northern Sante Fe (BNI).

Berkshire sold put options that will force it to purchase 1.95 million BNI shares between $77 and $80 per share. The contracts were sold for a total value of $12.76 million and will just defray the costs of buying more BNI…which they were probably going to buy anyway. Berkshire also sold put options for 1.3 million shares of BNI earlier in the week.

Jeremy Grantham

Equities:

(Barron’s, Lawrence C. Strauss, October 13)

(Grantham speaking) In a nutshell, we are as conservative as we can possibly get. One bet that has been very successful for us, touch wood, has been long high-quality, blue-chip stocks, particularly in the U.S., and short risky companies. We have been screaming against risk-taking for a long time, and in recent weeks, it has paid off enormously…

Going forward, you can think about slowly moving back into the cheapest pockets of global equities. So the next move that we make will be back to moderate neutral in emerging-market equities and small-cap international value. I can’t say we are going to be in a great hurry, but that will be our next move. We had finished selling almost everything except emerging markets two years ago. We finished selling emerging market equities three months ago.

But the next move will be buying, and we are encouraged that there are a few pockets that are cheap on an absolute basis. We are not encouraged that they will rally immediately. But we will be looking to buy the cheap pockets of global equities as our next move some time in the next several months.

(Morningstar.com, Russel Kinnel, October 14)

Nonetheless he’s now more constructive about equities because he believes they are trading at severely depressed prices. He said that at the end of Friday, global equities were trading as cheaply as they had been since the 1980s. In fact, the U.S. had traded below GMO’s fair value estimate–though as we spoke Monday morning a rally had brought it back to around fair value. Specifically, he prefers blue chips to small caps or highly leveraged companies.

“We’re buying carefully and slowly,” Grantham notes. Why slowly? “When bubbles correct, they usually overcorrect so that the market is selling well below fair value.”

Interestingly Grantham also says he’s now neutral on financials–a sector he has long disliked. He notes that most of the credit crisis is likely behind us and that the newest plan of worldwide governments to inject capital into banks in exchange for shares is a big improvement on past plans.

Commodities:

(Barron’s, Lawrence C. Strauss, October 13)

(Grantham speaking) Commodities have a great long-term future, now that the long-term trend has shifted from falling commodity prices to rising commodity prices. Having said that, the next couple of years will be quite different. We are in a global slowdown, which I think will be worse than expected even today, and it will be longer than expected — so this is not a healthy environment for commodities. Over a shorter horizon, I would be getting out of the way of commodities or I would be short commodities. I’m personally short oil; the firm is short copper.

(Morningstar.com, Russel Kinnel, October 14)

Grantham expects that slowing growth will also keep commodity prices falling. “I would keep out of commodities for the near term,” he said.

Currencies:

(Barron’s, Lawrence C. Strauss, October 13)

(Grantham speaking) I’m speaking for the asset-allocation unit at the firm. We have been substantially long the safe-haven currencies. We have been very long the yen and somewhat long the Swiss franc and short sterling, which is one of our favorite bets. We have been short the euro for three months, and slightly long the U.S. dollar. One of the paradoxes is, if the world is worse than people expect, the U.S. dollar will outperform.

Mark Mobius

Equities:

(Reuters, George Georgiopoulos, October 13)

“We are buying stocks with single-digit price-to-earnings ratios, price-to-book little more than one, dividend yields of around 5 percent. Tupras refiner in Turkey, for example, now has a dividend yield of around 20 percent,” Mobius said. Templeton’s favourite emerging markets include China, India, Russia, Turkey and South Africa. Its funds also invest in Greek companies that have a lot of their earnings in emerging markets, such as National Bank and Hellenic Bottling.

Jim Rogers

Bonds:

(Bloomberg, October 14, Wes Goodman, Anchalee Worrachate)

“The U.S. government is taking on gigantic amounts of debt,” Rogers said in an interview in Singapore, where he lives. “They’re printing gigantic amounts of money. Printing money has always led to more inflation. The last bubble in the world that I can find is long-term U.S. government bonds.”

Rogers said he is “shorting” 30-year debt, or betting prices will fall.

Sources:

“What The Smartest Money Is Doing Now”
GuruFocus.com, October 13, 2008

“Still Holding Back”
Lawrence C. Strauss
Barron’s, October 13, 2008

“Grantham: Stocks Haven’t Been This Cheap since 1987”
Russel Kinnel
Morningstar, October 14, 2008

“UPDATE 1-Mobius sees markets close to bottoming”
George Georgiopoulos
Reuters, October 13, 2008

“’Long Bond’ Favored as Investors See Waning Inflation (Update1)”
Wes Goodman, Anchalee Worrachate
Bloomberg, October 14, 2008

This morning, a piece appeared on the CNNMoney.com website in which Money Magazine reporter Joe Light and senior writer Janice Revell spoke with legendary investment investor Jeremy Grantham. The conversation took place back in mid-September, at which time the GMO chairman answered a number of their questions:

In retrospect, there were plenty of signs pointing to the serious and growing problems in the financial system before everything seemed to fall apart at once. Why didn’t anyone, on Wall Street or in Washington, take action sooner?

Jeremy Grantham: We got so good at denial. The Fed was in denial, the Treasury was in denial, the bosses of Merrill Lynch and Lehman were in denial. And yet this crisis was the most widely heralded “surprise” in the history of finance - there were plenty of people warning that it was going to happen long before it did.

You were one of them. What did you see that bothered you?

Grantham: All you had to do was open a history book and see what happens when you have a bubble. In this case, there was a bubble in housing and there was a magnificent bubble in risk taking. People were just shoveling their money into risk on the pathetic idea that risk is always rewarded.

That is completely misguided. You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.

You can lay the evidence in front of everybody, but they will yawn and ignore it. It’s that denial that’s impressive. It’s what happens in bubbles.

How much at risk were the financial institutions involved? That is, was this degree of intervention really necessary?

Grantham: Leverage is the ultimate demonstration of risk, and we never had system-wide leverage like this before. Ever. We had several firms that were leveraged 30 to 1. [For every $30 of assets on their books, they put up $1 of equity and borrowed the other $29.] At leverage of 30 to 1, you have to lose only about 3% on your $30 worth of assets and your dollar of equity gets wiped out. You’re bankrupt.

Why would those financial firms take on such extreme risk?

Grantham: They believed their risk models, which said they had a diversified portfolio, so their investments couldn’t all go down together. And the potential rewards were out of whack with the risk.

Say you’re in the hedge fund division of some investment bank and you have a billion dollars to invest. You hit the ball out of the park, make 120% on that billion and probably walk away with a $45 million bonus. If you lose the billion dollars, you’re fired. Hey, that’s not bad! If I thought the odds of success were fifty-fifty, I’d be a fool not to try.

What can the past tell us about where the stock market is going next?

Grantham: Historically, when a market bubble has popped, it has almost always overcorrected. But after the tech bubble burst in 2000, the stock market didn’t hit the lows it should have.

Before it could, the housing bubble and tax cuts that followed 9/11 kicked off the biggest sucker rally in history, from 2002 to 2006. So I think the market isn’t cheap yet. There is more pain coming. I don’t think we’ll hit the low until 2010.

What’s your advice to investors now?

Grantham: Understand that the market may recover for a while and then go to a new low. One of the lessons I have learned over the years is that things can get a whole lot more extreme, both up and down, than you ever dreamed of. So we may drop another 30% before we hit bottom.

Keep telling yourself every night that you’re a long-term investor and don’t look at daily stock prices. And it’s not too late to shift some of your money to high-quality blue chips. Emerging markets are probably no longer too expensive either. If you had 80% of your stockholdings in blue chips and 20% in emerging markets, you’d have a pretty reasonable portfolio to ride out the bad times.

Source:

“A little perspective, please”
Joe Light, Janice Revell
CNN Money, October 10, 2008

The Wall Street Journal’s Brett Arends wrote a piece yesterday in which he offered ten reasons why not to sell your stocks. Reason number six had to do with legendary investment adviser Jeremy Grantham, chairman of privately-held global investment firm GMO. Grantham’s track record in forecasting the financial markets is pretty impressive:

• In 1982, said the U.S. stock market was ripe for a “major rally.” That year was the beginning of the longest bull run ever.
• In 1989, called the top of the Japanese bubble economy.
• In 1991, predicted the resurgence of U.S. large cap stocks.
• In 2000, correctly called the rallies in U.S. small cap and value stocks.
• In January 2000, warned of an impending crash in technology stocks, which took place two months later.

To giver you an idea of just how well-respected the British money manager’s opinions are, his past clients have included U.S. Vice President Dick Cheney and 2004 U.S. presidential candidate John Kerry.

Arends wrote Thursday:

But if you are panicking and getting ready to sell everything and hide under a rock, here are ten reasons why you shouldn’t…

6. Even one of the most notorious bears is starting to concede some shares are reasonably valued. I’m speaking about fund manager Jeremy Grantham, of Grantham Mayo Van Otterloo & Co. I should add the caveat that Mr. Grantham, who has been predicting financial disaster for several years, remains deeply gloomy overall. Nonetheless he now calculates that shares have fallen so far that if you buy a basket of “high quality” U.S. stocks today and hold them for about seven years, you’ll probably end up making about a 50% profit – after inflation. Stocks that even Jeremy Grantham likes come pretty well recommended even in a financial crisis. His top “high quality” picks are Microsoft, Johnson & Johnson, Pfizer, Wal-Mart, Exxon Mobil, Coca-Cola, PepsiCo, Chevron, UnitedHealth Group, Procter & Gamble, QUALCOMM, Oracle, Merck, Home Depot, and Cisco Systems. (It sort of looks like a typical “Large Cap” fund without the financial stocks.) If you are really nervous, maybe you should just sell your other shares and buy these.

Source:

“Ten Reasons Not to Sell Your Stocks”
Brett Arends
Wall Street Journal, September 18, 2008

Yesterday afternoon, Brett Arends from the Wall Street Journal talked about moving from high-risk stocks to blue chips in an effort to protect one’s portfolio during this bear market. To help him get his point across, he brought up legendary investor Jeremy Grantham. Arends wrote:

Grantham has been successfully navigating markets for decades. He was among those who predicted the recent crisis before it happened, rather than after the fact. Right now, he thinks worldwide stock markets have further to fall, and at this point he is so bearish he wants to stick his money in the mattress. “I’m long the mattress,” he jokes.

That says, he still likes, at least in relative terms, high-quality U.S. stocks: big, blue-chip companies with solid balance sheets, strong franchises, and fairly stable earnings.

His top 15 picks, as of the end of May, were Wal-Mart, ExxonMobil, Johnson & Johnson, Coca-Cola, Microsoft, Pfizer, Chevron, PepsiCo, UnitedHealth Group, Merck, Procter & Gamble, Qualcomm, Cisco Systems, Oracle Corp. and 3M.

Arends also pointed out that these stocks were the biggest holdings (in order) in Grantham’s U.S. Quality Equity mutual fund.

Tokyo, Japan
Photo by Jon Butterworth, stock.xchng

Grantham also weighed in on overseas bargains. Arends wrote:

For those who are interested, Grantham also thinks the Japanese stock market is “less expensive than most other countries,” – which, for him, is high praise.

Source:

“Protect Your Portfolio With Blue Chip Stocks”
Brett Arends
Wall Street Journal, July 9, 2008

It’s not often that I encounter a piece written about legendary investor Jeremy Grantham, so when I do, I’m truly ecstatic. Chris Taylor of the Financial Times (UK) wrote about Jeremy Grantham earlier today, and did an exceptional job reminding readers as to why Grantham is considered one of the investing greats. Grantham, now 69, graduated from the University of Sheffield and began his illustrious career as an economist for Royal Dutch Shell in 1961. Over the years, the founder of GMO with Richard Mayo and Eyk van Otterloo and overseer $152 billion (£77 billion) in assets has made some brilliant calls. Taylor wrote:

He was proved right, but it was far from the first time. Some of Mr Grantham’s “greatest hits” are the technology-stock implosion of 2000; the insane Japanese valuations of the late 1980s; the emerging markets run of the last few years; and the plunging housing market of today.

In retrospect, all obvious. But at the time, before these massive booms and busts, he always seemed to be a lonely voice in the wind.

“I remember when Jeremy made a stand against tech stocks in the late ‘90s, and was in the wilderness for what must have seemed like 50 years,” says Jim Grant, founder and editor of Grant’s Interest Rate Observer. “He lost many clients during that time, but he’s a fighter, and just doesn’t back down from a deeply held conviction. I think the British army lost a talented field general when Jeremy migrated to the States and took up finance.”

Source: The Toy Soldier Shoppe

Grantham has proven to be a consistently-reliable forecaster due to his reliance on empirical data, among other things. Taylor noted:

Mr Grantham prefers to pay attention to hard numbers, instead of the misinformed musings of public officials. He is a quant at heart (a believer in quantative analysis), collecting reams of data and discovering what it all has to tell him - with a few crucial modifications.

And these days, what does the legendary investment manager recommend for individual investors?:

“The mattress is good,” Mr Grantham says, only half-joking. After all, boring cash - the “good, old-fashioned” kind of short-term government instruments - is at least a safe harbour, despite negligible returns.

And other places to consider stashing assets, for more aggressive investors? Half in the “bluest blue chips you can find”, and the other half in solid emerging market equities. Even though emerging markets have enjoyed a multi-year run of outperformance, Mr Grantham still likes them, given the stunning global growth story.

And Grantham’s economic outlook? Not rosy. Taylor wrote:

As for the current market nightmares, do not think they are over quite yet. Indeed last summer Mr Grantham said “In 5 years I expect that at least one major bank [broadly defined] will have failed and that up to half the hedge funds in existence today will simply have ceased to exist.”

Source:

“A general who relishes the heat of the battle”
Chris Taylor
Financial Times (UK), March 24, 2008