A veteran value investor weighs in on bubbles, AI stocks, and the existential threat of climate change.
Today on the podcast, we’re delighted to welcome back Jeremy Grantham. Jeremy is the long-term investment strategist at his namesake firm, Grantham, Mayo, Van Otterloo & Co., or GMO, which he cofounded in 1977. He serves on GMO’s Asset Allocation Committee and board of directors. Prior to GMO, Jeremy was cofounder of Batterymarch Financial Management and before that was an economist at Royal Dutch Shell. He earned his undergraduate degree from the University of Sheffield and his MBA from Harvard University. Jeremy is a member of the Academy of Arts and Sciences, holds a CBE from the UK, and is a recipient of the Carnegie Medal of Philanthropy. In 1997, he and his family started the Grantham Foundation for the protection of the environment, which supports research and action to address climate change.
Background
“Jeremy Grantham: The US Market Is in a Super Bubble,” The Long View podcast, Morningstar.com, Feb. 8, 2022.
Bubbles and the Market
“The Great Paradox of the US Market,” by Jeremy Grantham, gmo.com, March 11, 2024.
“AI Craze Stokes ‘Bubble Within a Bubble,’ Says GMO’s Jeremy Grantham,” by Christine Idzelis, marketwatch.com, March 11, 2024.
“Entering the Superbubble’s Final Act,” by Jeremy Grantham, gmo.com, Aug. 31, 2022.
“Jeremy Grantham Says the AI Bubble Will Burst and Take the Stock Market Down With It. Here Are His 14 Best Quotes From an Event This Week,” by Theron Mohamed, markets.businessinsider.com, Feb. 18, 2024.
“China Turmoil Poses a Risk to the Magnificent 7, Jeremy Grantham’s GMO Says,” by Yuheng Zhan, markets.businessinsider.com, Feb. 9, 2024.
The Environment and Sustainability
“Sustainability or Bust: The Sheer Impossibility of Eternal Compound Growth,” by Jeremy Grantham, gmo.com, March 18, 2024.
“GMO Horizons,” by Jeremy Grantham, gmo.com, Feb. 27, 2024.
“Pollution, Population, and Purpose,” The Great Simplification podcast with Nate Hagens and Jeremy Grantham, gmo.com, Feb. 15, 2024.
“Jeremy Grantham Assesses Long-Term Threats Through an Investor Lens,” by William Hughes, cruxinvestor.com, Dec. 31, 2023.
Christine Benz: Hi, and welcome to The Long View. I’m Christine Benz, director of personal finance and retirement planning for Morningstar.
Dan Lefkovitz: And I’m Dan Lefkovitz, strategist for Morningstar Indexes.
Benz: Today on the podcast, we’re delighted to welcome back Jeremy Grantham. Jeremy is the long-term investment strategist at his namesake firm, Grantham, Mayo, Van Otterloo & Co., or GMO, which he cofounded in 1977. He serves on GMO’s Asset Allocation Committee and board of directors. Prior to GMO, Jeremy was cofounder of Batterymarch Financial Management and before that was an economist at Royal Dutch Shell. He earned his undergraduate degree from the University of Sheffield and his MBA from Harvard University. Jeremy is a member of the Academy of Arts and Sciences, holds a CBE from the UK, and is a recipient of the Carnegie Medal of Philanthropy. In 1997, he and his family started the Grantham Foundation for the protection of the environment, which supports research and action to address climate change.
Jeremy, welcome back to The Long View.
Jeremy Grantham: Pleasure to be here.
Benz: Well, we’re thrilled to have you back here. We wanted to start by talking about bubbles, and you are a student of bubbles. I was listening to an interview that you did where you talked about your entry point into investing. You were looking for the places where your fellow business school grads were having the most fun, and you homed in on micro-caps. I’m curious, is the inverse kind of a signal to you today when you’re on the hunt for bubbles or on the lookout for bubbles? Do you look for those areas where people seem to be having the most fun and use that as a signal that perhaps there’s some froth there?
Grantham: Yeah, I think that’s not a bad idea. Bubbles and enthusiasm, ecstasy, they’re all kind of closely related. And I like to say it’s not an accident that the most euphoric periods in the market’s history, all four of them really—1929, 1972, tech bubble of 2000, the great financial crash, 2008, and you could add, 2011, December. Those are the five euphoric points, and the first four, it’s not an accident, they’re all followed, not by the best economic times and the best market returns. They are followed by the four worst economic setbacks and the four worst periods of stock market return. What a strange coincidence.
We all learned at business school that high P/Es are meant to be reflecting the best possible future. And what we find is the highest four P/Es, highest amount of euphoria are precisely followed by the four worst economic outcomes: the Great Depression, the Great Recession of ’73-’74, the worst since the Depression, the crash and the recession after the tech bubble burst, and the real moment of truth when the great financial crash occurred, when the whole financial system of the developed world teetered on the edge of total meltdown. So, what a strange paradox that the market’s predictive power is precisely, perfectly the opposite of what we were taught.
Lefkovitz: Well, we obviously had a major downturn in 2022, but then 2023, the market bounced back and the first half of ’24 was quite exuberant as well. Obviously, a lot of enthusiasm about artificial intelligence. Do you see two bubbles having formed, one that burst in 2022 and then reinflated, or is it all part of the same bubble?
Grantham: No, this is unique. This is two fairly distinct events, one merging almost into the other. We had a classic bubble in every way, perfectly ordinary in context of the other four in 2021. And melting down the first half of 2022 was the worst market for stocks and bonds since 1939, the year after I was born. That’s quite a long time. And then in November of that year, October or November, when they introduced the chat, a handful of stocks that happened to be very large that had a future that they could relate to AI took flight. The rest of the market drifted lower as a matter of fact for another 10 months. And all of the gain, plus a little, was in the hands of the “Magnificent Seven,” all of which had an AI story to tell.
And then finally, impressed by this steady advance, and also impressed by AI itself, the broader market jumped on board in late ’23, the other day really, and we had a broader market advance. So, this is unique as if you came in in 1932 with some magnificent new invention, some really cheap fusion or something. And AI is serious. It will change everything. And therefore, it’s not surprising the market took it seriously.
The bigger the new idea, the bigger the new invention, the more the market becomes overpriced, the more it attracts euphoric. It’s not accidental. Really great things happen in the internet phase, ’98-’99. But they overdo it. They overdid it with the canals apparently in England. They overdid it magnificently all over Europe, particularly the UK, but also the US with railroads. They were spectacular bubbles. The canals were huge; the railroads were even much more profound, changed everything. They were serious, but that didn’t stop them attracting too much capital, charlatans, putting eight different railroad lines between Manchester and Liverpool, or planning them and raising capital for them when one or two was clearly enough. And the result was a bubble that broke for canals and railroads, and then somewhat the same with automobiles and radio and so on in 1929. Electrification of everything and development of mass markets for a lot of them.
And then the internet. The internet was serious. We all use the internet. We can’t live without our iPhones, and yet it was overdone. Everyone knows that Amazon went up multiple times in ’99. I forget how many times, but several times. It was the star of ’99, which was a great year to be a star. And then in the break, they went down 92%. Very few people realize that. Amazon, huge success, went down 92%. And then it rose from the wreckage, as did a handful of them, and inherited the earth. But how many, what fraction of those stars of ’99 survived? I think 80% of the internet stocks just ceased to exist. Some were bought for scrap iron price. Basically, they ceased, and a handful of super leaders emerged.
So, the fact that it’s a real idea doesn’t say that there won’t be a crash. It’s quite the reverse. The more important the idea, the more guaranteed almost it is, historically, that it will attract too much short-term attention, then there will be a crash, and then the railroads will change the world, internet will change the world, AI will change the world. But it would be classic for it to be overdone. That’s what the history book is shouting at us. And to have that come in the middle, if you will, in the middle of a gentile old-fashioned bubble forming and breaking, is to create a very novel and complicated twist. But it happens. That’s what life is all about. Every now and then something really weird happens, and a guy catches the football on the back of his helmet. They do happen. And this is it.
So where do we go from here, I think, is back to the history books. When you have these great developments, they overdo themselves in the short term, they crash in the intermediate term, and then they come out of the wreckage and change the world in the long term. And that’s what I expect will happen this time.
Benz: So, you referenced the late ‘90s period and that basket of internet stocks, many of which were pretty junkie companies. I wanted to see if you could contrast that with the AI companies, which seem to be a higher-quality basket of companies. And you have been interested in quality for many years. You launched GMO’s Quality Strategy Fund 20 years ago, and GMO recently launched an ETF around quality. So, could you contrast the fundamental characteristics of the AI companies with some of those technology companies that led the bubble in that late ‘90s period?
Grantham: This seems like a PhD paper question. There were obviously a lot of Pet.com ideas in the internet, lightweight companies. There are probably quite a few. This time, and history will decide which ones they are, but the very nature of quality is monopoly. Let’s face it. We define quality and always have as high stable returns. The only way in a competitive society you have high stable returns is to find a nook or a cranny that is not that competitive, such as, you have a monopoly. You have a defensive moat. So, what we’re talking about is the dramatic emergence in the last 10 years or so of what you might call great global monopolies, almost instant in some cases, where winner takes all, first come, first serve, they grab the market, they defend it brilliantly, ferociously. It’s what capitalists do. It’s what they’re paid to do. And it’s what all the brilliant leaders manage to achieve.
The role of government, one might argue, is to try and maintain a world where they don’t become too powerful, where it doesn’t license to charge any price because you have a monopoly. And there is no question that the governments’ actions against monopoly have basically been soundly asleep for about 20 years until very recently. And now in the US and Europe, they come out of their deep sleep, and they start to poke around some of the great new monopolies. But that’s the essence of quality, a monopoly feature. It used to be Coca-Cola and yes, it was a duopoly with Pepsi, but you get my point. You couldn’t easily compete with these guys. They had wonderful brands.
And here we are with a couple of handfuls of brilliant, basically, monopolies and the introduction of the internet and everything related to the internet in the last 20 years has facilitated, first come, first served, the first mover, or the first best person to scale up has a huge advantage. And if they defend it cleverly, up to the letter of the law and perhaps a little beyond, in the end these things are up for interpretation, they can build a monopoly much more quickly than they ever could in the past. And they have to. And that is a major, major issue going forward. Will governments allow these basically American giant monopolies to rule the roost? Or will they break them up or act in some way that moderates their profit margins? We’ll find out.
Lefkovitz: Well, you mentioned governments’ role. You’re famously a student of presidential cycles and their impact on markets. We’re obviously in the midst of an election year. How do you see politics and policy impacting markets currently?
Grantham: I have no great insight other than to say they have been happy most of the time to leave the new companies to themselves. They haven’t in fear; they haven’t constrained them in any material way. They have been very benevolent. They have gone along with the Fed policy that allows the Fed and other government agencies—I don’t mean to imply that Fed is a government agency—the Fed and government agencies to adopt a very pro-bailout, pro-capitalist, pro-too-big-to-fail policy. There was nothing like this 50 years ago. So, it has become a much more benevolent world to the giant companies where they made very big mistakes in the great financial crash. Very big. You could argue as an outsider that they deserve to fail, several of them, and they were not allowed to fail. They were protected. They were loaned money or given money to keep them alive.
So, governments’ policy has been very, very much pro-big business. They’ve allowed those developments to take place. They have cut taxes on capital. They’ve reduced capital gains, dividend tax, interest rates. Every way, the money that you make while you sleep has had a lower tax rate. And the money you make while you work, therefore, has had to carry a larger share of the pie. The pie has not decreased. The pie has increased. In other words, there are more government expenditures as a percentage of anything. Through red and blue administrations, the share of government has gone up. And yet, the load on capital has been decreased. And the recent administration did not change that. So, we’ve lived in an era of uniquely low taxes on capital and capital gains and so on.
So, they have played a very pro-big-corporate role for the last 30, 40 years. And we have seen the pendulum swing against labor, say, for all the way since the mid-1970s. So that’s 50 years. And it didn’t stop under any administration except Clinton. And Clinton did not get the pendulum to swing back. He got it to pause for eight years. That is the best from a labor point of view that happened in 50 years is an eight-year pause. The other 42 years, it has actually continued to drift against labor. So, the share of the loot going to capital has increased and the share of the loot going to labor has declined 42 basically of the last 50 years.
So pro-capitalist, and that doesn’t mean pro all business. It really means in real life pro the giant businesses who have all the influence, who lobby and spend serious money, facilitated by the Supreme Court decision that it somehow equates money you spend on political maneuvering with free speech. That’s an amazing interpretation, I think, to almost anybody, but that’s what it was. And they have taken full advantage of it. That’s what capitalists do. They are paid to maximize the return to any little shift in regulation. They are allowed to influence the development of future regulations. So, we live in an era where the regulations have tilted steadily toward giant companies against smaller companies and against labor. And we should face that every now and then.
Benz: We wanted to stick with macroeconomics for a bit longer and you have said that you think the US is heading into a recession, that all the signals are there. And we recently have begun to see some softening in the employment picture. So perhaps you can talk about the signals that you see how they are consistent with recessionary storm clouds gathering.
Grantham: First of all, there are better people to talk about this than me. Because all I can do is look at the rules of thumb, basically, is what they are, that have been associated with previous recessions. And everyone knows them as well as I do. But the leading indicators are extremely good. The interest-rate spread between the six months and 10 years and so on. And even the rising unemployment, they have very strong associations with recessions. And I don’t think anyone’s really established the whys and wherefores, but we can see the association. I have no great insight as to whether the reason that they’re associated is cast iron or not. But I can see the relationships. Whenever they’re lined up like this, you have a recession.
I do have mild and obvious insight, if that’s not a contradiction, into why it’s dragged on so long. And that’s the $3 trillion extra from the amazing covid stimulus program. And what we found is the $3 trillion didn’t disappear very quickly. It sat around in people’s, individuals’ war chests. And it got to recycle. And yes, it’s pretty darn small now, but it extended this cycle and extended it and extended it. So, we were used to earlier times—we didn’t have much—we had no historical experience with the stimulus of this magnitude. This was like a major war. This dwarfed the great financial crash, which was really a matter of teetering on the edge of near total financial destruction. And this time we did more than ever. So, this is completely novel. And we have to recognize that. So, you expect different outcomes. And the ability to extend a cycle by a year or two I don’t think looking backward should be seen as that amazing. We can see why it would extend with extra cash. And it did.
Lefkovitz: When you last joined us in 2022 on the podcast, you talked about the US housing market as overpriced and vulnerable to economic weakness. Somehow the housing market has remained pretty resilient even amidst higher borrowing costs. Why do you think that is?
Grantham: It is a major surprise to me. The housing market in a way on a global basis has been somewhat similar, except in China, which is important by the way. The Chinese real estate market plays a very big role one way or the other in global economics, a very, very big role in local Chinese economics. And China, of course, has become a major player, a major cog in the global economic system. But in America, some regions were pretty good, some were not so strong. It’s been an odd market. And if you think about the nature of a mortgage, you can get some idea. You’ve seen mortgages fall to almost ludicrous low levels of 3% and below. And you’ve sensibly, let’s say, locked one in at 2.8%. And now back, they want 6%, how enthusiastic are you going to be putting your house on the market the way you had intended a year earlier? And the answer to that one is pretty obvious: not enthusiastic at all.
And so, you freeze the market. And the best proof that that is a major component is the actual house turnover rate, which dropped like a stone and stayed dropped. And the turnover in the UK, Canada, Australia, it’s a uniform feature of this era. So, when you change the rate that profoundly, people feel, well, I’ve got this great asset. I’ve got this 30-year mortgage—or even in the UK, a much shorter-term mortgage—it’s still financially significant. So, people hold on to see what will happen. And everyone tells them the rates will come down in the not-too-distant future. And so, they start moving. They change their plans, or they rent their house, and so on. And you create cross currents in that that are not typical. And that’s what we’ve seen.
It’s not so much a strong market as a weird market—very local, very odd, sometimes dips, sometimes recovers. And generally speaking, fairly bamboozling from my point of view. Because in the end, if you lower the rate for 50 years, you lower the real interest-rate structure, you’re going to increase the value of almost all capital. Farms go from a 6% yield to 3%, forests do the same. The stock market does the same. Instead of yielding 5%, which it did for 80, 90 years, it yields much less. And you would think, therefore, when you move real rates back, that it would have an effect. I have no doubt it will. But I have lots of doubt as to how long it takes to flow through the system. How long does the real rate have to be considerably higher than zero, which it was, to push back on the price of assets? I don’t know. But it’s almost a mathematical certainty that eventually they relate.
And any long-lived asset is not worth the same with a real rate of 2% than it is at zero. And yet, that is not the immediate response for some of the reasons we’re talking about. I have a family member involved in farms and forests. And that has become a strange, a weird market like the commercial real estate market, like the real estate market itself. They’re just strange. They lose volume and they act oddly. This is like a little interim, like the phony war at the beginning of World War II, where nothing seems to be happening in quite the predicted way. But in the end, basic relationships tend to exert themselves and higher real rates mean lower asset prices sooner or later.
Benz: So, switching back to the equity market, US equity returns have been so concentrated, as we talked about, in a handful of largely technology names. There’s been this widespread anticipation that there will be a rotation away from those names into other parts of the market, value, smaller stocks, non-US stocks. Can you talk about that, whether you think that there will be some rotation and whether you have a thought on what would be the catalyst for it?
Grantham: I have no particular insight, step one. Step two, however, a catalyst would be if global governments move against monopolies, and it becomes more politically acceptable, and the pendulum begins to swing back toward more consideration for labor and the ordinary worker. That would be a catalyst to watch out for the great monopolies. And they’re not ludicrously expensive, as we know, by the standards of 2000 and the tech bubble. They sold at substantially higher P/Es back then. But is the world more driven by monopoly today than 2000? Yes, it is. And if you don’t act against that, you’re likely to see huge earnings. And when you get to be that big, it is hard to sustain the 70 P/Es of the tech bubble. When you’re trillion-dollar market caps, it just becomes implausible to have such high P/Es. And so, we haven’t. And so, let’s say one of the main reasons for that is the sheer colossal, unprecedented size of the current group of superhero monopolies.
Lefkovitz: When you think about future asset class returns, are you expecting non-US stocks to outperform the US over the next, say, 10 years?
Grantham: Yes, historically, they’ve tended to rotate. There’s never been a period, never been a window like we’ve seen in the last, gosh, it’s almost 15 years now, where the US outperformed in earnings by such a wide margin. The typical measure would be 15% or 20%, and then the following decade, the rest of the world would come back. This time, it’s more like 80%, maybe 100% outperformance. And 75% or 80% of that are what used to be called the FAANGs and now the “Magnificent Seven,” they are the lion’s share. When I say lion’s share, they’re close to 80% of the extraordinary outperformance, the US corporate system over the rest of the world for the last, let’s say, 12 or 13 years. It’s just these couple of handfuls of stocks. Slight change between the FAANGs and the current iteration, but only two or three names.
Benz: So, we wanted to ask about Japan. You have been a student of Japan following Japan for many years. You famously avoided the Japanese market bubble bursting, and then you underweighted Japan for many years thereafter. I wonder if you can talk about the Japanese market today, whether you’ve been seeing signs that there are actually things in place to unlock shareholder value in Japanese companies once and for all.
Grantham: It does bring up an interesting topic, and that is, what are those periods when people have thought that GMO in general and me in particular were losing the plot? And at the time, one took an enormous amount of grief for not understanding how important Japan was. When it was 65 times earnings, Salomon Brothers had a head squad coming around explaining why mathematically, with rates so low in Japan, they were worth 100 times earnings. In the tech bubble, everyone was saying we had lost our way. We were fighting the bull market for all of ’98 and ’99. It was a huge move by the Nasdaq, must have nearly doubled. The S&P probably went up 50%, and we were considered ludicrous.
We started fighting it when it went over 21 times earnings—21 times earnings was the previous high ever of trailing 12 months. It hit 21 in 1929 and didn’t break that until December ’97. So, we managed, I’m not sure how, to stay fully invested in playing aggressively and winning. We had better than average performance through ’97. But then we fought it—‘21, boy, that’s like 1929, we said, and this is going to be bad things happening. And ’98, ’99, and the first quarter of 2000 was like a nightmare. And people treated us as if it was personal, we’d done it deliberately to rob them of good performance. They were really seriously upset with us. And although we had nothing but top-level institutional accounts, they fired us very much faster than we thought. We always thought you had three years of bad performance, and if you had a great relationship, maybe four. But at the end of two years and one quarter, in some products like asset allocation, we lost half our book of business. It was amazing.
So, you took an enormous amount of grief, and less so in the housing bubble, but to some extent. And you say, looking back, where did we build a decent reputation, and where did we make money? This is the same set. We made money getting out of Japan far too early, three years too early, very painful. We made tons of money in the tech bubble by getting out two-and-a-quarter painful years too early. And we were very defensive from the spring of 2007 in the great tech bubble, although we did OK because we had a huge overweighting in emerging.
But that’s the way life is. You have to go through these periods where people—of course, if you’re two or three years too early, they’re going to think you’ve totally lost the plot. Even though it turns out on the round trip, we made tons of money and reputation on Japan, tons of money and reputation in the tech bubble. And the housing bust, the great financial crash we handled pretty well, so that was OK. But in 2021, back to the drawing board, we kind of blew the whistle, let the wild rumpus begin in January 2022. And now a lot of time has gone by, and some decent amount of money has been made in the Nasdaq since then, a little bit on the S&P, and the Russell 2000 has lost money. But still, it’s gone on a long time, and one takes a lot of abuse. And I have to keep reminding myself that the more abuse we’ve taken, the better it worked out in the long run. It doesn’t make it any easier while you’re going through it.
And then of course, people misconstrue what you said. A year before January ’22, in January ’21, I wrote a paper called Waiting for the Last Dance and everyone says, oh, you said that was a bubble. No, I said, there is a bubble—they take a long time to form and break. But if you can’t tell the difference between waiting for the last dance and let the wild rumpus begin, then you’re not paying attention. So, we were not saying that the bubble would break in the first paper. But we were saying in Jan. 15, 2022, the wild rumpus had started, and it had. And then what we did not foresee is the introduction of AI as a complete game changer of long-term consequences, no doubt. And I think I may have missed the question.
Benz: Well, the question was Japan today, whether you feel like this is the beginning of some structural fundamental change in companies that there may actually be an opportunity to unlock shareholder value that we hadn’t seen for some years.
Grantham: Yeah, of course. And since Japan was our defining first great bubble and the mother and father of all bubbles really, much bigger and better than any of us, made me focus on that issue. But Japan now 50 years later—not even 40 years later—but a long time, 36 years later is an ordinary-price country market. That’s how long it took. It’s pretty healthy. It’s reasonably cheap compared with the rest of the world. They seem to be pecking away at all those problems that we used to talk about that the Japanese version of capitalism was a little weird compared with the rest of the world. It’s now more similar and they seem to be pretty good at their business. And they have some pretty good companies. And they’re very good at handling general social problems, in my opinion. And therefore, it’s more attractive than the typical country.
And yes, I would avoid the US. This is a very much US-based event. And why would it not be, because it’s based on dramatic unprecedented outperformance of US earnings. People don’t say, oh, it’s historically tended to cycle. Therefore, you should meet this with a lower P/E. They say, oh, boy, we’re kicking ass, and you have an unprecedented high premium P/E. And that’s the same incidentally with the growth sector, say, or even individual companies. If you have outrageously good earnings, they will be multiplied by an outrageously good P/E. You have a whole market that does that. It will be multiplied by an outrageously high P/E. That’s classic double counting.
And then when it goes down, like 1974, you have 6.8 times earnings. And what are the earnings? Totally crushed. So, 6.8 times super world-record-low earnings. It is classic double counting. So, you’re selling at about a quarter of book value back in 1974. And conversely, at the top, 1929 peak profits times peak P/E, 2000, peak new record profit margins times new record 35 times earnings on a trailing basis blew through the previous high. And that’s how we do it. We double count.
And if you’ll allow me to digress, the market does not make any attempt at predicting the future. The market is a coincidence indicator of what makes money managers feel comfortable today. They love high profit margins, even though they mean revert. They hate inflation, even though it mean reverts. And that’s the way it is. If you give me a market with high profit margins and low inflation in history, I will give you a high P/E. And that’s the way it’s worked. It’s beautiful correlation between 0.8 and 0.9, the little model that Ben Inker and I put together at GMO over 20 years ago now. We are now dealing with its second decent aberration since 1925. The first aberration was 2000.
Our model said, wonderful profits, no inflation, you should have the highest P/E in history, and we got that right. It just said it should be 23 up from 21 and it went to 35. So, that there we missed, the extra 40%. But this time, the diversion started in mid-’21 when inflation suddenly popped up. And when it first popped up, it was a great surprise though, why it was one historian might question because we’d had such incredible stimulus, you might have been braced for inflation. But in any case, it came. And for the first time in history, the P/E didn’t crash. You had unexpected rise in inflation and the market continued to rise uninterruptedly to new highs.
Unprecedented faith that the Fed would make it temporary. And maybe with hindsight today, you’d say, reasonably justified. But in any case, that was not the historical pattern. And that’s a historical pattern of 90 years. That’s not bad. And you broke it, and the market continued to rise. And now our model calls for perfectly reasonable P/E on trailing—or Shiller P/E trailing 10 years of earnings of about 17 times. I think the long-term average is 15 or 16 and the actual is 32. So, this is fairly spectacularly above the typical relationship on these major variables. So that’s yet another way in which this current market is atypical.
Lefkovitz: Well, we wanted to switch gears and talk a little bit about the environment. You spend a lot of time thinking about climate and environmental issues more broadly. Renewables have clearly made a lot of strides, electric vehicles, and yet carbon emissions remain stubbornly high. Curious as a climate solutions investor, what you’re excited about these days?
Grantham: Well, what I consider important is the ability of senior people to miss the point. Climate change is like some giant python. It’s got us gripped and it isn’t squeezing that tight yet. But each year it’s getting a little tighter and it shows no inclination to go away and we’re ignoring. If we continue to take climate change this lightly, if we continue to protect our short-term profits and ignore longer-term consequences to the general world, we will have a very hard time maintaining a stable world, stable social, stable corporate, stable anything. And I would say, to me, on a global basis, it looks like we’re quite a handful of years into a destabilizing mode and the climate change has a lot to do with it.
If you look at a hit list of the billion-dollar weather-related, climate-related penalties, fires, floods, droughts, adjusted for inflation, they’re very low on the left of the exhibit and they rise dramatically multiple times until last year, this year. World record numbers. Somewhere in the world there are billion-dollar climate-related accidents, events occurring all the time. So that’s step one, the reality of it.
But these are all loaded later in time as we approach a level where you can’t go out and farm on the Indian subcontinent. A couple of degrees warmer than this, a bit more humidity, and humidity increases in a mathematically certain way with temperature. The hotter air carries more humidity. Humidity causes more heavy downpours, more dangerous floods. And I think that is the most reliable thing we’ve seen for the last five years is a dramatic, how-could-you-miss-it increase in heavy, expansive, dangerous flooding. And then close behind it, dangerous droughts. And the droughts are not because of less rain. The droughts are because temperatures are so high that they’re taking the moisture out of the soil and the forest so dramatically that you have trouble getting a decent crop. And then of course fires. With the moisture lacking, any accident will start a forest fire, and that is truly obviously dramatically increasing. So, if you live in a big forest in the west, you have to be worried. If you live in a low-lying piece of land too, then water level rising already by quite a handful of inches. And down the east coast of America, there are many important cities that are certainly going to have their time cut out building seawalls and protecting. In the case of southern Florida, most of it is indefensible. We are guaranteed to have water-level rises that will make it impossible to live on the water’s edge.
And right up until the other day, you could get insurance. Now you can’t. And right up until the other day, you had generous increase in housing being developed in these critical, dangerous zones. And even more implausibly in a way, the prices were rising faster than anywhere else. Now for a couple of years, the prices have been rising faster elsewhere. And people are beginning to get the point that insurance is going to be only accessible through state subsidies, that is, load the burden onto the general taxpayer for you having been nitwitted enough to build and live in the house in the flood zone. And half of Florida is in the flood zone, but almost all of Miami is.
And so, we’ve seen these hazing increases, obvious. And every scientist in the climate business was defining this 30, 40 years ago. These were all inevitable. And yet, we acted as if it was never going to flood in Miami, and so on, as if it was never going to catch fire in the forests of California. And the insurance companies were very slow on the uptake, not now, but they were very slow to get the obvious point. So, everything is changing. And these are very destabilizing forces. And the biggest one waiting in the wings is food and farming. At this rate, it is more than just probable, it is highly probable that in the Indian subcontinent, they will not be able to farm as they currently do with hours out in the hot sun. Three hours of 100 degrees with humidity and your internal organs begin to fail, and you start to die. And if you look at the number of deaths attributed to heat, they’re very small today, but they are rising very rapidly, 15%, 20% the last two or three years. And these things are not gentle. They’re going to explode one day. And we’re going to realize what a high price we pay. Particularly in farming, you’re simply not going to be able to grow food on the Indian subcontinent in a way that can feed your two billion people.
Benz: You’ve made the point that China has made some great strides on the climate front, yet it’s not received much attention. I’m wondering if you can talk about that and also talk about potential takeaways for the US. What can we learn from some of the things that China’s done?
Grantham: Obviously, China has a very different system that gives them certain cards they can play and certain cards they can’t play. But when it comes to the commons, capitalism doesn’t do tragedies of the commons. If you’re allowed to pollute the air, you do. You’re not going to spend more than a penny or two to reduce your CO2 or your methane output if you don’t have to, because they believe the executives that they’re then vulnerable to a suit from their stockholders that they’re not doing their job. So, we only follow the law of the land. The law of the land lets us get away with polluting water and polluting the air, we do. And in China, they can finally say, don’t do this or we’ll put you in jail. And it concentrates the mind wonderfully and things happen very fast.
The cliché—and politics is kind of a rolling cliché, isn’t it? Some idea gets accepted. And the moment—China is the villain and therefore China can do no right, and why should we worry about climate change because China does this, that, and the other. Point number one is no country, and notably, the US, has ever given up any growth voluntarily in order to improve the climate or to protect a local butterfly or anything ever. You only do what legislation tells you you have to do, or they’ll fine you or slap you in jail. And China has the luxury of many scientifically sophisticated leaders. Sometimes their central committee is dripping with PhDs. Almost no one in Congress fits that description. So, they can at least appreciate and understand the problem. And China is right in the line of fire of so many of these things. It is not a marginal player. It is really going to suffer from climate change more than most people. It was super polluted. Now it’s just heavily polluted, but they’re improving very rapidly.
Anyway, they recognize that pollution and smog and deaths and so on was a political issue, which they don’t like. And so, they started to move against it. And the speed with which they are gobbling up the green industry is quite remarkable and has been very obvious to anyone who looked at it. But last year, they installed 75% of the wind that we have ever installed in 60 years, added together. In one year, they did 75% of all the US wind power. But in solar, it’s better because they did measurably more last year than we have ever done collectively over the years in the US. Just think about that. That is amazing, isn’t it? This is perhaps the most obvious long-term, intermediate-term problem. And they’re able to do in one year what we’ve taken 20 years in solar and 40, 50 years in wind. They produce 80% of the world’s solar panels. A solar panel, if we allowed them in tax-free, is a third of the cost that we pay in America: $0.10 per megawatt versus $0.30 or something like that, and in Europe, it’s $0.20.
And there’s so much progress, however. Solar panels have come down so rapidly in price that now the cost of installation and the cost of administration, bureaucracy, are much bigger. Each of those two are bigger now than the cost of the solar panel. And China produces 90% of the material, specialized silicon, that makes solar panels. They have a death grip on all of what I call the green metals. Lithium is processed 80% plus in China. Cobalt, 80%, 90% processed in China. And nickel, not so much, but still a handsome chunk. They are building, as we said, more than half of the world’s nuclear generation is going up under construction in China. These are not trivial fractions. China is not 50% of the world’s economic GDP. Hydropower, they develop further and faster than anybody else. What can they do that they haven’t done? EVs, they’re building—over half of all the EVs under construction today are in China. Their fleet is now 25% versus, you tell me, 5% or 6% in the US or less.
And that’s what we should be doing. The US should be leading. You can’t lead overnight. I feel for the effort now being made belatedly. But to catch up, when the other guy had a 15-year running start, you can’t do that overnight. You just have to plug away. And it becomes very expensive when you let them get that far ahead. And it is very expensive. So, we will not be putting in nearly as much solar, which is desperately needed, because we are willing to tax them so highly, 100% tax. And I get the point why you would want to tax them. But I also get the point how tragic it is that it will slow down our installation of solar power, because we feel we have to produce everything now in the US. How much better it would have been to maintain a strong position over the last 15 years. But water under the bridge.
Lefkovitz: So, Jeremy, what would you suggest for the investors out there who want to make their portfolios more environmentally friendly or align them more with climate?
Grantham: It’s a nontrivial issue. My personal attitude is to try and look out 10 years and try and imagine what the world will be like and dissociate myself from the things that are involved there, fossil fuels, and so on. Recognizing that these are commodities, they will rise and fall and drive you crazy before 10- or 20-year period is gone. But in the end, it’s inevitable. In the end, we’ll all be driving nonfossil fuel vehicles or taking electric buses or whatever. China, by the way, makes 90% of all the electric buses in the world. This is not 19%, this is 90%. These numbers are just crazy.
Many firms out there are tilting portfolios in a useful way. That won’t guarantee you success in one year or even three years. But it will more or less guarantee you some success, I think, over 20 years. At GMO, we have portfolios that overstate green progress, understate fossil fuel, and so on, and don’t deviate from the indexes by more than something like a point and a half. These are very useful products, and I’m sure other firms can try and do them. I think we’ve had something of a start thinking about them. But that’s what you have to do. You have to just tilt and hold it for long periods of time and recognize that in anything that looks faintly like a commodity, you are going to have moments of incredible pain and regret. And you have to play for the long term because commodities just do not, they’re not conducive to short-term guarantees. That’s why incidentally, they’re always cheap because it’s so unbelievably unpredictable. And because they’re always cheap, they have actually a pretty decent lifetime performance.
And for the record, a resource fund such as one at GMO is the only thing you can find that is over 10 years negatively correlated with the balance of your portfolio. Industry subgroups are incredibly highly correlated over one year, three year, five years, 10 years. If you get it down to 0.8, 0.75, that’s massive. But by five years, a resource fund is 0.25, and at 10 years, it’s actually insignificant negative. It tends to go up when the balance of the portfolio is going down. And you can see why. If you have to pay a massive increase for your metals and your oil and your raw materials and your food, of course, that’s a drain on the balance of the economy. So, the logic is pretty straightforward.
Benz: For our last question, you are widely regarded as a pessimist and certainly people listening, I think may come away with a sense of pessimism, certainly about the AI stocks and the trends in climate. But I’m wondering if you view that as a fair characterization that you’re a pessimist. And I’d also like to hear what you’re most optimistic about today.
Grantham: First of all, in terms of pessimism, in a sense, you ain’t heard nothing yet. Because in my opinion, there are not just one python squeezing us, there’s two—the other is toxicity. If we do not move against toxicity, we are going out of business. And to give you the most shocking single number, our sperm count, which is the best indicator of general health, is down to a third of what it was in 1950—1950 was not a healthy place to be. Hunter/gatherers a few thousand years earlier would have been much healthier still. And it’s falling at an accelerating rate. And the kind of great epidemiologists who study this, one of them said, “It’s as if we mean to go out of business.” The drop since 2000 is over 2.5% a year from where we were. And the drop in the 20th century was closer to 1.5%. But no one gives it rat’s tail.
I gave a talk to the Boston financial analysts and the New York financial analysts, not together, at different times. And they didn’t care. I said to them, OK, so 50% decline in 50 years leaves you totally untouched. How about 100% decline in 100 years? Would that do it? We’re sitting around looking at data that suggests we should be not just in climate, but toxicity, treating this like an encroaching serious war. Again, a second war. And we’re just ignoring it. It’s moving faster than climate change. And it’s in its way, more personal, more dangerous.
We wrote seven years ago that we would not be enthusiastic about buying chemical companies. And two months later—and I gave a talk at Morningstar on this very topic—and two months later, the suit came out was found against Bayer Monsanto for a Roundup. And Bayer today is worth less than Monsanto was worth the day they bought it. And it turns out that the entire chemical industry has seriously underperformed since the time that the study on sperm count was published a year before that. Seriously underperformed, by the way. You can hardly find a winner. And I think the suits against most of these companies will be outstanding and much more dangerous even than fossil fuel companies because cancer and personal damage simply means more to most people than CO2 and long-term effects on the climate, don’t you think?
And we have the case, for example, of MMM, DuPont, and PFAS. PFAS are a group of several thousand chemicals that are not destroyed by nature, ever, and they’re bad for your endocrine disruption. They lower your probability of having successful birth. And they’re bad for cancer. And the cancer part was known decades ago. It’s in the archives, it’s in the files, DuPont being open with MMM as a customer about what the problems with PFAS and cancer were, and MMM went on and created masses of products dripping in PFAS. And we are all impregnated with PFAS. It’s in our brain, it’s in the rain, it’s everywhere.
And the same with plastics. The great fallback for the fossil fuel industry, plastics are ruining the environment, which gives us trillions of dollars of advantage, your healthy environment. But it’s also ruining us. It’s in our brains, it’s in our arteries. There was a wonderful Italian report and peer-reviewed serious journal like science, and it looked at your ability to recover from a serious heart operation, depending on how much microplastics you had in your arteries, and your death rate was three times higher if you were in the worst quartile by a particulate matter or microplastics. Massive.
Anyway, just to make the point, toxicity did not enter our conversation, should be treated very seriously. I would not own chemical companies, period, if I had that flexibility. And you will remember, I hope, a report by GMO where we took out every industry group in the S&P of the 11 major groups, we went through and we looked over 100 years, what the return was of the remaining 10. And you could not see the difference. They were all a couple of basis points here and there. Take out the oil, didn’t matter. Take out chemicals, it doesn’t matter—materials actually. Take out anything. It turns out that one thing the market can do pretty well is price, growth stocks, tech stocks, banking stocks, or finance stocks can do it pretty well.
So, if you jump around, that can ruin your investment performance. But if you take out a group and leave it out, it probably will cost you nothing, just as likely to make you money, as lose you money. Unless, of course, as in the case of chemicals or fossil fuels, you have an inevitable economic logic behind getting the hell out, is that it will be replaced and the world will not settle back and allow itself to be poisoned, because unlike climate change, toxicity is local. If Denmark or the EU behaves well, they have banned 1,200 cosmetic chemicals. We have banned less than a dozen. If they behave well, their life expectancy, their health, the health costs of the industry will simply expand. Twenty years ago, Sweden had two years of extra life and now they have about six. When that becomes 10 or 12, presumably there’s some boundary where we refuse to take it anymore.
So, I expect that we will respond. I also expect that China will get the point momentarily. In the next five years, I think it’s highly likely. They often come fairly late to something and then they move at Chinese speed. They will come to toxicity sometime in the next five years, as they did to cleaning up some of the air, which is partly toxic, and they will move very fast, and they will ban chemicals, and their health will improve, and they will save billions of dollars. These are very positive return moves seen through our health. Even by the way, EVs, we don’t realize that in 20 years, Boston will be cleaner than it’s ever been in its history from Day One. You’ll walk down the high street and you’ll be surrounded by relatively breathable air for the first time.
OK, that was my riff that I have missed out. In terms of optimism, pessimism, at the bottom of the market in 2009, as it turned out, the day the market hit a low, I put out one of only two special one-page reports I’ve ever put out called, what was it called: Buying when terrified. Reinvesting When Terrified. It said, of course you’re terrified, you should be terrified, but this is cheaper than it’s been for 22 years, get your money back into the market. Not bad. Also, my first quote ever in 1982, the summer of 1982, market was getting down to seven or eight times earnings and The Wall Street letter, now a defunct, had me toward the end, we were a brand-new firm saying, I thought we were near an unprecedented rally in both the stock and the bond market. And frankly, the turn in 1982 and the turn in ’09 are the only two market bottoms that really count. So, I did get them.
Secondly, or thirdly, I view this not as pessimism or even as contrarianism. I’m a natural contrarian. I believe 2% or 3% percent of general public can’t stop themselves. So, I’m attracted to market lows when everyone’s pessimistic, I’m attracted to market highs. And let’s face it, the 21st century has been one giant market high basically with that little dash in ’09, that little sprint to reasonable pricing. And that was it. The rest of the time, do you know we’ve averaged 60% higher P/E in the 21st century than the 20th century and 30% larger share of profits of the total GDP pie. So, it was a very different world we’ve lived in with very much higher prices. And I’m not sure how that will work out. But the bedrock is facts. Look at the facts, look at history, and make them a sensible relationship you can.
Knowing that the timing will be irritating and that your big successes, Japan, the tech burst, and so on, will be the times when you take the greatest grief. The world is incredibly impatient and incredibly upset when it misses the great bubbles, misses even a piece of the great bubbles. We used to think it was very dangerous to underperform in a bear market. Nah, not at all. Underperform in a bear market, everyone’s catatonic. They lose the ability to think until the market has bottomed out, and then they start to scratch their head and think who they’ll fire. But in a giant bubble, they’re playing golf with their buddy who’s 40% ahead of them, and Jesus, it drives them crazy. And they fire you on the run with great enthusiasm and talk to you as if, as I said before, as if it was deliberate. You’re trying to hurt them personally.
So, the great bubbles are the most dangerous things to fight. And if you’re sensible, and most investment firms and most advisors are, keep your head down and never fight a bubble. It’s not good for business. It is much easier to run off the cliff with everybody else, as Keynes pointed out in 1936, just be the same as everybody else in policy and be a little quicker and slicker on the draw. Make a little bit more money, get in a little bit quicker, get out maybe a day or two earlier, and that’s all you have to do. Once you start to try and do something seriously different, you will sooner or later be wrong. And he said, “You will not receive much mercy.” And that’s how it works.
Always be a bull is a great long-term policy for an advisor. For an individual, these things are so obvious. It really does seem you could sidestep some of the pain if you wanted to. But an institution can’t really afford that. They have to be seen as playing the game. They have to be seen as keeping dancing while the music is playing. Prince may have gotten his timing wrong, but he was honest. That’s how everybody does it and always will.
Because there is one, I think, pretty optimistic point of view in investing. And that is, in contrast to the American capitalist system and maybe the global capitalist system, which I think has gotten fat and happy—and particularly in America, it’s been allowed to become monopolistic. Monopolies, by the way, are great for stock markets. They’re terrible for GDP and productivity. Our productivity has dropped pretty steadily, dear listener, fewer over the last 50 years in America. We’re very pleased with ourselves now because we are less bad than Europe, which has plummeted. But we have drifted way down in productivity gains and GDP growth.
Monopolies are not good. They’re not aimed to have growth. They put profit margins ahead of growth. They’re aimed for good earnings, which we have, good stock prices, which we have, and bad, if anything, declining growth rates, which we have. So be advised on that. But the side exception to that is the venture capital industry. The venture capital industry is not monopolistic. It is backed by the great research universities. Fifteen of the 20 great research universities in the world are in the US, out of which are poured armies of brilliant new ideas, plus plenty of others. The US has an attitude to risk-taking, which makes the rest of the world look pretty starchy. So, we forgive people for failing once or twice. In other countries, they do not, although I think they are slowly acquiring some US characteristics.
And the VC structure, the fundraising structure, has always been the envy of the world. The VC industry in America is attracting the greatest entrepreneur brains, scientists who are capitalists, capitalists who are scientists, from all over the place. About a third of all of the VC leaders are not born in America. And we see it through the lens of green venture capital, hugely inventive people. And in the case of green, they actually care that they’re doing something useful. They care that green is important, the most important, maybe of all things. And they are really, I think, very good people. They are pleasure to do business with. And the Grantham Foundation, which has 90% of all the money I’ve ever made, is 50% in venture capital, maybe closer to 60% today, and half of that is green. So, we get a ringside seat at what is going on.
In the nongreen part, it’s very impressive, but it’s still kind of capitalist as usual. And in the green part, it’s massively encouraging. And we do it better than anywhere in the world. So, we have the machinery there to lead the world in green innovation. China coming up, by the way, very, very fast. And let me just finish on that. It’s something that’s happened that is never talked about.
In 2003, the Chinese contribution to major peer-reviewed articles was a rounding error by 1%. America, totally dominant. Last year, China overtook the US. You can’t do this in 20 years. It would seem to be impossible to go from an educational system that is not producing any material number of peer-reviewed articles in the top journals to having the most. It is a major, major achievement. Their academic achievement standards, the average graduate, been rising steadily as ours have been sinking down—they trust, the list. And they’re cranking out multiples of our engineers and scientists and physicists. And the rating of their universities still way behind us, but it is roaring through the international list. This last year, they have made average top Chinese university has jumped 10 or 20 places. And in the next 20 years, they will be butting their head into the top 20. And it’s an achievement that has come completely—have you heard it—completely silent. The cliché is China sucks. The fact that it’s just pulled off this amazing research progress has not even made the press as far as I’m concerned. So, thank you, by the way.
Benz: Yes, thank you. This has been a fascinating conversation. We so appreciate you being here today.
Grantham: You’re extremely welcome. Bye-bye.
Lefkovitz: Thank you, Jeremy.
Benz: Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
You can follow me on social media @Christine_Benz on X or at Christine Benz on LinkedIn.
Lefkovitz: And at Dan Lefkovitz on LinkedIn.
Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we’d love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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