The Recession Was a Lie—Here’s What’s REALLY Coming!

So the gap between value and growth is as big as it gets. It's in the top few percentile of history. And the gap between foreign and the U.S. is at or close to an all time record. So these are the things you have to do. Emphasize value. Emphasize non-U.S. On WealthTrack, legendary value investor Jeremy Grantham. What does he see now? Funding provided by ClearBridge Investments, the Fairholme Foundation, First Eagle Investments, Bill Miller, Baird, Strategas Asset Management, Research Affiliates, Royce Investment Partners, Seafarer Capital Partners and Women Investing in Security and Education. Hello and welcome to this edition of WealthTrack. I'm Consuelo Mack. When legendary value investor Jeremy Grantham appeared on WealthTrack for his first ever television interview, it was November of 2008. In the depths of the financial crisis, Grantham saw the credit crisis building years in advance of the meltdown. The Economist called him the Cassandra of the investment community for his bearish and accurate 10 year forecast. Before and after the global financial crisis, the British born Grantham has been known for his prescient market calls. For those of you not familiar with Grantham, he is a longtime value investor, co-founder of the global investment management firm GMO, where his title is now long term investment strategist, having been as chief investment strategist for many years. Grantham no longer manages money at GMO, but oversees the Grantham Family Foundation, which is devoted to fighting climate change and is investing the bulk of its funds in green venture capital companies. He is also known for his research on what he believes are the five biggest challenges facing civilization, climate change, resource depletion, biodiversity collapse, deficiencies of capitalism and toxicity. We will provide links on our website to his latest report, Rising Toxicity and the Threat to Capitalism and Life Itself. Our wide ranging conversation started with his assessment of the state of the current financial markets. We were talking earlier that outside it's a pea super. You can't even see the next building. And that's a pretty good analogy with the market from my perspective. It's seldom. It's seldom easy to see what's coming. You only get a little kind of glimpse through what they used to call the fog of war. And now you don't even get that glimpse. The all the old ratios. Don't seem to work. For a variety of reasons, but you start with Covid. Covid rattled the world to its bones, and then the Covid stimulus was an order of magnitude bigger than anything we had ever seen. And it ended up with trillions of dollars in very weird hands. People who were bored and forced to be at home with nothing to do but speculate on on stocks, and they did, and it stayed that way. So even in the recent decline. The selling was by institutions, the buying was by individuals. This is incredibly new. So that's influence number one. The second great difference here. That's also changed all the traditional responses is the introduction of A.I., which really came to be recognized with chat GPT and October 22. And we were having what you might call a traditional bear market. And it kind of ended overnight with half a dozen mag seven, half a dozen roaring upwards and eventually dragging the market with it. That cut right across all the traditional reflexes. And then finally, we have a tariff war. So if anyone can unravel that series of abnormal influences, we're still we're still unpredictable because of Covid response. We're certainly still unpredictable because of A.I. No one knows what A.I. is going to do. It's going to change the world, but no one knows when and how. And on top of all that, no one has a clue what the tariff war is going to do and how quickly it will do it. Are we going to have a major recession, a small recession? None at all. The economists are completely at sea in case you hadn't noticed that. You can find an economist with with any view today on a huge spectrum. And since the stock market in a way takes its lead from the economy and no one knows what's happening to the economy. So they're the three levels of abnormal responses that have completely scrambled the market and makes it very, very hard to know what's going on. Number one, the fact that you described it and noticed it and marked it is so you, Jeremy, you know, you're connecting dots and you're noticing things that are completely kind of off the wall, abnormal, whatever it is. But it strikes me that what you're describing to our extremes in the market. And that's, again, kind of your one of your expertise is to to say that something is amiss, something's unusual. And therefore, what are you telling yourself? What are you telling your friends? What are you telling GMO about what these abnormalities are telling you? Well, the single thing all three have in common is that they should increase your respect for risk, volatility, uncertainty, be more careful than normal. That's kind of round one. And then round two, you you back down to looking at more traditional views of the market and the ones I respect the most, the ones that have provably the best predictable record over many years, over seven, eight, nine, ten years. They all say that the market is about as high in December recently as it has ever been in history, higher than 1929 and at least as high as 2000 and as high as the recent peak in December 21. But the most predictable ones are variants of the total market cap versus the GDP, OK, which is Warren Buffett's said to be Warren Buffett's favorite. Right. And there are fairly elegant, serious variants of that. And Hussman does a very well worked out variant, which he believes is the single most predictive. And I have no reason to doubt it, since we have a very, a very similar model at GMO. And that suggests that the market could easily go down by 50 percent and be well within its historical boundary. That would not be a colossal low, a colossal low. I've been through a couple, 1982, 1974. They sold at seven times earnings, seven times depressed earnings, for heaven's sake. The market, by the way, loves double counting when it has peak profit margins, it has peak PEs. And when it has terrible profit margins like 74, it has terrible PEs. So seven times terrible earnings goes up to 35 times wonderful earnings in 2000, guaranteeing that 74 to 2000 was one hell of a of a good trip. Right. The market can be overvalued for a long, long time. So you take that information and what do you do with it? You said just be aware that there's a lot of risk in the market. But give us some concrete steps that we might want to consider taking. The quote attributed to Keynes, although he unfortunately never, never said it, he should have said it, is that the market can stay irrational longer than the investor can stay solvent. Yes. And that's really true. If you're in the institutional business, as we have been, you run the risk of getting forced out of your positions, even if you're right. And in 2000, we were right. The PE went to a new all time high in January 98. It overtook the previous high of 1929 at the top of the legendary bull market. And then it just kept going. 21 times earnings, 23, 27, 29, 31. Oh, my God, it has to stop. 33, 35. And at 35 times earnings in March of 2000, it finally quit. And how were you to know once you were in new high territory like that? And earnings continued to rise. So you not only went from 21 to 35, which is kind of a 50 percent hit, but you had earnings go up 20 as well. And and of course, there's no way of knowing. And all you know is that in the end, it doesn't change the outcome. It just meant that the break from 35 times earnings was spectacular. And the NASDAQ that led the charge upwards went down pretty much 80 percent. And the same in Japan, although Japan is even worse. Japan had never sold over 25 times earnings. And then it did. And for some miraculous reason, we stayed invested until about 45 times. And then we got out. We said, this is ridiculous. We're out of it. 100 percent out. It was the biggest part of foreign portfolios. The IFA index. And we went to zero. And then we watched as it went from 45 to 50 to 55. You must be kidding me to 60 to 65 times earnings, by which time we had underperformed by 10 points a year. It came back all the way. And only instead of taking five years, it took 20 years. And now Japan finally is an ordinary country selling a little bit cheaply from the highest price of any major market ever by a lot. So you have a wonderful ride on the way up. It changes nothing. Eventually they come down. But getting the timing right, just about impossible. And in each case of the great ones, we got right. We thought we suffered a loss to Japan and 2000. And the one we got fairly right was was the so-called great financial crash because we focused on the housing market and we saw how much overpriced it was. So we knew it was coming down. Housing market was unbelievably well behaved. It went up to, in statistical terms, a three sigma event, which is the kind that would occur every hundred years or so. And then it came all the way back down again. It was beautifully symmetrical. It took three years going up, three years coming down, sucked in a lot of poor people into the housing market who should never have been there, gave an opportunity for the rent seekers, as we call them, to design crazy bits of of sliced and diced subprime mortgage paper to sell to idiot European banks and so on. And then the shock nearly destroyed the banking system. Queen Elizabeth said, why did no one see it coming? Which was particularly irritating since we were describing it quarter by quarter from from 2007 spring from there onwards. In 2007, the Federal Reserve boss and secretary of the Treasury both used the same word, describing it and saying it was contained. I took the opportunity to be very cute and said, if it was contained in this case, it was likely to be Pandora's, the container. The problem we have, you can't predict any outcome except one. There will come a time when you will be happy to have been out of the market is my definition and my only definition of success. So when I say let the wild rumpus begin at the end of 21, every condition of a crazy bubble was in place. I expect that there will be a time in the not too distant future when you will be happy to have been out of the market from December 21 until then. And the market will be considerably cheaper than it is now. But it was always difficult to get the timing right without the three major changes I described at the beginning. That makes it absolutely impossible to know what the heck is happening. It's an occupational hazard, in other words, to be some sort of to be early. That is for sure. And I remember GMO lost a lot of its assets at one point. It's actually quite interesting in Japan, which was our biggest failure. We lost nothing because Japan was so obviously crazy. And we were here and they were there. And we we could all see how crazy they were. The tech bubble was our second biggest. We lost six and a half points for two and a half years versus 10, 10 each for three years in Japan. But the difference there was that was here. So our clients didn't see that at all. They they saw Japan as crazy. But when it came to America, they they bought into the golden new era. The Greenspan was selling. It's much harder to to stay cool when it's when it's your market. And so we lost a ton of business, maybe almost half our asset allocation business in two years and a quarter. There used to be a kind of saying that if you have a decent track record, which we had a very good track record in ninety seven, they will hang. They will hang tough for three years. Well, forget it. They weren't. The other thing is people think you get fired by underperforming in a bear market. Absolutely not. You get fired by underperforming in a bull market. And the reason is in a bear market, everyone freezes and they postpone moves until they've recovered from the shock. In a bull market, they're out there talking to their neighbor on the golf course, and he's making tons of money because somewhere Fred is leveraged the market and there's always a Fred and he's always killing you. And they go crazy. They can't stand the shock of being outperformed and listening to all these wonderful stories of other people getting rich. And so they shoot you. And much more lethal, much quicker than than in a bear market. It doesn't feel as crazy to me as the tech bubble or Japan did. But how does it feel to you? I mean, what's your sense? I think. The speculation in after covid stimulus was more impressive than anything we have seen, right? All that speculative money from the covid stimulus where they were hopping around saying, AMC, let's take it to the moon, to the moon. And the thing was going up 40 times in two weeks. And I'm becoming billions of dollars. And forcing the poor hedge fund guys into jumping out of the window. There's no way you can calculate things like that. It was on such a scale. And there were so many of them, each one more ridiculous than the next. Now, I think that was I think that was a good candidate for beating 1929. And has that been corrected sufficiently? Well, that was the interesting thing. Quite a few of those things just fizzled away to next to nothing. The market itself never corrected. It was beginning to in 22. Of course, that was a major 25 percent wipeout. And in that the growth stocks came down 50 percent in a hurry. But then they rallied so much with. Yeah, they I that they got it all back in the following year, stabilized the whole market again, which which went to new highs. So there is no precedent for this kind of bubble within a bubble. We had all the frenzy, all the speculation. We had the thing bust. We had a lot of the flakes go to nothing. We had the growth stocks come down 50 percent. And then they rewrite the novel with with AI. And AI, of course, is the real McCoy in the sense it's a major, major development. And people say, well, then it's not a bubble. And I say it's quite the reverse. The great inventions like railroads. And I'm told the canals even before them. Internet, the more you could see that they were brilliant ideas, the easier it was to see how they would change the world, the more effective it was of sucking in your money. Of course. Why would it not be? So they designed six railroads between Manchester and Leeds, which is not a great idea. It changed the world. It brought down the cost of transportation. Everyone's GDP was helped. But the people who invested in the railroads had a terrible bust. And out of the wreckage, the world advanced. Internet was identical. Amazon and the boys, the the little flakes like pets. Pet dot com. They all went to nothing in nine months or so. But Amazon, believe it or not, went down 92 percent in 2000 and 2001 to the low, to the low of that market move. It fell 92 percent. And out of the wreckage, the Internet was a terrific, life changing idea. And it and it and it worked. And it was precisely those wonderful ideas that actually work, that suck in the money and give you up front the biggest bubbles. And you would have to think that A.I. is is right up there in in the significant, in the general significance potential. It's hard to imagine that that will not be a bubble. And out of which wreckage? I really count on the fact that A.I. will change everything, some some for the good, some for the bad. It's going to be the biggest destroyer of jobs that you have even thought about. How do you participate? I mean, how do you decide how to participate? Or do you just do you know, I might as well just do an index fund. Yes. Indexing has this advantage that you might not have known which companies would be mag seven companies, but the index had them all, which is pretty cool. And so the index is is always going to be. Hard to beat. What what should you do now? The stock market is gloriously overpriced. In the US, but foreign stocks are perfectly reasonable. And when you have a major bubble, you also have incredible stretching of traditional relationships. So the gap between value and growth is as big as it gets. It's in the top few percentile of history. And the gap between foreign and the US is at or close to an all time record. So these are the things you have to do. Emphasize value, emphasize non US. And if you're in in the US and you have to be. And I have to be a little sympathetic. Most people really have to be in the US. The thing to do is concentrate on risk. One way to do that is high quality. High quality has less debt. If the economy goes into the tank and it may well do just that because of the tariff war and other problems, record debt and so on. You do not want to have that. And high quality companies have very little. And you want to have high profit margins so they can be squeezed without sending you out of business. Climate and resources have been utterly crushed. Even if they are American securities, a lot of them are not. And resources not only are unprecedentedly cheap, but they are the only group that tends to be uncorrelated to the broad market. As in on a 10 year basis, they have no positive correlation at all. And it's the only group do what you should do when you invest, kind of lock them up for 10 years and throw the key away. You will you will make a decent amount of money. But if you do that in the S&P. I think 50 50, you won't make any money at all. There's a prediction. Happy to say I made that made that prediction in 2000. And by 2010, the S&P was down. We have a wonderful forecast. We have some terrible forecasts. I've got to admit it. But that was that was the the winner. A 10 year forecast from 2000 to 2010. Congratulations. I'm sure you studied your methodology in that and have tried to duplicate it since. We've had the same methodology all the time. And. We ebb and flow from looking like heroes to looking like idiots. And of course, we think the market is the idiot and we're long term sensible. Is there one investment for a long term diversified portfolio that you would recommend? I think I can tell you what I have in in my sister's pension fund and my children's accounts. We have the biggest position is developed country value stocks, which I think is 30 percent, 15 percent in emerging country debt, which is always yields a little more than other things. 10 or 15 percent in cash for liquidity. To be able to buy something, should it become desperately cheap? We don't own quality because there is a hedge fund that we have that is 170 percent long and 70 percent short. So that turns out to have beaten beaten our quality index by two points a year for the last five years. And then we have a long, short value fund which goes short. The overpriced ones and and long are the cheap ones. It hasn't done that well recently, lost a couple of points or so. And we have my children, my sister have 10 or 15 percent in that. And then we have an asset allocation fund with a bit of everything. For most of the rest, nothing heroic. Well, we have a 10, 10 percent in emerging market equities. But the biggest one is developed country value stocks, which I'm which is up 15 percent this year. So this is one of those unusual years where the S&P has been down quite a bit and the foreign equivalents have gone up. It's been a long time since that happened. Jeremy Grantham, long term investment strategist, GMO and valued WealthTrack guest. Thank you so much for joining us, Jeremy. I really appreciate it. As always, a great pleasure to be here. Thank you. At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week's action point is stay largely invested in stocks, low cost diversified index funds in particular. Jeremy Grantham and one of his firms were pioneers in indexing for institutional investors before Jack Bogle created the first index mutual fund for individuals. As Grantham revealed, research has shown the best and most consistent investment results over the years have come from long term investments in low cost index funds. And one of the reasons is they eliminate the temptation to time the market. One of the skills for which Grantham is known. A great admirer of Jack Bogle's, Grantham is delighted low cost index funds have caught on with individual investors. Next week, Bridgeway Capital's Contrarian Portfolio Manager John Montgomery discusses what his quantitative models have identified as the best and worst investment opportunities. Please follow us on Facebook X and our YouTube channel. Thanks for watching. Enjoy your weekend and make the week ahead a healthy, profitable and productive one.