Jeremy Grantham’s Quarterly Letter: “Pavlov’s Bulls”

One of the great asset allocators and market timers, Jeremy Grantham, has graced us with his latest quarterly letter. This one is titled “Pavlov’s Bulls” in reference to the famous Russian scientist who broke open the field of conditioning in psychology. The Fed’s monetary policy and the US government’s fiscal policy are ringing the bell loud and clear with the market participants playing the roll of the dog and salivating at a newly perceived bull market.

Grantham is among the very few who not only saw the developing bubble forming but who was also able to correctly pinpoint the end of the bear market and once again buy in the first quarter of 2009. In this letter he first recounts his rationale – the arrival of an unprecedented government stimulus – while critiquing himself on not being able to correctly forecast the profitability of US companies. Grantham concedes that it is unheard of to have so much slack in the economy coupled with peak profit margins.

The most important portion of this letter is where he provides his insight on what is ahead for the new year:

  • Be prepared for a strong market and continued outperformance of everything risky.
  • But be aware that you are living on borrowed time as a bull; on our data, the market is worth about 910 on the S&P 500, substantially less than current levels, and most risky components are even more overpriced.
  • The speed with which you should pull back from the market as it advances into dangerously overpriced territory this year is more of an art than a science, but by October 1 you should probably be thinking much more conservatively.
  • As before, in our opinion, U.S. quality stocks are the least overpriced equities.
  • To make money in emerging markets from this point, animal sprits have to stay strong and not much can go wrong. This is possibly the last chapter in a 12-year love affair. Emerging equities seem to be in the early stages of the “Emerging, Emerging Bubble” that, 3½ years ago, I suggested would occur. How far a bubble expands is always anyone’s guess, but from now on, we must be more careful.
  • For those of us in Asset Allocation, currencies are presently too iffy to choose between. Occasionally, in our opinion, one or more get far out of line. This is not one of those occasions.
  • Resource stocks, as in “stuff in the ground,” are likely to be fie investments for the very long term. But short term, they can really ruin a quarter, and they have certainly moved a lot recently.
  • We think forestry is still a good, safe, long-term play. Good agricultural land is as well.
  • What to watch out for: commodity price rises in the next few months could be so large that governmental policies in emerging countries might just stop the global equity bull market. My guess, though, is that this is not the case in the U.S. just yet.

Based on the above, we can safely add Grantham to the growing list of impressive market timers who are now bearish.

We also have a bonus with Part 2 of the letter being a republication of a speech Grantham gave to the Annual Benjamin Graham and David Dodd Breakfast at Columbia University on October 7th, 2009 titled “On the Importance of Asset Class Bubbles for Value Investors and Why They Occur”.

The complete letter is – as always – a must read. You can download it (free registration required) at or read it here.

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