Source: The Master Investor Podcast with Wilfred Frost

Compiled by: Felix, PANews

Jeremy Grantham founded and led the Boston-based investment firm Grantham Mayo Van Otterloo (GMO) for decades, managing $150 billion in assets at its peak. In his nearly 60-year investment career, Jeremy has almost accurately predicted all the major stock market bubbles and subsequent rebounds of the past 60 years, achieving long-term excess returns.

Recently, Jeremy appeared on "The Master Investor Podcast with Wilfred Frost," where he focused on the current market environment, assessing the impact of the Iran war on oil prices, AI, influencer stocks, and the "G7," comparing it to the boom periods of the 1970s, 1999, 2007, and the post-COVID-19 pandemic era. PANews has compiled the highlights of this conversation.

Host: Jeremy, welcome back to the podcast. It's great to see you in person.

Jeremy: It's nice to be here. However, I have to object to the word "prediction" you just mentioned. I'm not predicting bubbles; I'm just pointing out their existence when they arrive. It would be convenient if I could foresee their arrival, but all I can do is wait for them to appear—and they always seem obvious. Then I'll say, "See, there it is."

Host: In your book "The Making of a Permabear," published this January, you mentioned that you're from Yorkshire. Every true Yorkshire person naturally understands that "cheap is always better than expensive," which gives you a keen eye for finding excellent value. You also talked about your "butterfly effect" mindset, where ideas and thoughts flutter around like butterflies in a garden, seemingly lacking focus. Can you explain why this is important for you as an investment thinker?

Jeremy: This might be considered a form of self-justification. I find it difficult to stay on one topic for too long and tend to move on to another, which often annoys my colleagues. But the key is that I'm quite persistent. Anyone who has observed gardening will know that this is exactly how butterflies work: you think they've flown away, but they may actually be returning to the same flower repeatedly over a day or two. I've found that brainstorming should be done this way. If you get too fixated on one topic, it only makes your brain rigid, like banging your head against a wall. The best way is to wander around and then return to the original topic; this way, your brain will be more open, and you might have an epiphany.

Host : You also wrote that working very hard can actually hinder thinking because you're too busy absorbing new data. You rarely have time to truly think. Do investment professionals today spend too much time on Excel spreadsheets or AI modeling? What do you mean by "truly thinking"?

Jeremy: Real thinking isn't about typing numbers into a spreadsheet. Real thinking is about taking a walk through Boston Common, or even just showering, letting your brain work at a comfortable pace, and thinking about where you are right now, what's going on, and what it leads you to. Historically, when I arrived at the office, I usually already had two or three ideas (though most of my colleagues thought they were stupid). I was lucky to have a colleague named Chris Darnell, who's the only person in the world who can convince me an idea is stupid in 20 seconds. You really need this combination: someone who generates a ton of ridiculous or superficial ideas, plus an "idea crusher" who can spot fatal flaws and keep you moving forward. We'll review 10 to 20 ideas before finding one worth further investigation.

Host: Regarding this point, you said in your book: "Getting the big picture right is everything. One or two good ideas a year are enough." Is this what made you a legendary investor?

Jeremy: Yes, there are many years when I don't even have a good idea. But if your thinking is advanced enough, like "Will small-cap stocks win this year?", you don't need to guess right too many times. Just knowing that small-cap stocks are strengthening is enough to outperform the market for three or four years. As long as you get the general direction right, it's actually not difficult.

Host: From a micro perspective, if I'm not mistaken, your real winning formula is basically the dividend discount model, plus some adjustments you've made. That's your core focus, right?

Jeremy: Yes, the dividend discount model is just a tool we use to measure the quality of other ideas. It gives the ratio of different stocks to their relative fair value, which we use to test whether our intuition is correct. We have a dividend discount ratio for each stock. What is the ratio to fair value? If it's 0.79, it means it's undervalued by 21%. If it's 1.12, it means it's overvalued by 12%. Then we add them all together and find that all small-cap stocks combined are very cheap, and vice versa. It provides us with a metric to test whether our intuition is correct. It's very convenient.

Host: Here you've clearly weighed value more than other factors like growth and momentum. I think you can appreciate the importance of those other factors as well.

Jeremy: No, actually I have a secret reverence for anything that works, no matter how absurd it may seem. Of course, momentum is a rather simplistic inefficiency. It really shouldn't work. But it has worked remarkably well throughout my investment career, and for a long time before that. And it still works in many forms now. It simply illustrates that something in motion tends to remain in motion for a while. Market efficiency theorists, like the author of *A Random Walk Down Wall Street*, have said that prices alone provide no information. That's completely wrong . I think the biggest inefficiency has always been in pricing "quality." High quality means less debt, higher returns, greater stability, and a lower chance of bankruptcy. No matter how much you manipulate the data, you can't convince anyone that "quality" is a risk factor.

In academia, lower risk should translate to lower returns; however, in reality, high-quality stocks consistently outperform the market. Given their lower risk, they should ideally underperform by one percentage point annually, right? AAA-rated bonds yield about one percentage point less per year than B-rated bonds. Based on the same low-risk logic, AAA-rated stocks should do the same. But they don't; they outperform the market by about 0.5% annually. Therefore, due to market inefficiency, there is approximately 1.5% free excess return annually. You gain the privileged return of holding these high-quality large-cap stocks, something academia failed to discover and capitalize on for decades.

Host: Over time, have markets become more efficient? Has your job become more difficult?

Jeremy: As my career has progressed, I've tended to focus on increasingly broader issues , from individual stocks to sectors to the entire market. Speaking of absurd inefficiencies and bubbles, like those meme stocks that surged sixfold in a year, the market is probably worse now than ever before.

Host: Regarding your investment approach, you once mentioned, "We can never make big money without experiencing painful losses beforehand. You need to have the confidence to hold positions when they are against you and to increase your weighting when they become more attractive. It is value that gives you this confidence." That must be very difficult.

Jeremy: It's really tough; you have to trust the data. If you want to catch those once-in-a-century super bubbles, you often have to go through a regular bubble that happens every 15 years first. If you want to make big money, you have to watch the market go from "overpriced" to "extremely overpriced," and then to "Oh my god, ridiculously high." Only when you reach that turning point can you make big money. But before that, you'll endure tremendous pain. For example, in 2000, the market fell by 50%, while our portfolio achieved considerable gains within three years.

Host: Many people say it's impossible to time the market, and I think that's true at the individual stock level, but I really admire your bold position.

Jeremy: No, I don't think it's about market timing. I think it's just about exiting stocks that are clearly overpriced and always focusing on cheap stocks . Every time you buy a small-cap stock, someone might say, "Oh, you're timing that stock. Is that it? Or is it that if you hold cheaper stocks, you'll always win in the long run?" So, don't hold your ground in a severely overpriced stock market unless you ultimately want to get punched. Sure, others will outperform you in the meantime, but in the long run, you will win.

Host: In the first 9 years after you founded GMO, you achieved an 8% annual excess return, which is an amazing performance.

Jeremy: Compared to Buffett's 9% excess return over a longer period, our results only highlight how incredible Buffett is. Buffett made making money a simple and fun goal. Meanwhile, Jack Bogle (the father of index funds) received an award for "doing the most useful thing in the investment world" for saving billions of dollars for hundreds of millions of investors.

Host: Compare this to historical bubbles. In 1999, clients complained about your poor performance, and you said, "Value has skyrocketed, Inflation-Protected Securities yields are 4%, and Real Estate Investment Trusts (REITs) are trading at a discount." Can you apply all of that to today?

Jeremy: No. The year 2000 was great because it provided many safe havens. Real estate investment trusts (REITs) were selling for even less than the cost of construction. Right at the market peak, the S&P 500 yield was down to 1.6%, a level not even seen in 1929. That's what happened back then. Small-cap stocks were cheap.

Then you look at other markets, like the 2007 housing bubble, where there was practically nowhere to hide. That was a risk bubble. All risky assets were overpriced. In 2008, there were no obviously cheap assets. The current market is somewhere in between; it's more like 2000. Half the time you have excellent alternatives during a bubble, the other half you don't. Regarding this time, I remember saying on a podcast early last year that we have no bias against non-US stocks. We won't touch US stocks, but the rest of the world—emerging markets, Europe, Australia, Canada—have extremely reasonable stock valuations.

Host: In 1999, many people talked about the productivity and GDP growth brought about by the internet, just like people talk about AI today. Why is this bullish logic foolish?

Jeremy: There is no necessary correlation between past high market prices and future growth. In every bull market, people say the future will be bright, otherwise market prices wouldn't be so high, but the opposite is true. If you ask when the three or four worst periods in history were, they aren't randomly distributed; they follow massive bubbles. The Great Depression followed the famous peak of 1929. Japan's "lost decade" and "lost two decades" followed the astonishing 65 P/E ratio in 1989. Historically, there are no examples of high P/E ratios necessarily indicating higher profits, faster growth, or higher productivity. They truly foreshadow difficult times. If this is ever going to happen, it's now.

The current situation is that we've done everything wrong. We've gone to great lengths to ruin the wonderful growth of postwar international trade with tariffs and trade wars. We've gone to great lengths to destabilize geopolitics and damage our relations with countries like Russia and China. I'm sure these relations worsened at times and on some side, but the fact that both sides are worsening simultaneously is clearly unsettling. Billions of dollars in losses from floods, droughts, and fires are happening so frequently that they could wipe 0.5% of global GDP annually, and the situation is getting worse; then there's the decline in population, in some countries like Japan, South Korea, and China, where the decline is as rapid as a stone falling, and this trend will continue. So, the world will have to get used to slower labor force growth.

Host: With the outbreak of the conflict in Iran and its obvious impact on oil prices and inflation, are you reminded of some of the challenges of the 1970s?

Jeremy: Yes, as a species, humans have a tendency to think optimistically. We are very good at wishful thinking. If you study the stock market now and in the past, you'll conclude that given even the slightest chance, we'll generously interpret the future and say how good things will be. If the economic data is bad, we'll say, "Great, this gives the Fed an excuse to cut rates," and the stock market goes up. If the economy is growing well, we'll say, "Great, profits will be high," and the stock market goes up again. So the market is always looking for optimistic excuses and over-interpreting good news.

We tend to extrapolate linearly and continue to extrapolate. For example, in the summer of 1929, the economy was doing well, and if extrapolation continued, people would expect an absurdly high price-to-earnings ratio (P/E ratio). Then in 2000, profit margins reached historical highs, the P/E ratio soared to 35, and stock prices even rose to four times their book value. These phenomena are not complex, but most people failed to pay attention. Why didn't these warnings make the front page? Because this is not a business strategy. Any large company in the financial sector must constantly tell you that everything is fine, then lead everyone off a cliff and make as much money as possible while cleaning up the mess. Goldman Sachs, JPMorgan Chase, and Morgan Stanley would never tell you to get out of the market because the market price is already dangerously high. In fact, they could all see that the price was dangerously high. So don't assume the market price is reasonable just because no professional tells you to sell; the reality is not so.

I often use the analogy: it's like scattering a bag of feathers on a Miami skyscraper during a hurricane. In the short term, you have absolutely no idea where those feathers will end up. But you can be absolutely certain of one thing: eventually, every single feather will fall to the ground. To me, "value" is equivalent to gravity. No matter how high your value skyrockets now, sooner or later, the high cost will make you pay the price.

Host: In your book, you wrote about the strangest condition for a bubble bursting: "When the previous market leaders plummet, while the broader market, led by blue-chip stocks, continues its strong upward trend." This happened in 1929, 1972, and 2000. Considering that the MAG 7 (the seven major tech giants) has lost momentum in the past few months, but the rest of the market remains resilient, would you add late 2025 or early 2026 to the list?

Jeremy: Maybe I should add it. I haven't before, I guess I've been too busy with book tours. But I'd like to add 2021 to that list. Many speculative and unprofitable stocks started to fall after a strong run following the COVID-19 lows, while the broader market continued to rise, resulting in a 25% drop in the S&P 500 and a 40% drop in MAG 7 stocks in 2022. But then ChatGPT came along. Without the AI ​​investment boom, we would likely be in a mild or moderate recession, with the market potentially down 40% or more. AI, like the discovery of the railroad in 1930, forcefully nipped a real bear market in the bud .

Host: In March 2009, you published your famous article, "Reinvesting in Fear." How do you determine when to enter the market during periods of extreme panic?

Jeremy: That's because I'm familiar with the panic of 1974, the kind of fear that brought the market to a state of "ultimate paralysis." In 2009, I advocated for having a plan, even a bad one, than paralysis. You have to understand: market turning points don't come when people see "light at the end of the tunnel," but rather when "everything looks pitch black, but it's just a tiny bit less dark than the day before." While it hasn't reached the absolute undervaluation of 1974, according to our dividend discount model, it's already very cheap and is destined to deliver substantial returns far exceeding historical averages over the next seven years (an actual return of 12%).

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