From Jeremy Grantham's quarterly letter. Register at GMO.com to get all of their commentary... Now he has always been a bear, but it looks like he is about to vindicated...GMO's long-term record is remarkable. The letter is being passed around. Paul Kedrosky posts it too.
The Anti-risk Bet in Perspective: A Once or Twice in a Career Opportunity
In 40 years I believe I have been offered three obvious and extreme opportunities to make or at least save money. The first in 1974 was presented by the extreme undervaluation of small cap stocks in absolute terms – many were below 5xearnings and even more yielded over 10%. And compared to the Nifty Fifty – the great high quality franchise stocks– they were almost ludicrously underpriced.
The second opportunity was in 1999 and 2000 when the extraordinary overpricing in absolute terms of growth stocks, especially technology and the internet, meant that in round numbers everything else was relatively reasonable and some assets, notably real estate and U.S. TIPS, were simply very cheap, even in absolute terms.
Well the third great opportunity is now upon us in my opinion, and that is anti-risk. It is almost certainly the most important of the three because of its diffusion across assets and countries. That is the good news, for most of the time we have to make do with modest opportunities and this one is the real McCoy. The bad news is that for equity managers the first two opportunities were easy to spot and easy to execute. Anti-risk in comparison is a diffused and complicated opportunity, and is as much or more in fixed income with all its new complexities as it is in equities.
The ideal way of playing this third great opportunity is perhaps to create a basket of a dozen or more different anti-risk bets, for to speak the truth none of us can know how this unprecedented risk bubble with its new levels of leverage and new instruments will precisely defl ate. Some components, like subprime and junk bonds, may go early and some equity risk spreads may go later. Some will prove unexpectedly rewarding and some, no doubt, will be disappointingly modest. Such uncertainties would be moderated by a complicated package approach. It will not be very easy, but some of the best hedge funds will, I’m sure, pull it off even as most of them pay the price for too much risk taking. Where we have the funds, the mandates, and the skill we will also try our very best to capture the spirit of the exercise. To conclude, I have been trying to come up with a simple statement that would capture how serious the situation is for the overstretched, overleveraged financial system, and this is it: In 5 years I expect that at least one major “bank†(broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist.
I have often been too bearish about the U.S. equity markets in the last 12 years (although bullish on emerging equity markets), but I think it is fair to say that my language has almost never been this dire. The feeling I have today is that of watching a very slow motion train wreck.