Jeremy Grantham Explains How To "Survive Betting Against Bull Market Irrationality"

Tyler Durden's picture

Ridiculous as our market volatility might seem to an intelligent Martian, it is our reality and everyone loves to trot out the “quote” attributed to Keynes (but never documented): “The market can stay irrational longer than the investor can stay solvent.” For us agents, he might better have said “The market can stay irrational longer than the client can stay patient.”


Jeremy Grantham

As one may have guessed by now, the topic of this post will be Jeremy Grantham's much anticipated quarterly letter, titled "The Tension between Protecting Your Job or Your Clients’ Money" - a topic very germane to most asset managers, who according to Grantham, engage not so much in alpha discovery (or even pursuing levered beta), as much as preserving their careers, and in the process succumbing to the one fundamental flaw of finance- herding. But don't worry: everyone else does it too. Which is precisely what makes it so attractive. After all, if everyone underperforms, nobody stands out, and vice versa, which is why for every manager who succeeds and becomes a billionaire, there are 999 others who try to break away from the herd, blow up and are never heard of (pardon the pun) again, thank you survivorship bias. It is this tension between the draw for riches and the probability of flaming out on one hand, and the slow steady grind, associated with being a member of the "flock" that more than anything, is at the true heart of modern capital (mis)allocation decisions. And it is because precisely of this herding effect that stock prices end up whiplashed around fair value by a margin of ±19% two-thirds of the time, even as GDP and fair values moves at a glacial ±1 pace. Call it momo, call it "safety in numbers", it's real name is irrationality. It is precisely this irrationality that Keynes had in mind when he may or may not have uttered his infamous quote.

This is how Grantham puts it.

The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority “go with the flow,” either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other ineffi ciencies in market pricing, but this is by far the largest. It explains the discrepancy between a remarkably volatile stock market and a remarkably stable GDP growth, together with an equally stable growth in “fair value” for the stock market. This difference is massive – two-thirds of the time annual GDP growth and annual change in the fair value of the market is within plus or minus a tiny 1% of its long-term trend as shown in Exhibit 1.


The market’s actual price – brought to us by the workings of wild and wooly individuals – is within plus or minus 19% two-thirds of the time. Thus, the market moves 19 times more than is justifi ed by the underlying engines! This incredible demonstration of the behavioral dominating the rational and the “efficient” was first noticed by Robert Shiller over 20 years ago and was countered by some of the most tortured logic that the rational expectations crowd could offer, which is a very high hurdle indeed. Shiller’s “fair value” for this purpose used clairvoyance. He “knew” the future flight path of all future dividends, from each starting position of 1917, 1961, and all the way forward. The resulting theoretical value was always stable (it barely twitched even in the Great Depression), but this data was widely ignored as irrelevant. And ignoring it may be the correct response on the part of most market players, for ignoring the volatile up-and-down market moves and attempting to focus on the slower burning long-term reality is simply too dangerous in career terms. Missing a big move, however unjustified it may be by fundamentals, is to take a very high risk of being fired. Career risk and the resulting herding it creates are likely to always dominate investing. The short term will always be exaggerated, and the fact that a corporation’s future value stretches far into the future will be ignored. As GMO’s Ben Inker has written, two-thirds of all corporate value lies out beyond 20 years. Yet the market often trades as if all value lies within the next 5 years, and sometimes 5 months.

Since in our day and age, the only way to generate wealth is to manage asset, not to collect wages (as everyone's favorite peak Marxism chart has shown over and over), everyone is now an fund manager. Which means that the above observations have to be put in the context of managing one's portfolio. Grantham does that next, and this is the part that the hedge funders, those so terrified to fight the Fed, and thus shivering in groups of like-minded momentum chasers, should pay attention to:

Ridiculous as our market volatility might seem to an intelligent Martian, it is our reality and everyone loves to trot out the “quote” attributed to Keynes (but never documented): “The market can stay irrational longer than the investor can stay solvent.” For us agents, he might better have said “The market can stay irrational longer than the client can stay patient.” Over the years, our estimate of “standard client patience time,” to coin a phrase, has been 3.0 years in normal conditions. Patience can be up to a year shorter than that in extreme cases where relationships and the timing of their start-ups have proven to be unfortunate. For example, 2.5 years of bad performance after 5 good ones is usually tolerable, but 2.5 bad years from start-up, even though your previous 5 good years are wellknown but helped someone else, is absolutely not the same thing! With good luck on starting time, good personal relationships, and decent relative performance, a client’s patience can be a year longer than 3.0 years, or even 2 years longer in exceptional cases. I like to say that good client management is about earning your fi rm an incremental year of patience. The extra year is very important with any investment product, but in asset allocation, where mistakes are obvious, it is absolutely huge and usually enough

So is there any hope for those who wish to break the mold, fight the Fed, and be contrarians for the sake of reality, and, well, because sometime it is just much more fun to tell the lemmings the cliff ended 10 feet ago. Why, yes Virginia. Here is how Grantham explains betting against euphoric bullish irrationality:

You apparently can survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like “margin of safety” and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage. In my personal opinion (and with the benefit of hindsight, you might add), although we in asset allocation felt exceptionally and  painfully patient at the time, we did not in the past always hold our fire long enough or be patient enough. It is the classic failing of value managers (and poker players for that matter) to get impatient and bet too hard too soon. In addition, GMO was not always optimally diversified. We are generally more cautious (or, if you prefer, “more experienced”) now than in 1998 with respect to, for example, both patience and diversification, and at least we in asset allocation always stayed away from leverage. The U.S. growth and technology bubble of 2000 was by far the biggest market  outlier event in U.S. market history; we had previously survived the 65 P/E market in Japan, which was perhaps the greatest outlier in all important equity markets anywhere and at any time. These were the most stringent tests for managers, and we were 2 to 3 years early in our calls in both cases. Yet we survived, although not without some battle scars, with the great help that we did, in the end, win these bets and by a lot. Hypothetically, resisting the temptation to invest too soon in 1931 may have been a tougher test of survival in bucking the market. Luckily we, and all value managers, were not around to be tempted by that one. (Although Roy Neuberger – who died in December 2010, unfortunately – was, and he could talk about it as lucidly as any investor ever.)

Yet even so, doing the right thing is often precluded by one's career limitations:

This exemplifies perfectly Warren Buffett’s adage that investing is simple but not easy. It is simple to see what is necessary, but not easy to be willing or able to do it. To repeat an old story: in 1998 and 1999 I got about 1100 fulltime equity professionals to vote on two questions. Each and every one agreed that if the P/E on the S&P were to go back to 17 times earnings from its level then of 28 to 35 times, it would guarantee a major bear market. Much more remarkably, only 7 voted that it would not go back! Thus, more than 99% of the analysts and portfolio managers of the great, and the not so great, investment houses believed that there would indeed be “a major bear market” even as their spokespeople, with a handful of honorable exceptions, reassured clients that there was no need to worry.


Career and business risk is not at all evenly spread across all investment levels. Career risk is very modest, for example, when you are picking insurance stocks; it is therefore hard to lose your job. It will usually take 4 or 5 years before it becomes reasonably clear that your selections are far from stellar and by then, with any luck, the research director will have changed once or twice and your defi ciencies will have been lost in history. Picking oil, say, versus insurance is much more visible and therefore more dangerous. Picking cash or “conservatism” against a roaring bull market probably lies beyond the pain threshold of any publicly traded enterprise. It simply cannot take the risk of being seen to be “wrong” about the big picture for 2 or 3 years, along with the associated loss of business. Remember, expensive markets can continue on to become obscenely expensive 2 or 3 years later, as Japan and the tech bubble proved. Thus, because asset class selection packs a more deadly punch in the career and business risk game, the great investment opportunities are much more likely to be at the asset class level than at the stock or industry level. But even if you know this, dear professional reader, you will probably not be able to do too much about it if you value your job as did the nearly 1100 analysts in my survey. Except, perhaps, with your own assets or, say, your sister’s pension assets.

As usual, terrific advice from one of the few people out there who still gets it. Much more in the full letter below (pdf link)


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LawsofPhysics's picture

So the paper-pushers first priority is to "protect their jobs" and not their client's money. That says it all right there. Crash the system and let's find out the real "value" of all those jobs. Fucking bring it.

I think I need to buy a gun's picture

What about all those astute analysts we see on Cnbc all day? What about their jobs, you can't crash the system or say goodbye to Jim Cramer and all those productive analysts,,,,,,,,,,

AldousHuxley's picture

cnbc analysts = entertainment for fools


wall st. and the entire financial gang should be reporting on how much money is in the vault and not trying to predict the future.



you don't need a job. human productivity should provide wealth for many, but rich have taken all the gains of productivity increases.

Michael's picture

From previous thread;

Here’s what me and Elmo can’t figure out: Why would attempting to break this spiral be labeled Class Warfare?

Elmo not so smart after all. They don't want "Sector Warfare" to become the spoken meme. That's Private Sector vs Public Sector Warfare for the not so intelligently endowed among us. It's the public sector that gives us the national debt and expects the private sector to pay for it. Fat chance.

AldousHuxley's picture

there is no true private sector.


it is either direct public sector or sector supported with public funding. name one industry that doesn't depend on government subsidies or contracts or bailouts?


debt is due to top 0.1% desire for world domination so they use taxes for wars instead of interior growth like education.


what's wrong is that government dependent "private sector" executives getting paid more than public leaders in the name of meritocracy when is it just pure socialism.

Michael's picture

Alex Jones is just a play by play announcer for the progress of The New World Order.

mach777's picture

Lots of good posts from you recently. +1

Oh regional Indian's picture

I think one of the points to note is that failure as a learning tool cannot be practised on other people's money. Just never works out well.

And it's really ironic that even if they suffered from a leedle bit of hind-sight, Robotrader's "picks" would have made everyone a lot more "money". But is that the point anymore?

Being contrarian is a natural instinct anyways, not one you can stay comfortably in if your natural sense is to go with the herd.

In the herd, heard counts.

Have you heard?



AldousHuxley's picture

natural for you, most others are sheeps.


in china, bankster failures have real consequences....when you are managing communazi wealth, you better not fail.

putaipan's picture

inna long enogh timeline .... even  china bankster failures have real consequences....when you are managing communazi wealth, you better not fail or else it drops to zero.

fixed it for greenspan, paulson, summers, rubin, giethner et all.....

AldousHuxley's picture

mother nature has provided us with a justice system called death from old age no matter how powerful, evil, cunning a bankster may be.


greenspan is due soon.

Unprepared's picture

Paper pusher or not, an agent's job is always more important than the principal's interests. There is no going around it.

LawsofPhysics's picture

Precisely why fiat always fails.

rocker's picture

The U.S. Capital Markets are just a Fukn shame. Period.  All commodities are failing for two years or more except oil.

The miners have been loosers for two years now. Why?  Is it the real economy or Goldman and JPM's market manipulation.

The Banking Cartel, (the FED controlled and ran by Goldman Sachs) keeps shorting the miners. 

So, what to believe?  The markets are rigged, are phony, are manipulated or controlled by the powers in charge of the same.

The U.S. markets look to me to be a ponzi scam worst than anything that Bernie ever did.

The powers to be, (the FED) are paying off bankers everywhere. So, we don't need stuff, we just need bankers.

What a crock of bullshit.  Please, will somebody end:  Currency Swap Lines, (Free Money to those who have counter risk with Goldman)

And then, End the FED,  The U.S. Capital Markets are the worst I have ever seen.  Fuck the FED and Goldman.

Speaking about Goldman, did anybody notice how the SEC let them just get away with insider trading that they were doing for years with a little fine and a hand slap.

Lord Blankfein belongs in Jail.  Nobody can tell me why he should not be Bernie's Butt Buddy along with Big Ben.

"I will Not Monetize"   LOL, no, it makes me want to cry to think of what Ben and Goldman are doing to the U.S. Dollar's value and the people who really work for a buck.

Ron Paul has it right. The FED and Goldman are stealing from the little guy. And then they do not even want to pay their share of taxes.

Less than 15% for Hedge Funds like Goldman. And just how did they get to be a bank anyway? Just a Fukn shame.  

The Big Ching-aso's picture



This BS market too shall end like the passing of a Rockwell-60 stool.

AldousHuxley's picture

goldman Sachs is not a bank but a marketing organization like women's handbag luxury brands that fools all fools to believe that they are worth x1000 the productive value.


what is the difference between a casino and a bank? in a bank, the casino masters do the gambling with your money.

Clowns on Acid's picture

"Just how did they become a bank?" GS was bankrupt (Buffet was going to be out $5B), in order to get bail out funds that had to be incorporated as a bank.

Their application took about 5 nano seconds to be approved.



Dr. Engali's picture

I disagree with that statement. A lot of us are so concerned about our client's money that it may cost us our job. if it does so be it. I'd rather know I did the right thing and got fired ,than screw my clients up in this market.

AldousHuxley's picture

who are the clients who bank with goldman sachs?


fools who deserve to lose or co-conspirators who are in it with the banksters. both don't give a shit about you nor ethics.

tempo's picture

The fractional banking system has been in existence for about 100 years and will continue. Yes, its now 30 to 1 but thats because the velocity of money is near zero. So there is no alternative. The leverage will decline as the velocity increases. Me not worried.

Change-In-Trend's picture

Heading into an important low in GOLD

I think I need to buy a gun's picture

how about an important end to the monetary system?

stocktivity's picture

They (ECB and others) won't let the Spanish auction fail tomorrow. The casino will be in there buying to keep the hopium going.

Off topic - RIP Dick Clark - one of the nicer guys in show business.

ReactionToClosedMinds's picture

yep (> Dick Clark) ... was a good guy all the way around from what I understand ... helped many get started in 'the business' selflessly.  RIP

chump666's picture

April's correction looks pushed back into May.  A total liquidation trade is due, or overdue.

ReactionToClosedMinds's picture

not that anyone cares ... agree with the premise of this analysis ... but still think  Jeremy G is a self-infatuated blowhard ... who likes to read the volume of his work and various unrelated  musings

Assetman's picture

Yeah, Jeremy G usually provides pretty good insights... but I was left more than a little disappointed in this piece.

Why he frames his asset allocation decisions solely between stocks and bonds is more than a little puzzling, though it should have been made clear upfront that perhaps the decision itself was a binary asset allocation decsion based on the fund strategy he was endorsing.

If bonds provide very little return for the modest risks entailed, and stocks provide much lower returns and a higher duration timeframe than normally experieniced-- and the Fed just keeps on printing-- just what asset class deserves some sort of mention, anyway?

I really didn't see any cursory mention of higher PM's in his asset allocation framework, whether valid or not.  Lots of shameless peddling for his "no benchmark" asset allocation fund, though... which could (or not) be loaded with PM's by now.


machineh's picture

'Just what asset class deserves some sort of mention, anyway?'

Indeed. His chart from 1999 shows REITs as an asset class. No mention of them now. And no mention of, say, gold or total return commodities. Strange.

'No benchmark' is even more baffling. The only way to tell whether active asset allocation adds value is to compare it to a passively-held portfolio of the same assets. Otherwise it's a mystery whether the trading is adding or subtracting value.

Bottom line, Jeremy, we ain't your sister who gives you perpetual carte blanche.

Godisanhftbot's picture

 Your job is to surf the insanity and extract as much out of others idiocy as possible.  


 Everything else is excuse making for failure to do that.


 Any fool can be rational. (L. Rasmussen Filip)

CryingBear's picture

so what do i buy puts on?

1C3-N1N3's picture

If you only do what everyone else does, you can only get what everyone else gets.

tony bonn's picture

speaking of fund managing, and somewhat tangentially at that, i would love to see a mud wrestling match over the random walk theory.....if you don't get the implications, stay away from the mud....

upb's picture

irrational?? who gives a hoot!!!  print print print

SoCalBusted's picture

It's been said before and worth repeating.

The only winning move is not to play.

GernB's picture

Using leverage must be safe, banks use it all the time :)

Vic Vinegar's picture

You know GernB, I read this article and my only key take away was: "The pigmen can play games longer than you can expect a return to free and fair markets."

Truth told, the article bored me and I reverted back to my point: "The pigmen can play games longer than you can expect a return to free and fair markets."  Jeremy G had no fuking point in my mind.

I want dividend paying stocks and I wanna have fun until the Titanic sinks.  Sure, it's all going down, man, but let's have fun until then.

See you in the boys room.  Let's find a few 5%+ dividend payers before then.

Only nerds care about what some economist might have said in the past and whether it was fairly attributed or not.  You and I are nerds for reading this.  LOL.

mantrid's picture

the market moves 19 times more than is justifi ed by the underlying engines (...)

demonstration of the behavioral dominating the rational and the “efficient” was first noticed by Robert Shiller


I disagree. it is demonstration of leverage courtesy of fiat money IMO. it just encourages these overamplified movements turning it into gambling.

Vic Vinegar's picture

I disagree.  It's the singer, not the song, bitches.

And since you cannot write for shit, your nonsense = nonsense not even worth trying to comprehend.  LOL

Buy physical.

machineh's picture

Equity volatility averaged 15% even during the 19th century gold standard.

Stock indexes (such as the S&P 500) don't incorporate leverage.

Fiat money has imposed an inflationary trend, and thus higher nominal returns. But this has little if any effect on volatility.

TwoShortPlanks's picture

SHHHHHHHHHHHHH!!!!! Everyone shut-up, Clarke and Dawe is about to start.


hettygreen's picture

Isn't it about time someone like Grantham stood up and said: "Listen people, this market is approaching a six sigma event in the spectrum of odd behavior. I don't understand it nor do I trust it any more. Flipping a coin, throwing a dart is as good a strategy as any and I'm sure you can do that as well as I can. Here's your money back. Have fun."

gnomon's picture

This information is exactly why no one with half a brain (and ruthlessly independent) should ever allow someone else to manage their money/assets.  Self-inflicted wounds are at least honest mistakes that one can learn from.  The other is being caught up in the Ponzi madness.

The only time a money manager can "help" you is when you don't need his help.