Jeremy Grantham's long career exploiting irrational exuberance for investment gain has gone into extra innings with his current focus on venture capital investments in companies such as QuantumScape and Snap.
Grantham — a co-founder in 1977 of Boston-based quantitative equity shop Grantham, Mayo Van Otterloo —noted that his emergence as a "specialist in bubbles" goes way back, to the U.S. stock market's more than 20% "Black Monday" plunge on Oct. 19, 1987.
In the wake of that "interesting aberration … we decided, or certainly I decided, that we shouldn't miss trying to capitalize on odd behavior," said Grantham.
Building its business on estimates of the long-term value of asset classes, GMO looked for opportunities to take advantage of a market predilection for going "periodically crazy" that's pretty much hardwired into humans, Grantham maintains.
"We had a few 100,000 years to work out what it was going to be like and it's pretty steady now," he said. "We are given to periods of euphoria" and much shorter periods of "blind panic," he said.
"My estimate is something like 85% of the time the market is approximately reasonable, approximately efficient. Close enough. And then 15% of the time, it's not. That divides something like 11% or 12% crazy optimism and 3% or 4% crazy pessimism. And that seems to be the model," Grantham said.
Until recently, however, the gains Grantham's GMO garnered by sticking to its valuation discipline when the broader market was pushing earnings multiples to dizzying heights only emerged after the firm first endured considerable pain.
An early test: Japan's stock market bubble of the late 1980s, which saw GMO slash its exposure to Tokyo stocks to zero a full two years ahead of the 1989 market peak that lifted Japan's weight in MSCI's Europe, Africa, Far East benchmark index to about 60%.
"We had some fairly dreadful underperformance but we still beat the S&P, so we were forgiven by those early adopters of foreign equity," Grantham said.
And then of course "it all blew up and we made it all back in profit," he said. Japan's high flying stock market fell off a cliff from the start of 1990, days after the Bank of Japan raised rates. GMO, with zero exposure to a Japanese market accounting for more than half of the EAFE index, more than made up for the performance pain it had endured owning little or nothing of that market during the bull run of the second half of the 1980s.
That experience had only a modest effect on GMO's approach to the next bubble – the internet craze. At the end of that period, the firm would once again come under pressure for making the right moves too soon.
The Japanese experience "gave us a passing interest in trying to hold our fire, a bit," Grantham said. "We did not take a position" against the internet bubble until the price-earnings ratio on the S&P was higher than it had ever been before – reaching a record 21 and a half times earnings around January 1998.
"When it did that, we started to move distinctly against the U.S. market and the U.S. market punished us by going from (a price-earnings multiple of) 21 to 35 – which is not an insignificant record breaking – (giving) us a horrific two and a half years of underperformance," Grantham said.
"Then it all blew up, and in asset allocation accounts we actually made money in 2000, 2001 and 2002. So, we had made nice money by the time the S&P was minus 50, which is pretty cool, you have to admit," Grantham said. And it was that performance that brought in a lot of assets to GMO between 2003 and 2006, he said.
Opportunities to take advantage of the occasional tulip bulb continue to surface every now and then. The "2021 growth bubble with the meme stocks" suggests that the market's ability to get carried away is "every bit as alive and well today as it ever was," Grantham said.
Grantham, meanwhile, has continued to reap benefits from market excess over the latest stage of his career, which saw him turn over management of GMO to the firm's leadership team to focus increasingly over the past decade on venture capital investments by his $1.5 billion Grantham Foundation for the Protection of the Environment.
The most striking example there, Grantham said, and perhaps the biggest bubble of all time – "much bigger than anything you can find in 1929" – was the $12.5 million venture capital investment he made roughly a decade ago in QuantumScape, a private research lab trying to develop the perfect lithium ion battery for electric vehicles, with half the weight and half the volume of legacy batteries.
It was, at the time, the biggest investment the foundation had ever made, he said.
"The next part of the story is that I was publicly saying I thought SPACs — special purpose acquisition companies — were a disgrace that should have been banned … a complete rip-off," Grantham said. "And then of course QuantumScape comes to the market as a SPAC" at $10 a share," he said, four times what he had paid for it just seven or eight years before.
"And then in two months, by December 2020, before anyone has even thought about bubbles except me, it goes to $131 and it's worth more than General Motors … the biggest bubble ever," he said.
"So, for a second, my $12.5 million because worth $625 million," he said. Sadly, Grantham noted, under the terms of the SPAC deal, he was locked in for six months – a period which saw the air start to gush out of growth stocks that had no earnings. At the close of that window, QuantumScape's stock was down to $25 – "still 10 times my money," even if a "brutal reduction from $625 million," he said.
The foundation sold over 80% of its holding at that point, locking in its 10 times gain – money that paid for some of its other early climate change investments, Grantham said. The foundation still has a modest stake in QuantumScape, which remains one of the frontrunners in the competition to develop batteries for electric vehicles, he added.
Another company that delivered enormous gains for Grantham's foundation, through a commitment to a venture capital fund, was Snap, producer of the SnapChat app. The $55,000 of the foundation's commitment the fund invested in Snap "made us 220 times our money," or $12 million, Grantham said.
Opportunities to net such attractive gains may prove more limited for the near term, as venture capital looks to be on "the downside of a bubble here," said Grantham, adding "it's going to take it on the chin for a while."
