PROFITING FROM A
BUBBLE IN GROWTH
EVENT HIGHLIGHTS
STOCKS
Equity Dislocation
Jeremy Grantham, Simon Harris, Ben Inker, and Catherine LeGraw | March 25, 2021
OVERVIEW
Jeremy Grantham, Simon Harris, Ben Inker, and Catherine LeGraw sat down to provide
their perspective on how investors can profit from a growth bubble. A decade of low
rates and tepid growth has seen investors aggressively bid up the relative valuations
of growth stocks. This intensified even further in the Covid environment and investor
“
frenzy around fast-growing companies has catapulted them to “bubble” levels. Despite
value’s recent outperformance relative to growth, the current valuation spread remains
absurdly wide and provides one of the most exciting investment opportunities we have
The termites of doubt in
seen in decades. To exploit this growth bubble, GMO recently launched the GMO Equity
2000 attacked the stocks Dislocation Strategy, a long value/short growth portfolio designed to balance risks while
with the greatest level of profiting from this valuation gap closing to more normal levels.
optimism first. And they
If you are interested in accessing the replay, please contact us.
are doing almost eerily the
same now. I would say on
that ground, this bubble
is behaving itself very well KEY POINTS
and looks like we are in the ■ Jeremy’s current thinking on today’s “full-fledged, epic bubble”
closing weeks or months of
the game. JG: I have heard quite a bit the argument about healthy rotation. That brings
-Jeremy Grantham
the memory of 2000. We are rotating out of super overpriced tech into cheaper
stocks, so the market is getting cheaper. We are attacking first Tesla and the SPAC
index, down 25% each, they are the very center of the bubble. They embody
more euphoria by far than the average. People see that as healthy. But what
they are missing is this: this is not about value. Value has been forgotten long
ago. This is about enthusiasm, confidence, optimism. The termites of doubt in
2000 attacked the stocks with the greatest level of optimism first. And they
are doing almost eerily the same now. In September 2000, having kind of
finished with the slicing/dicing, they then transferred to the merely substantially
overpriced broad market and the entire remaining market – 70% – rolled over like
some giant iceberg and went down 50% over two years. Bubbles always peak
in times of maximum confidence. That is the very nature of how these bubbles
go – forget value, concentrate on overconfidence. Look for the market to attack
the highest confidence first, and work its way down to the broad market, which is
merely overconfident as opposed to supremely overconfident. I would say on that
ground, this bubble is behaving itself very well and looks like we are in the
closing weeks or months of the game.
GMO EVENT HIGHLIGHTS
Profiting from a Bubble in Growth Stocks | p2
JG: Today, it is clear to me this is the most dangerous package of overpriced
assets we have ever seen in the U.S. Jim Grant would say we have the most
overpriced fixed income market in the history of man. That combined with an
equity market that can easily lose $5 or 10 trillion dollars depending on the
magnitude of the break and is a contender for the highest priced market in
American history. Housing in February hit the same price as the top of the great
housing bubble of 2007. This time we are going for the trifecta: we have
suddenly a housing market that is racing upwards, the euphoric equity
market, and a ludicrously overpriced bond market. If they go together, they
will carry a write-down in perceived wealth that would have no precedent.
■ The GMO Equity Dislocation Strategy was specifically designed to profit from the
view that growth stocks are in a bubble.
CL: There are many ways you can play a growth bubble. You can short growth
stocks but that is a challenging way to compound wealth in the long term. You
can take a long position in value stocks, but if the market melts down, you can
potentially lose money even though your core thesis is correct. The absolute return
nature of our Strategy is critical because we are set up to make money if our
investment thesis is correct, independent of overall market performance. The
Strategy is 100% long the cheapest value stocks and 100% short the most expensive
growth stocks. Active security selection is a key feature of the Strategy: it reduces
unrewarded risks, makes a more sophisticated and nuanced valuation assessment
(some growth stocks actually deserve their valuations), and concentrates our
capital in the most misvalued (and therefore highest opportunity) names. We are
invested in this Strategy across our Asset Allocation portfolios but also have a
Limited Partnership vehicle for investors to access this Strategy directly.
GMO EQUITY DISLOCATION STRATEGY
Absolute return strategy designed to profit from a Growth bubble
Non-Directional 100% each side with ex-ante beta of approximately zero
Global Opportunity Set Portfolio includes U.S., EAFE, and EM names
Diversified Portfolio <1% max position size ~200-250 names per side
Meaningful Sector Tilts +/-10% industry and sector limits
Small Country Bets +/-3% country limits
Vehicle Limited Partnership
Strategy Inception October 31, 2020
These are internal guidelines only and are subject to change without notice.
■ Why launch the Strategy now? Value is extraordinarily cheap while many growth
companies are showing signs of speculative excess.
BI: This is not the first time we have launched a strategy in response to what
we have seen as a real dislocation in the equity markets. We did do that in
2000 when we saw the huge dislocation between value and growth stocks. The
current value opportunity is reminiscent to us of previous bubbles in global
markets. It doesn’t really matter how you slice value – region, sector, size – value is
GMO EVENT HIGHLIGHTS
Profiting from a Bubble in Growth Stocks | p3
extraordinarily cheap. A notable difference between today and this time a year ago
is that we are also seeing “the stupid,” or the grossly speculative kind of behavior
that had been the hallmark of prior bubbles. That doesn’t mean every growth stock
is grossly overvalued, but what we do see is a series of such companies trading at
extraordinary valuations on the back of pretty thin narratives. One of things about
speculative bubbles that gives us confidence – even if we are betting the other
side – is the fact that once a speculative bubble gets going, it is on limited
time. There is only so long these bubbles can continue because they are kind of a
naturally occurring Ponzi-like scheme. At some point when you stop being able to
get more and more money in, the ability to maintain these extraordinarily high
multiples just becomes impossible. We have seen a recovery in value since last
October, but it’s only a small down payment on what we think is potentially
available for investors. If value fully reverts to a historically normal discount,
that would get you about a 70% return of value relative to growth, that is the
scale of opportunity remaining for us to try to capture.
VALUE IS EXTREMELY CHEAP
Relative Valuation of Cheapest 50% of U.S.
1.4
Stock Market vs. Expensive Less Average
1.3
1.2
1.1
1.0
0.9
0.8
February 2021
0.7
4th Percentile
0.6
0.5
0.4
0.3
1981 1985 1989 1993 1997 2001 2005 2009 2013 2017
As of 2/28/21 | Source: GMO
Composite Valuation Measure is composed of price/sales, prices/gross profit, price/book, and price/
economic book. Value and Growth groups are both sliced over 12 months.
■ What is unique about our alpha engine? A few critical advantages over simpler
value metrics.
SH: Any model that seeks out the cheapest stocks in a simplistic way will always
gravitate to those with the most problems, e.g., the junkier, lower quality ones with
the poorest growth prospects. We are not using any of the traditional valuation
metrics to select securities for this portfolio. We at GMO have been shouting for
more than two decades about the problems of the accounting numbers. Put
simply, the accounting rules that we use today were put together for a different
era, when an asset was a tangible item like a factory or machine and certain
activities like buybacks weren’t allowed. It means that many accounting values
today are at best misleading, and at worst are totally meaningless. Our Price-
to-Fair-Value model (PFV) builds on years of work adjusting reported accounts to
better reflect economic reality. We have built growth expectations directly into our
model and are giving higher growth, less capital-intensive businesses a better
GMO EVENT HIGHLIGHTS
Profiting from a Bubble in Growth Stocks | p4
chance. We are giving everyone a chance, making them look comparable across
industries, countries which is much better for our valuation.
■ If you find yourself today with a significant growth bias that you do not want, our
Strategy is a very capital effective way to get rid of that.
We believe the GMO Equity Dislocation Strategy can enhance return and reduce
risk in a diversified investment program. It can serve in a wide array of roles,
including as an uncorrelated source of return in a traditional balanced portfolio, as
part of a diversified hedge fund allocation, in a liquid alternatives program, or as
a way to reduce the beta within a global equity allocation. The Strategy could also
be used as a positive expected return hedge for a growth style equity portfolio.
BI: One reason why a number of successful investors have been quick to put
money into a Strategy like this is they have somewhat inadvertently gained a very
substantial growth bias to their portfolio. This comes from the venture capital
they have, or their high conviction managers have tended to have a growth bias.
If you find yourself today with a significant growth bias that you don’t want,
our Strategy is a very capital effective way to get rid of that. In our multi-
asset portfolios, where we are prepared to bet strongly on areas where we see
tremendous opportunities, we have allocations to this as high as about 20%
and we are comfortable with that. We see this as a very high conviction bet, a once
in a decade opportunity. The size we are seeing people in their own portfolios is
really a combination of two things: how much are they prepared to have a value to
bias in their overall portfolio and what the rest of their portfolio looks like.
■ Value Reversion has Much Further to Run – Opportunity Remains Robust
Looking Forward
Our Strategy has experienced solid performance to date (20.9% total return gross
of fees and 20.2% net of fees as of March 30, 2021), and we believe this is only the
beginning of a major value reversion.
EQUITY DISLOCATION STRATEGY SINCE LAUNCH
25%
Equity Dislocation Beta to Value vs. Growth: 1.04 20.9%
Cumulative Performance
20% 20.2%
15%
12.8%
10%
5%
0%
-5%
Oct-20 Nov-20 Dec-20 Jan-21 Feb-21
Equity Dislocation (Gross of Fees) Equity Dislocation (Net of Fees)
ACWI Value less ACWI Growth
Data from 10/31/20 to 3/30/21
GMO EVENT HIGHLIGHTS
Profiting from a Bubble in Growth Stocks | p5
Jeremy Grantham
Mr. Grantham co-founded
RELATED STRATEGIES
GMO in 1977 and is a Please click on the links below to access strategies related to this event.
member of GMO’s Asset
Allocation team, serving ■ GMO Equity Dislocation Strategy
as the firm’s long-term
investment strategist. He is ■ GMO Benchmark Free Allocation Strategy
a member of the GMO Board of Directors and has
also served on the investment boards of several ■ GMO Alternative Asset Allocation Strategy
non-profit organizations. Prior to GMO’s founding, Mr.
Grantham was co-founder of Batterymarch Financial
Management in 1969 where he recommended
commercial indexing in 1971, one of several claims RELATED THOUGHT LEADERSHIP
to being first. He began his investment career as
Please click on the links below to access thought leadership related to this event.
an economist with Royal Dutch Shell. Mr. Grantham
earned his undergraduate degree from the University ■ Waiting for the Last Dance: The Hazards of Asset Allocation in a Late-stage Major Bubble
of Sheffield (U.K.) and an M.B.A. from Harvard
Business School. He is a member of the Academy of ■ GMO Quarterly Letter - 3Q 2020
Arts and Sciences, holds a CBE from the UK and is a
recipient of the Carnegie Medal for Philanthropy. ■ The Duration of Value and Growth
Simon Harris
Mr. Harris is the Head
of GMO’s Global Equity
team and is a partner of
the firm. In his decades
at GMO, Simon has
had extensive portfolio
management, quantitative research, and team
leadership experience including as the head of the
UK Equity team prior to its merger with Global Equity.
Previously, he also served as co-CEO of GMO UK
Ltd. Prior to joining GMO in 1989, he earned his BSc
in Mathematics from The City University (London).
Mr. Harris is a Fellow of The Chartered Institute for
Securities & Investment.
Ben Inker
Mr. Inker is head of GMO’s
Asset Allocation team and a
member of the GMO Board
of Directors. He joined
GMO in 1992 following Disclaimer
the completion of his B.A. Performance data quoted represents past performance and is not predictive of future performance. Gross returns
in Economics from Yale University. In his years at are presented gross of management fees and any incentive fees if applicable. Gross returns include transaction
GMO, Mr. Inker has served as an analyst for the costs, commissions, withholding taxes on foreign income and capital gains and include the reinvestment of dividends
Quantitative Equity and Asset Allocation teams, and other income, as applicable. If management fees were deducted performance would be lower. Net returns
as a portfolio manager of several equity and asset are presented after the deduction of a model advisory fee and a model incentive fee if applicable. Net returns
allocation portfolios, as co-head of International include transaction costs, commissions and withholding taxes on foreign income and capital gains and include the
Quantitative Equities, and as CIO of Quantitative reinvestment of dividends and other income, as applicable. Fees paid by accounts within the composite may be higher
Developed Equities. He is a CFA charterholder. or lower than the model fees used. A Global Investment Performance Standards (GIPS®) compliant presentation is
available by clicking the GIPS® Compliant Presentation link on GMO’s website. GIPS® is a registered trademark owned
Catherine LeGraw by CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or
Ms. LeGraw is a member quality of the content contained herein.
of GMO’s Asset Allocation
team. Prior to joining GMO The views expressed are through the period ending March 25, 2021, and are subject to change at any time based on
in 2013, she worked as market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should
a director at BlackRock. not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not
Previously, Ms. LeGraw was intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
an analyst at Bear, Stearns & Co. She received her
B.A. and her B.S. in Economics from the University Copyright © 2021 by GMO LLC.
of Pennsylvania. She is a CFA charterholder. All rights reserved.
