Invest Like the Best with Patrick O'Shaughnessy - Jeremy Grantham - A Historic Market Bubble – [Invest Like the Best, EP.214]

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Starting point is 00:01:32 their website, www.mptomco.org. Some of MIT's best partnerships have been initiated during challenging market environments. Matimco looks forward to hearing from you. Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfield guide.com. Patrick O'Shaughnessy is the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not

Starting point is 00:02:15 reflect the opinion of O'Shaunacy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. My guest today is Jeremy Grant them. Jeremy is the long-term investment strategist and co-founder at GMO. Jeremy has an encyclopedic knowledge of the history of markets, which made it such a pleasure to have him back on the show. In this conversation, we discussed the three key signs of a bubble, why Jeremy believes we're in a bubble right now, and how it's being led by retail rather than institutional investors. We close with the important role that demographics,

Starting point is 00:02:53 and productivity will play over the next few decades across the world. Please enjoy my conversation with Jeremy Grantham. So, Jeremy, I've been excited to do this with you again. The last time we spoke in early July of last year, we were still in the throes of the early stages of the pandemic and the market was about 35% below where it sits today. Not a whole ton has improved about the economy. The market has done quite well. And the topic of our conversation today, I think, is going to be your view on the state

Starting point is 00:03:24 of this equity market and its potential to be in the bubble category with some of the great bubbles that you've studied as a market historian. So to begin, I would just love to hear your broad market perspective through what lenses you're viewing this market and what history might teach us. Incidentally, I've been making a hobby of collecting the many measures of speculation and overpricing. The simplest low-tech way of doing that has just been to take screenshots. So I have an army of little measures. They're pretty clear to me. I think about 80% of the value measures have this one higher than 2000, which was the champion, way over 1929.

Starting point is 00:04:13 A 2000 tech bubble was a real hero. Trailing 12-month earnings was 35 times earnings. And in 1929, it had peaked at 21 and it never got back to 21 until, the run-up to 2000. And when you compare that 2000 peak to today, and you change the value approaches a little bit here and a little bit there, you find about 80% of them have today higher, and about 20% of them still below 2000. So I conclude on the sheer weight of numbers, this is more impressive even than 2000 on value. And then, of course, in terms of timing,

Starting point is 00:04:57 I've always thought that other things were more important than value. The thing you have to bear in mind if you're going to use value as a timing mechanism is that in Japan it went to 65 times. It had never sold over 25 times in the Japanese cycle that peaked in 89-90 until it did. And then it went to 65. I like to say that that's the nightmare

Starting point is 00:05:18 from which value managers wake up at 3 a.m. sweating in fear. If you look at the straightforward vanilla chilepea is higher in 2000. If you normalize for profit margins, which I prefer, because I believe this chunk of time since about 2000 is historically abnormal. If you take it back to long-term normal profit margins, this is more impressive than 2000. We were talking about timing and values are very poor. timing mechanism. What is much better, the two factors, acceleration and crazy behavior. When the

Starting point is 00:05:54 stock price starts to move up at two or three times the normal speed, which it did in 99, which it did in 1928, 29, and did it in Japan for a couple of years at the end, that's a pretty good sign that a long, long bull market is coming to its end. Perhaps the single best one, although hard to put your fingers on precisely is crazy behavior. Because each cycle, the craziness is manifest in a different way. Obviously, there was no Bitcoin equivalent in 1929. So each cycle is different. But the common most easily noticed factor is newsworthiness.

Starting point is 00:06:35 When the financial page headlines migrate to the front page, you know you're getting very warm. when the evening news mentions the market or some crazy behavior of GameStop Tesla. My favorite example from 2000 was lunchtime greasy spoons that we went to in downtown Boston. And they all had quite a few television sets and they were all playing replays of the Celtics and the pets. For a few months there in late 99, early 2000, they'd close the sports. swans and transfer them to CNBC and we'd have talking heads talking about the latest pet.coms. That was terrific. That gave you just a month or two to plan accordingly, plan evasive action. And I would say we have passed the acceleration test brilliantly.

Starting point is 00:07:31 And I would say we have passed the crazy behavior test brilliantly. And a lot of the craziest behavior actually taken place this year in January 5th. February, the number of new issues and SPACs have gone through the roof. The total issuance as a percentage of GDP has gone way up. This is now modestly above 2000, like many of the other indicators. So you mentioned some of these in your letter you call these touchy-feely characteristics of a bubble that aren't necessarily quantifiable. They're always different. I'd love to just ask about a few of them and hear your perspective. And you mentioned SPACs there. that's a great place to begin. Again, as a market historian, how do you approach something like

Starting point is 00:08:18 this proliferation of SPAC issuance? I can't remember the number. It's 130 billion of capacity or something that's been raised in SPACs that are all on a clock, you know, a two-year clock, typically. How do you approach something like this? What are your thoughts on the rise of SPACs in this cycle? As an instrument, SPACs are terribly speculative, undesirable, unnecessary instruments. a license to rip investors off. The first rip-off is for the organizer. Organizer uses name recognition or reputation or whatever, scoots around the countryside, looking for a deal for six months, pays a few million dollars for time, energy, and organization, and then in return takes 20% of the money you give him for himself or herself. Quite remarkable. Secondly, the professional

Starting point is 00:09:10 hedge fund types sign up immediately, and then when it comes time to actually put up their money, when the deal is booked, half of them or so do not. They get a decent return in the few months while they're waiting to see. They are given traditionally a few warrants as profit. Some of them are useless, some of them are great, for nothing. And then they take their money and re-sign up for the next SPAC. The burden is borne by the other half who put up their money under normal conditions get a sub-market return. And that has been established by academics for seven years of SPACs. They did dismally. Now, of course, in the late stages of a bubble, everybody makes money and speculation. And these are speculations, so you'll make some money despite the rip-off structure. They are

Starting point is 00:10:02 hardly regulated by the authorities. So they're not the same level of protection. Basically, they shouldn't be allowed. It's a testimonial to the sloppiness and slow-moving nature of the SEC that they haven't banned these things long ago. Is there a version of them that you think could be virtuous, especially if the economics were better reflective of who is taking the risk and in what amount? I guess a different way of asking the question is there's been interesting discussion on the IPO process and aspects of it that may be suboptimal for the companies going public. Do you have any thoughts there on alternatives to that or whether it's a problem at all? Yeah, the traditional IPO is sadly deficient also.

Starting point is 00:10:47 That's a pretty lame excuse for having specs, but they should improve the IPO structure. A direct listing made a little easier. It would be entirely doable, perfectly straightforward. But the traditional IPO, as we all know, suffered from the fact that there was a big financial incentive for the investment banks running the deal to bring it to market lower than the expected value. So they would have a big jump on the open. They would then market this hot deal to their favorite large fidelities who would have an

Starting point is 00:11:27 unspoken agreement to reciprocate by doing. doing a multiple of that potential gain in commission dollars. That worked for years. It was unethical, but legal. It guaranteed that the people who bought on the Open did relatively badly for a few years. The people who were given the hot stocks had a license to steal and would sell at the open or within the first day or two. The HAVs did well and the regular investors were screwed.

Starting point is 00:12:00 And that's typical IPO. And you have to change that so that you put the incentives to get closer to market. And the direct listing, a modified direct listing, would be much better. But the SPACs don't seem to have addressed that issue of ripping off the average investor. They've actually made it worse. And of course, you know the irony that my biggest investment ever was in quantum scape seven years ago, a brilliant solid state battery research enterprise. Seven years ago, it was three years old already.

Starting point is 00:12:37 We bought in five times up in price. And it had a long list of very, very difficult physics problems, engineering problems, chemistry problems. And it does appear that almost all of those have been taken care of. But to my surprise, they came with a SPAC deal. with still four years left to run before they actually have their battery running down their production line. Four years is a pretty long time. Anyway, it came at 10 like they all do, and at 10.

Starting point is 00:13:09 It was the same price we had been informally carrying it on our books, a multiple of four. Four times our investment over seven years, very good, but not utterly sensational. And then it went from 10 to 130. At 130, it was worth more than General Motors. It was worth more than Panasonic, if you want to talk batteries. That, I think, we can agree, is amazing. In fact, it compares pretty well in scale with anything around in 1929 or 2000, for that matter. To have a company that has no earnings or sales for four years, brilliant or not,

Starting point is 00:13:45 and to look out that far into the future and make it worth more than General Motors, that's a pretty good demonstration of something, I would say. And it was wonderfully ironical because by then I'd already been sounding off about the undesirableness of SPACs. And there I am with far and away for a second or two of the biggest investment. We're not allowed to sell it, of course, until May the first about. That's another delicious irony because here I am also predicting that we'll be rather lucky to have this bubble last until May the first. I can't sell it. At 130 when you paid two and a half.

Starting point is 00:14:23 That's 53 times our investment, and it was the biggest investment we ever made. So it wasn't even a small fortune. It was a large fortune. I think the story is wonderfully representative of a lot of individual episodes like this in markets today, where it seems as though the horizon over which the market is willing to discount outcomes is forever. And the color of their glasses is very rosy in predicting the potential of these outcomes. And I want to make sure that we go through kind of each of the three dimensions, if you will, of bubbles that you laid out at the beginning, valuation, acceleration, and speculative or crazy behavior. And I want to ask maybe the obvious question, which is about what it's like for you as a historian to watch this episode with

Starting point is 00:15:09 GameStop and other stocks that were pretty intense short squeezes and driven by retail behavior and record volumes. As you were watching that, what were you thinking and what were you feeling? What did it make you remember or consider in history? I have to confess that I find it all exhilarating. I'm only concerned somewhat for the relatively new investors who get drawn into these things as they do and then find out the hard way. I'm very tempted to tell my story because I'm sympathetic and I don't know if I told you this story last time, but 1968, 69, when I was in the pump and dump business without thinking of it in those terms, gotten into the mutual fund business, and I got in because my friends were having much more

Starting point is 00:15:55 fun than my classmates in any other industry. One of the reasons they were having fun, 1968, 69 was a lovely little bubble in tiny stocks. The bubbles were not tiny. The stocks were tiny, but the movements were sensational. And after I'd gone to Boston, joined this mutual fund group, and we'd have lunch together with all the guys at Fidelity and so on, fellow classmates, and compare notes and talk about the stock of the week. And one week, it was American Raceways, which was going to introduce Formula One Grand Prix racing, which had not taken off in the US,

Starting point is 00:16:32 but was hot as hell in Europe and South America. Speed and power and danger and noise, death. It sounded very American to me. We bought one track, the firm that had one race, and everyone showed up. It turned out for novelty reasons, but what did we know? and it was gloriously profitable and allowed us to extrapolate into 14 tracks around the countryside times three or four races a year times bonanza we had the sterling master world champion

Starting point is 00:17:02 former world champion on the board i bought 300 shares at seven went on my summer vacation with my wife to england and germany when we came back three weeks later it was 21 i did what every good value manager would do, and I sold everything else I had and tripled up. 900 shares at 21, involving considerable debt, by the way. But by Christmas, it was 100. So that's what we went through. And there were hundreds of those tiny little stocks. Almost all of them did what American Raceways did, and that is went to zero. But very cleverly, I jumped out a third of the way down and got into another. brilliant idea to trade options about 20 years ahead of its time. And then by the time I jumped out of

Starting point is 00:17:52 that and the third one, I was back to the $3,000 that I'd had two years earlier. At the peak, I'd had enough to buy a house without a mortgage. I learned a lesson. It was absolutely thrilling the whole thing. That was one of the most thrilling years. We went from nothing to having quite a lot of money and then losing it all. It was extremely exciting. So I sympathize completely with these people out there enjoying this bubble. But they've always ended very badly and no doubt this one will. Do you think that investor education is possible? The repetition of the same things over and over again, the GameStop today is your American Raceways back then. What do you think can be done about this? Nothing. The answer just no. You can do nothing. By the way, this is not primarily an institutional bubble.

Starting point is 00:18:41 This is an individual bubble. These are very rare. We haven't had one of these, other than my mind. one I just described in 68, 69. 1929 was kind of institutions and individuals. They were rich individuals in those days. The ordinary individuals didn't play the market. But 2000, which is the real McCoy bubble, it's basically an institutional bubble, where you had pension funds, foundations, endowments, and so on, where the majority of almost every committee we dealt with were an institutional investment.

Starting point is 00:19:12 They bought into the golden new era. They all believed Greenspan that the internet was going to drive away the dark clouds of ignorance and produce permanently higher productivity for decades to come. And that was a bit heartbreaking for me. I was completely shocked that they were so easily swept up in the bubbly psychology. But they were. This time, I think not so much, but they're going along for the ride. But the individuals are absolutely crazy.

Starting point is 00:19:40 and they have expanded their share of the market trading, and they have really entered into the market with great enthusiasm for the first time in decades. Do you think that the lack of the institutional role in this one tells us anything about what to expect in terms of how this plays out? I would think that one of the things looking at this market is, I'm also an institutional money manager, so I'm probably talking to some of the same people.

Starting point is 00:20:06 It seems as though everyone is, maybe their guards down a little, but they're still considering things like the valuation ratios that you mentioned at the beginning. These tools are proliferated. The top stocks in the market, the Googles of the world, don't necessarily have those same characteristics that the top stocks did in 2000 when it was more institutional. How do you think about that, the fact that this one is more retail and less institutional and whether that will impact the outcome? I'm having enough trouble with the first derivative effect. When you start getting down to second and third derivatives, you really have to say, it's a very uncertain world. And every bubble is different. They have different players.

Starting point is 00:20:42 They have different origination stories. They're nearly always very strong economies, very strong profits, extrapolated forever. And you can get your brain around that if you extrapolate handsome profits and unusual growth in GDP and profits. And you extrapolate that forever. Of course, they're worth many multiples of asset value. Of course, it never happens, those abnormal high profit margins and abnormal growth windows always closed. But you can see how people could believe it. This one, of course, is unique in that we had a fairly damaged economy from COVID, a very long-in-the-tooth economy before that. So you'd had this 11-year economic growth ending up with full employment and not too much spare anything. And then you give it a real kick. So it's quite unique. And you

Starting point is 00:21:36 And you wouldn't want to extrapolate the damage at infinitum. So what you're doing here is you're leaning on the second component, which is every bubble in addition to having hitherto a nearly perfect economy, has had a very friendly Federal Reserve situation, favorable money supply, favorable interest rates by the standards of the time. This time, since the economy was quite damaged, you had to rely 100% on the future behavior. of the Federal Reserve and the federal government.

Starting point is 00:22:10 That makes this one unique. And of course, they can't be sustained forever any more than profit margins and abnormal growth can be sustained forever. Sooner or later, something goes bump in the night. Reminds me of Hyman Minsky's point that stability is unstable, which so perfectly described the financial crash, that if you give me stability, I'll take more debt,

Starting point is 00:22:33 I'll take more risk, I'll use up my stability units, Eventually, when something goes bump, we're completely stretched out, having used up all our stability units, and we'll have a sickening crush. And he said, for that reason, periodic financial crises are, quote, are well-nigh inevitable, unquote. You can apply that principle to the stock market and the Fed. If you give me low rates and plentiful money, I'll borrow and invest and borrow and invest and borrow and invest and use up all those extra. units and then one day something will go bump and I will be exposed as having extended to the limit and the consequences will. We might be approaching a rather similar Minsky moment in the not too distant future.

Starting point is 00:23:22 You know, the market tops out when, in a sense, the last bull has put his last money in. I know that's an oversimplification. Everyone is getting a little richer all the time. Some people are. And so there's always extra money can push the stock price. But in terms of a general cycle, there is a moment of maximum enthusiasm. And the next day, there's plenty of enthusiasm, but less than the previous day. And so the buying pressure is released a little bit, like famous water jets under the ping pong balls.

Starting point is 00:23:55 You know, you turn the faucet down a little bit, and the ball is still way up in the air, but it's just dropped a couple of inches. It's that process of slowly lowering the pressure and the overpriced ping pong ball, if you will, slowly descends until it hits the proper level. You remind me of two other interesting features often shared in common of great historical bubbles, which is the general attitude towards market bears and also the behavior of clients, institutional especially. Can you say a bit about what you've seen historically and the attitude towards market bears in bubbles, how it changes, and whether or not we're seeing rhymes of that

Starting point is 00:24:38 attitude today? Yeah. I think rapidly rising hostility to bears is a very good, very late signal that the bubble is way advanced. Because this is an individual game, you expect to see the most egregious hostility from individuals. I did an interview with Bloomberg. called front row. And I gave my fairly bland opinion about Bitcoin, I would have thought, just that it was faith-based. There's nothing new or shocking about that. But armies, armies of individual fanatics descended on the comments, there was no insult that was not good enough for me, not just senility and old age and complete ignorance about Bitcoin. They'd sent me off to study Bitcoin, another level of detail, I will say that.

Starting point is 00:25:35 It hasn't caused me to change my mind, but it did cause me quite a few hours of extra work. But I got three insults about my big ears, which I hadn't had since I was seven years old. I was a wonderful reading. I could only take about 100 of them, and I thought from my ego, I'd better limp away. But in 2000, an institutional bubble, the people who were upset were institutions. Quite a few of them talked as if it was deliberate. as if we were deliberately almost robbing them of money. It was somehow a malevolent intent to have them lagged the market.

Starting point is 00:26:11 We were up 16% and the market was up 24 and Fred, there's always a Fred was up 52. And they hated us. And the classic one, which actually made it into a business school case, it was so good. We went to a local account for a breakfast meeting. We had the usual committee, and we were all hanging around eating cookies and getting the coffee early in the morning. And the boss of the investment committee says, come along. Let's cut the crap and let's get on with this. Sit down and Jeremy, explain why things are going so badly.

Starting point is 00:26:49 And for heaven's sake, don't give me any more of this nonsense about regression to the meat. So there I was. staring at my notepad, kind of flushed, looking down. And little bubbles were going through my head, get up and walk out, surrender, apologize. And finally, I said, I'm sorry, I can't get that from here. There is no way I can both answer your question and avoid talking about regression to the mean, because that is what rules everything.

Starting point is 00:27:24 So what the world is all about regressing around long-term normal. And of course, we did. We did regress once again back in 2000. The NASDAQ went down 82%. Just to rub it in, the S&P went down 50. I'm very proud to say that in the economist, we were quoted as saying we thought that NASDAQ was worth minus 75%, and the S&P was worth minus 50.

Starting point is 00:27:52 And we got that one right. we did hold out the possibility that it would overcorrect. The S&P did not overcorrect. That was the first time in history, by the way. It went down from magnificently overpriced. It hit trend, the old-fashioned trend that had been going on for 75 years and bounced. Every other bubble breaking like the nifty 50 of 1965 and 1929, they went way down below trend in the 1965, which really broke in 1974. It didn't get back until 80s. And of course, 1929 didn't get back until the early to mid-50s. And that was typical. But because of the Fed, throwing the kitchen sink at everything, the S&P minus 50 had enough buying support to stop a trend and bounce back. And had to wait a few years until the housing bust, much more dangerous than a stock market bust, incidentally.

Starting point is 00:28:44 And it did finally go through the trend for the first time then in decades. What do you think of the rate? change of I'll call it economic dynamism in the United States and globally. Because you mentioned this idea that typically at the end of these bubbles, you've got fantastic economic conditions, that the markets are extrapolating too far into the future. And then we get reversion to the mean. In this case, you mentioned already that it's peculiar and that the economy by any measure is, I guess, growing faster now, but is not good. A lot of people unemployed and the pandemic has continue to wreak havoc on economies around the world. So we're in a very different economic situation

Starting point is 00:29:22 today. And therefore, we're faced with interesting things like incredible fiscal stimulus, the likes of which we've probably never seen, the potential for there to be this pent-up demand bounce back that would be a better economy. How do you think about just the long-term trend of our dynamism has been going the right or wrong direction? And what have recent events done to change your view on the nature of the economy? In the intermediate term, I think there's a real hope that an emphasis on infrastructure is just the right thing. And like Summers, I do worry that writing big checks will use up too much of the resource going to individuals

Starting point is 00:29:59 and will then undercut the ability to spend much money on infrastructure. Infrastructure and particularly green infrastructure, have a very high return. If you can borrow at the government level at a negligible real cost in interest rate, and then you can invest it in storm windows and insulating homes in the north of the United States. In training, retraining workers in R&D, on average, has a very, very handsome return

Starting point is 00:30:29 if you invested in green energy and improving farming. What is not to like about spending long-term money at decent returns, which you're borrowing at negligible rates? That's a pretty handsome return for everybody. So I would hate for that to be undercut. They talk of a good game, and I was really counting on it. But if they, by writing huge checks, so raffle the political cage, and perhaps short-term overstimulate various parts of the consumer economy.

Starting point is 00:31:02 And, of course, the stock market, as I believe the first one did to some considerable degree. I think that's a problem. but if they really focus on infrastructure and kind of grind away, I think that could kick up the growth rate of the economy for perhaps a decade or two, and that would be very handy. Longer term, what I worry about is that before COVID arrived, it was clear that we were hitting a steady reduction in growth rate, which had not been fully appreciated by the authorities.

Starting point is 00:31:35 And the main reason was the population bust. When I came to America in the 60s, we were having years where you'd have as much as one and a half percent increase in labor force, natural growth. And now we're down to 0.2. And within 10 years, we'll be about minus 0.2. Europe is already flat to down. Japan has been down for over 20 years. And South Korea will be down momentarily. And China, incredibly important, will be having declines in the 20-year-olds coming. into the workforce pretty soon. So all over the world, you're having declining growth rates of workforce workers. And then the second part of growth is productivity. And if you look at the data, whether it's the US or international in the developed world in particular, it's clear that for 50, 60 years, the productivity level has been wending its way down from in the 60s, which was pretty much

Starting point is 00:32:35 a peak almost 3% a year. And today, somewhere in the 1 to 1.5%. So if you have 1 to 1.5% productivity and minus 0.2 growth rate in the workforce, and if you keep up the tendency for everybody to work a little bit less, about 0.2 in the US, we like working here. But still, 0.2 is a real drag. You're going to struggle to do much more than 1%. And the authorities, particularly the Fed, have been very slow to get that point. I wrote a paper called seven lean years, 10 years ago, and followed it up a couple of times, pointing out that our long-term trend was really more like one and a half. And the IMF, the World Bank and the Fed and the OECD were all using three.

Starting point is 00:33:24 And now they're down to two is about the going rate, but they're going to come down lower as time goes by. So we are facing a slow decline, probably. activity is always hard to call, but it has had some up legs for a few years. It's pretty steady downtrend. And the baby bust is a done deal. And the baby bust is going to be worse than anybody thinks. It's going to change the world. Basically, we had a very strange era for the last 20, 30 years, where 500 million workers in China went from being more or less totally useless on the farm, redundant to part of a very efficient, hardworking industrial system in the cities. $500 million compressed into 30 years.

Starting point is 00:34:09 And then you had thrown in the middle of that a couple of hundred million Eastern Europeans who hadn't really part of the capitalist system who had been pretending to work while their employees pretended to pay them was the communist joke. So you had $700 million. And that put enormous pressure on workers' pay rates, made it easy for brands to make more money, and the unions became very weak, and so on, and inequality, if you will, prospered. And that's over.

Starting point is 00:34:37 China has gone from some of the fastest growth rates in young workers because of immigration from the countryside to a bust. Fertility rate. 2.1 is replacement. Their fertility rate last year was politically embarrassing. It was about 1.6. And the early report, not all the provinces are in yet, is that COVID knocked it down by 15%. So they'll be below 1.4.

Starting point is 00:35:01 And the COVID numbers will be so shocking that you'll be reading about this all over the place in the next few months. South Korea is the only one efficient enough to get their numbers signed, sealed and delivered. And they, coincidentally, had the lowest fatality rate ever recorded in normal times, which was 1.0, which means every 35 years, every. generation, you halve your number of babies. Anyway, under COVID, they went to 0.85, which is outside of the bubonic plague, the lowest fertility rate in the history of math. The U.S. is 1.7 pre-COVID. The U.K. is 1.7. Italy's 1.4, Hungary is 1.3. They're finding it very, very hard to encourage people to have

Starting point is 00:35:43 more babies when they don't want to, and they don't want to. It's not just choice, but it's postponement. Women quite understandably want to have their babies later. and get their career going and so on, but they're postponing into lower fertility years. In the end, they have two children instead of three or one instead of two. And then into this morass, there is coming toxicity, endocrine disruption, has been working its way since World War II, but didn't matter because we were so over-engineered. We could stand the shock, and the sperm count in the developed world is down to a third of what it was, and it didn't really matter until about a dozen years ago.

Starting point is 00:36:20 And suddenly, starting then, the number of young couples having trouble has started to go through the roof. And it's about 15% now. But it's growing at almost 2% a year. You're going to come back. And that is the impotility problem is growing at 2% a year. So you're going to come back in 20 years. And the median couple, young couple, is going to have some problem and need advice and help. This is dramatic.

Starting point is 00:36:45 So you're choosing to have fewer. You're postponing. And then when you postpone, you're finding that toxicity is leveraging that postponement because toxicity doesn't have much effect on a 16-year-old Nigerian just to pick on them because they have very large families, five children. If it takes an extra year or two to get the five, that's okay. But if you're 36-year-old Parisian and you've postponed and then you find you're having endocrine disruption problems and your man, that's going to make it.

Starting point is 00:37:17 an important difference. So we're going to have to get used to perhaps a baby bust way off the scale of anything we've ever talked about. And that's going to have a powerful effect on a lot of things. It's going to increase the significance of the workers. It's going to mean there's a shortage of workers. It's going to mean that there's pressure on inflation to get those workers, that inequality will go into reverse, as it did for 100 years after the bubonic plague, incidentally, for the same reason. It's also going to mean that the population pyramid is inverting an upside down pyramid, and it's happening at a speed unlike anything we've ever seen. So suddenly you will find the percentage of people over 65 today is five times what it was in 1960 in China, five times the ratio.

Starting point is 00:38:09 So you have a shortage of workers. And the one thing about old folk is we take an awful lot of resources if you include labor as a resource. We need to be looked after. We need medical treatment. So you move a lot of your resources to looking after them and that we are totally unproductive as a group. And then you have even fewer workers in the business of being productive, making the goods that we really, really need. And the price pressure becomes even more interesting, shall we say. It will move us back to a world that feels a lot more like the 20th century, where workers in unions have more influence, where you have to do CAPEX to keep up the productivity

Starting point is 00:38:50 of your diminished supply of workers, and where you actually welcome the labor-saving devices instead of fearing them, as we have unnecessarily, I think, but we've always had a great fear of them for the last 50 years. And now, as in Japan, Japan has done brilliantly. Japan has had more productivity per man hour than the U.S. since their crisis. And they have five times the number of robots, worker that we have.

Starting point is 00:39:20 And South Korea has a lot, too. You're going to have to do that. You're going to have to improve your social contract, too. You have to do a lot of tough things. You have to look after these old folk. You have to be efficient. You have to keep your society moving as a stable enterprise. So what I worry about is as we come out of a bust in overpriced assets,

Starting point is 00:39:44 that has a negative wealth effect like it always does, piles on the agony when you least need it like it did in 2009, 10, 11. We're going to have this headwind of slowing global growth. That's going to change a lot of things. So I think the inflation will tend to drift back towards 20th century levels where it's moderate and you have to be a little more careful, that real interest rates will drift back to where they were, where you get a respectable return. And of pricing of assets will tend to drift down. Let me just point out that overpriced assets are the worst things that can happen to young people and to society over the long run. That if you take a farm or a forest, for example, which I'm reasonably familiar, and you look at the yield

Starting point is 00:40:31 on a forest or a farm, it used to be 6%. It came down to 3% in this 30-year repricing. At 6%, you're doubling every 12 years. And at 3% you're doubling your society's wealth every 24 years. In 48 years, you're down to a quarter. In 96 years, you're down to a 16 of the wealth that you would have had in the old 20th century world, where you had a handsome return. The same on the stocks. We used to consider four and a half percent yield normal. Now you're lucky if you've got two. So we're compounding the wealth of society much more slowly.

Starting point is 00:41:06 And if you're not in the game, just think how terrible it is. You pay twice as much for a house. you simply can't afford it. The mortgage is great, but you can't afford it. And the stock market is twice the price it used to be. And every damn asset, the farm up the road, if you're in the countryside, is twice the price it used to be. What a disadvantage for the well-being of society it is. And how quickly, it only takes 12 years to reveal how much better it would have been to have had cheap assets for the higher yield compounding away. And yet we think it's glorious. It's glorious for the people who own a lot of assets for old fogies who are selling their assets. That's terrific. But for everybody else,

Starting point is 00:41:45 and particularly the young, it's a pain in the ass. I'd love to turn from the population part of the growth equation to the productivity side a little bit and ask a question at the risk of having someone make fun of your ears again. One of the interesting arguments, I would say, I'm no religious Bitcoin follower, one of the interesting arguments you see thrown about is to study the period of history when we had a hard money standard, a gold, standard, the productivity growth and the technology advancements that happened under that standard, people often point to the late 1800s through the end of the gold standard as a particularly productive time. As you did that deeper dive on something like Bitcoin, whose strongest

Starting point is 00:42:26 proponents, of course, hopes that it does usher in some sort of hard money standard again and changes time preferences and encourages more innovation. What's your take on that concept? If you'll allow me to start at the kind of meta level, I am not as impressed with the significance of the financial world as apparently almost everyone else on the planet is. I think debt, for example, is overwhelmingly merely double entry bookkeeping. As I like to say, why would I worry that half the Japanese owe the other half a lot of money? Why aren't I as impressed with the fact, look at all the Japanese who are lending people money? how rich they must be to sustain such a massive level of debt. The thing is, for every dollar of debt, there is an offsetting entry. There is an asset. And consequently, I don't believe the banks are

Starting point is 00:43:18 nearly as important as they would love us to believe. They managed to fake as, not me, incidentally, but they faked the majority of people in 2009 into thinking they were so desperately important that if we didn't bail them all out, we'd be deep in 1932 in the Great Depression if we let a single banker go out of business. And consequently, we threw a lot of our stimulus at the banks instead of the mortgage holders who were getting ruined by the housing bust. So that's step one. You can't transfer real wealth or real income across time. Everyone says, are you living off the future or et cetera, et cetera? That's all BS. Pensions are paid out of this. year's GDP pie. The Germans know that. They account for it, pay as you go. We pretend that there's

Starting point is 00:44:06 some sort of lockbox and there's social security and there's assets there you can actually pull out. It's all nonsense. All you have available each year to look up to your retirees is this year's GDP pie, the flow of that year's goods and services. All you can store is a few cans of bully beef in your basement, or if you insist, you can have the infrastructure be up to date, because a crappy infrastructure is a burden on the future. It's not exactly transferring it, but it's almost as good. So for heaven's sake, do the little that you can do to prepare for the future, which is to have a great infrastructure and a great educational system, of course, for the same reason. Reality is the quality and quantity of your workforce, how motivated, how

Starting point is 00:44:54 happy, how well organized they are, how well trained they are, and how well retrained they are, if necessary, plus the quantity and quality of your assets per worker. That's real life. Paper are just to facilitate transactions and to keep a record of this and that. It is not underlying reality. So that's my top level thing. I just want to point out, we have very low real interest rates. I think we can all agree the only virtue of low interest rates is to facilitate borrowing. They have obvious disadvantages is that they take the return away from retirees who'd spend every penny and facilitate life for hedge funds and borrowers who don't. Generally speaking, we know there's plenty of disadvantages, and presumably they're all

Starting point is 00:45:46 offset, the argument goes, by the facilitation of debt. Okay, great. So therefore, debt must have its own virtue. And the theory is that debt increases on the margin economic activity because you go out and you borrow and you make capital spending that otherwise you would not have done. So back to Greenspan, let's start in 1985. 1985, you look backwards to the war and you see a very slow increase in total debt to GDP ratio, very, very modest due to the commercial technologies of banking, just facilitating. the very early days of credit cards. So you have a drift up. And then in 85, it kinks and starts to shoot up to the top right-hand corner of the page at a 45-degree angle. And just around the numbers,

Starting point is 00:46:38 you go from about one-times, including all that, one-time GDP, to three times. And this ignores the special effects of COVID. So that's a pretty noble experiment. You take the richest country in the world, the biggest economy in the world, you take a big chunk of time, 35 years, you triple your experiment, your ratio, debt to GDP. What happens? CapEx steadily declines as a ratio of anything. There is utterly no evidence that it increases capital spending. Therefore, not surprisingly, if CAPX has been dwindling, productivity would dwindle, which it has. Productivity dwindles that entire 35 years, not regularly. There was a four or five year bump for internet, but it declines. The net effect, of course, since we know population has been kind of neutral in that period,

Starting point is 00:47:33 you have a diminishing GDP growth. So what an experiment? You tripled that on the back of lower and lower interest rates. And let me just point out that in 82, the 30-year bond was 16. It comes down from 16 to 12. You get a bull market from 12 to 8. You get a ball market from 8 to 4. you get a bull market, and from four finally to a half, now one and a half, and have you played that game? And what happened? Growth slowed. My argument here is if you look at the meta level, which I love to do, there is absolutely no proof that low interest rate stimulate the economy, that debt stimulates the economy. There is no association between those two. If you wanted to be mean, you would say there was a negative association for the reasons I just outlined. There is a convention that we will assume it to be the case, which happens a lot in economics.

Starting point is 00:48:24 We assume the market is efficient. It's a guy from dimensional fund advisors in today's FT saying how efficient the market is, and that Tesla doesn't disprove that. I wanted to write to the FT that only goes to prove that you can fool some of the people all of the time. I mean to say, either Tesla was efficient at an eighth of the current price a year ago, or it's efficient today at eight times the price, and the sales are up a very handsome 25%. But it hardly compares to 800%.

Starting point is 00:48:55 So which is efficient? One of them is gloriously inefficient. The market is 17 times more volatile than is justified by the flow of dividends and earnings. If you were clairvoyant in 1925, and you were looking at real life, you had that handsome advantage of knowing exactly what was going to happen and you built the world's greatest dividend discount model.

Starting point is 00:49:16 you have a very stable market gain of two or three percent real plus dividend a year. In real life, it is 17 times more volatile because we're a crazy marketplace full of irrational human beings who behave themselves 80 percent of the time. And then 20 percent of the time totally freak out one way or the other. I love the concept of what really matters is the quantity and quality of the assets and the quantity and quality of the workforce. obviously things that boost those two things are good, I think. Things that detract for them are bad. Just to round out the question on the money standard, do you think that there is any influence that the prevailing money standard has on the potential to improve those two things?

Starting point is 00:50:02 As differently, a more finite, harder supply of money might encourage more investment in those two things than less, or is there just no evidence of that sort of thing in your opinion? My opinion is that a big chunk of a commentating world has been freaking out about currency and inflation and debasement of the currency and the end of the world and rack and ruin my entire investment career, which is 55 years. It's all BS. The dollar is reasonably fine. The euro is reasonably fine. The Rambi is reasonably fine.

Starting point is 00:50:39 and even sterling has not been the end of the world, all things considered. There's semi-decent stores of value. They're backed by governments who can raise taxes. They will take their currency as payment of taxes, which is absolutely critical. I think it's good enough. That is not the problem. What do you think is the best way to incentivize or what is the rosiest version of the future of investment in infrastructure assets and people's skills and willingness to do work?

Starting point is 00:51:14 What would you love to see happening in the world right now that would make you more optimistic about the prospects of the improvement of those two categories? Yeah, that's not my area of expertise. So let me say, I don't know. Okay. And then I can give you my guess. My guess is that a massive increase in government R&D. which is, by the way, in general, very good.

Starting point is 00:51:42 Yes, of course it backs losers, don't we all? But it also backs Teslers and so on. Since I spend most of my day these days in Green, BC, we're always bumping into people who've had help from some of these government agencies that put out small, helpful loans to brilliant new ideas. If we massively increase that, we will get a very high return.

Starting point is 00:52:08 We are not at the top of the hip rate for the amount of money we spend on the early stage R&D. We do a lot of development, but very little research. And we are hopelessly outspent as a ratio by South Korea and China as a percentage of its available wealth, if you will, and Israel and a few others. We should endeavor to make it very hard for anyone to keep up with us. We're a rich country. We have a wonderful venture capital industry. All our best and brightest want to go into venture capital these days or start a new company. So that's great.

Starting point is 00:52:48 We're very tolerant of failure here. I think capitalism in the U.S. is particularly fat and happy. It's not in a good shape at all. But the venture capital part of it is terrific. It is not an accident that the fangs all jumped out of venture capital in the last handful of decades. But GMO, when we started our firm, we hired away, potential employee number 25 from Microsoft. Microsoft and Apple are the two oldest ones, but that isn't very old. These were not the Coca-Cola's of the 1929 era, or the General Motors or the General Electrics.

Starting point is 00:53:21 These are new firms, the FACs, and they have created huge amounts of value as a fraction of the total. All of it really dependent on a healthy venture capital industry. And on the great, we research universities on which America also is truly exceptional. And the UK is pretty good, too, but great research universities go hand in hand with terrific venture capital. It's the one true exceptionalism that we have left. Americans love to think they're exceptional. To close the book on our discussion of the present bubble, as you see it in equity markets, I guess most specifically, we sort of talked about these three characteristics being valuation, individual behavior that's speculative and sort of crazy and the acceleration of returns vertical, to some degree, we have all those things.

Starting point is 00:54:09 Obviously, the world can't put all their money in venture capital, especially large institutions. Venture capital historically is a very small amount of absolute dollars each year has been or maybe able to be deployed. What is one to do? If one is in a traditional asset allocation, some sort of diversified basket of assets globally, and faced with what you see as a extreme bubble on the order of some of the historic ones. What is one to do? Well, acid allocation comes with an enormous amount of career risk and business risk. If you're an institution, you have to look fairly traditional. If you play against the convention, even if you win, they merely pat you on the head while you're in the room. And when you leave, they describe you as a dangerous eccentric.

Starting point is 00:54:53 And if you lose, you will not receive much mercy. And that is true. If you get out of the market with your clients a year or two early, even if it makes enormous sense on the round trip like it did in Japan or 2000 tech bubble, you'll lose tons and tons of business. The big enterprises would never do that. It's not short-term commercial, which is the game they have to play. Individuals are lucky. They don't have the career risk. They don't want to look foolish with their neighbor. And I concede that seeing your neighbor get rich is about as irritating as anything that life has to offer. So they're under psychological pressure, but they have no career risk. They have the luxury that they can build up a decent cash reserve, and if they're 18 months too early, who cares? On the round trip, it will come in

Starting point is 00:55:40 very, very handy. And that's what I recommend for them. For institutions, life is more difficult, but happily, in most bubbles, there is something that is cheap. 2000 was the perfect asset allocator's dream. Bonds were cheap, tips yielded 4.3, reeds yielded 9.1% against one and a half in the S&P. All the value stocks were at a legendary relative low. Small cap was at a legendary relative low. You had a wonderful set of opportunities despite tech being brutally overpriced

Starting point is 00:56:14 and the S&P being very overpriced. If you bought tips, you made 30% by the time the S&P was minus 50. Just think about that. The S&P had to go up 160% to close that gap. And small cap value made 2 or 3% versus minus 50. Even though it had a high beta, a cheap really matters in a major meltdown. What we have this time is that value has been hammered for 11 years on a relative basis to growth.

Starting point is 00:56:46 Last year was a world record worst hammering in 200 years of data. And the 10 years before that was the worst decade in data. So that's a terrible combination for a value manager. but the consequence is that the factor, value, almost however you define it, they're relatively cheap, however you define it. And then you have emerging. Emerging has had a decent rally since the COVID low, but it's about as cheap relative to the S&P as it has ever been. It's been this cheap a couple of other times, and both times worked out handsomely. The intersection of those two is value. I prefer low growth, by the way, as a definition. You can't value and high growth don't really.

Starting point is 00:57:26 fit together, but low growth and high growth are, of course, opposite sides of the market. So if you take the low growth companies that are intrinsically valuable as you could select from emerging markets, I guarantee it almost, you will have a 10 and 20 year return that will be perfectly acceptable. These are not overpriced securities at all, which considering the pricing of the U.S. market is quite remark. So there is a glorious haven and you should take advantage of it. And if you're an individual perhaps have, in addition to that of your money in simple cash, grin and bear it as best you can for the duration and then have some money to really buy some bargains when they occur. If we were to close on sort of an interesting, I'll call it high note, you mentioned you

Starting point is 00:58:17 spending so much of your time in Green Venture Capital on a daily basis, what are you seeing in those portfolios, technologies, teams, whatever, that has you most excited about the future as specifically as possible? QuantumScape has been a wonderful example. A quantum scape has a battery that when it finally makes it to market in four years, an automobile engineering takes forever, as they all know. But it's half the weight and half the volume. So you can squeeze two days into an iPhone, you can double the range of an electric car. They don't burst into flame, which is pretty important. If you make a thousand cars, you don't want one of them to blow up. And they don't. Solid state does not do that. It charges in 10 minutes, maybe turns out to be

Starting point is 00:59:07 eight, maybe 12. You can have a cup of coffee and you're on your way. It will just get better with time. This is a done deal. You know, we have killed gasoline and diesel cars. They'll be cheaper to build electric cars. They're already cheaper to run and cheaper to operate by far and safer and better to drive. My Tesla Model 3 is a fabulous machine. We have all manner of things in the farming area. We have engineered RNA that will tell the Colorado potato beetle.

Starting point is 00:59:38 And only that, not even a cousin beetle is affected. it will be instructed that it cannot digest carbohydrates. So it eats the potato and dies of starvation and drops death. A gram per gallon does half an acre or whatever. It's unbelievably cheap and effective and doesn't involve the toxins that we drip on in modern agriculture. We have a microbe that will fix nitrogen. This is amazing, like a clover, nitrogen fixing plant, acacia trees.

Starting point is 01:00:10 This will take the nitrogen out of the air and provided as a fertilizer for growth in the ground. And normally they last a few hours. Ours will last already a couple of weeks, and they're engineering it with aspirations to last long enough that you'd be able to supply enough nitrogen to grow the entire crop. Half of the people on the planet exist because of Harbour Bosch nitrogen, enormously energy intensive, originated in World War I. explodes us and then converted to fertilizer, enable the great boom in population, which is its own problem. Carbon sequestration,

Starting point is 01:00:49 we invest in five or six of these, biological sequestration, seaweed, farming practices, physical sequestration. We are going to have to sequester carbon. We don't reach a satisfactory point, just on good behavior. We end up with far too many particles,

Starting point is 01:01:08 molecules of carbon dioxide and other gases in the air. We have to take carbon dioxide back eventually to 280. And we see endless opportunities. And they need the government to eventually have a carbon tax and a credit for these things. And I think in 30 years, we can extract carbon dioxide at $50. It does much more harm than that on the margin today, perhaps as much as $200 of damage per ton. But I believe in 30 years we'll be able to extract it at $50, possibly even $25. So we can do this, but we really need a government help to drive that forward. And nothing will drive it forward as effectively and as simply as some form of sensible carbon tax.

Starting point is 01:01:53 I don't mind, rebate it to every man, woman, and child equally at the end of every year. That's neutral from an economic point of view. It induced us massive behavior. If we just said we'll adopt the EU's carbon tax, which is about $40 a ton, and we're going to increase it by $2 a ton per year for 30 years to 100, that does the job. You don't need 100 today because everyone who's building a 30-year plant is booking that increase into the game. You get a lot of it for nothing. It will change everything in a real hurry.

Starting point is 01:02:27 You mentioned earlier that one of the interesting features of this bubble, if it is a bubble, is that the participation is so deeply retail and that also this expansion, the market expansion is quite long in the tooth. So there's many participants of this that maybe you're 30 years old that have really never seen any market carnage. I'm hopeful that this episode, given your incredible personal experience, having learned by doing, but also being such a deep historian, I hope that this episode reaches a lot of people that weren't around in, say, the 09 crash. To that group, Do you have any closing thoughts on this market or any closing advice? Yeah.

Starting point is 01:03:04 I'm not optimistic that anyone caught up in this wants to hear my advice and consequently would act on it. When you get into that kind of excitement, mini frenzy, pretty hard to stop you with dry historical stories. You know, that was then, this is now, baby, get a board you don't understand. You dinosaurs don't get it. Well, the trouble is we do get it. And I sympathize.

Starting point is 01:03:36 How can I persuade you? There is no way I can persuade them. Just trot out the regular story and one out of a hundred might listen. I will sympathize with them when they're cleaned out. Well, Jeremy, this has been, as always, a fantastic conversation steeped in history and ideas and cautionary points and optimistic points. Thank you so much for your time. Entirely welcome. Thank you for having me. If you enjoyed this episode, you can sign up for a new email newsletter sent out each week called Inside the episode.

Starting point is 01:04:07 Each week, I condensed that week's episode to my favorite big ideas, quotations, and more. I've been recommending books to members of this email list for years, and we'll keep doing so in this weekly email. You can sign up at investorfieldguide.com forward slash book club.

Invest Like the Best with Patrick O'Shaughnessy - Jeremy Grantham - A Historic Market Bubble – [Invest Like the Best, EP.214]

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