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Jeremy Grantham: Why to Buy Stocks Now

Legendary investor Jeremy Grantham

Over the past three decades, Jeremy Grantham has become
legendary for zigging when most other investors zag. The co-founder of money
management firm Grantham, Mayo, Van Otterloo —
which now manages about $85 billion in assets, mostly for institutional
investors — played Cassandra in early 2006, warning hoards of
doubters that the stock market was overpriced and a crash was inevitable.

"Almost everyone we talked to saw it coming, except
for the leaders of companies and governments," he recently told
MoneyWatch. As a result, Grantham's group of funds has outperformed
during the crisis, losing just 6 percent annually over the past three years,
compared with the S&P 500's loss of 13 percent, according to

Recently, as investors were fleeing stocks — pushing the Dow down below 7,000 for the first time since October 1997 — the
contrarian Grantham was slowly moving cash into equities. He predicts there
could be one more severe downswing. But he says, "If you can stick it
out for a while, this may be the buying opportunity of a lifetime."

Long before the credit crisis, you warned stocks were overvalued and housing was a bubble. Any surprises?

Even going back to 1998, I was counting
on the market coming back to what we consider a long-time normal price, around
900 for the S&P. We can’t say we were enormously surprised,
though now it’s trading below that level, because after a big bubble,
markets have always over-corrected.

And I was saying in 1998, when we were
horrible early sellers, for which I took a lot of
grief, that my next great mistake would be buying too soon. I
have no doubt that will happen. And we were buying in October, happily from a
very low base of equities. We added a big dollop of U.S. blue chips and two
small dollops of riskier assets — emerging markets and small-cap international
— to our asset mix.

Looking out over the next seven years, we see
annual returns in the range of 7 [percent] to 11 [percent] for all three asset

Is it time to buy stocks? Or could they fall further?

If you’re tough enough to hang
in there for a while, you’ll eventually get a decent enough return.
On the other hand, I think there’s a 2-to-1 chance it will go to new
lows in the near term. You need to build up some cash, though, because the
market could drop another 30 percent. We think it’s perfectly capable
of hitting 600 or below in the next year or so, which would be a great buying
opportunity for stocks. In the meantime, the market could be pretty brutal.

Will asset valuations revert to their historical means?

Yes. Reverting to the mean is a pretty
slow, mild process, but it’s dependable in the long run, say over
seven to 10 years. The market will go back up, the valuations will increase
from today’s levels, and over the long term you’ll do
pretty well. That said, it would be nice to have some ammunition to buy some
strong stocks when the S&P 500 hits 600 or lower. And that’s
what we’re planning.

We’ve kept some pretty substantial
buying power in most of our accounts — money in fixed income so we
can transfer into equities. If the market continues to drop at this pace, we will
be fairly steady buyers at intervals on the way down. We’ll throw in
most of our lot and buy stocks when the market hits 600.

Do we need professional help more now?

It all depends on how much time
and energy you’re willing to put into it. I don’t think
professionals hold a lot of advantages, because even though they know what to
do, they can’t bring themselves to do it. It’s not good for
their business in the near term. An individual doesn’t have that
career risk.

It isn’t that difficult to see when the market is
overpriced. So when the market gets way over 16 times earnings [roughly the
S&P 500’s historical price-earnings ratio], reduce your
exposure. When it gets down below that level, it’s time to buy.
You’ll outperform most professionals if you do something that straightforward.

So, go beyond just buying and holding good investments?

I think that’s a very low
hurdle. If you have no time and are completely traumatized and are thinking about
finances, then buy and hold some index and throw away the key. Buy-and-hold
works fine in an efficient market. But if you haven’t learned in the
last 10 or 15 years that the market is capable of being utterly crazy, then
you’ve learned nothing.

If you have a certain amount of self-control
and patience, you can move the pieces of investing — stocks versus
bonds and cash — around. Reduce the risk when people are too
aggressive and prices are too high, and increase the risk when everyone’s