This quarter’s letter from GMO’s Jeremy Grantham doesn’t disappoint – I particularly liked the weighty, truthiness of his intro:
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 Keynes1 knew so well, is fi rst 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 inefficiencies 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.
Jeremy goes on to explain how the market is essentially 19 times more volatile than it should be based on the relatively tranquil underpinnings of economic growth and corporate profits.