Episode #286: Jeremy Grantham, GMO, “What Day Is The Highest Level Of Optimism? It’s The Day The Market Hits The Peak”
Guest: Jeremy Grantham co-founded GMO in 1977 and is a member of GMO’s Asset Allocation team, serving as the firm’s long-term investment strategist. He is a member of the GMO Board of Directors and has also served on the investment boards of several non-profit organizations.
Date Recorded: 2/3/2021 | Run-Time: 1:20:04
Summary: In today’s episode, Jeremy begins by talking about the current market, which he believes will be recorded as one of the great bubbles of financial history. He puts this bubble into historical perspective by comparing it to the Japanese, technology and housing bubbles. Then he addresses the commonly cited argument that low interest rates justify high stock valuations. Next, Jeremy explains why he is so bullish on venture capital and has allocated almost 60% of his foundation to the asset class, making it, as he says, one of the most aggressive portfolios in the philanthropic world.
As we wind down, Jeremy explains why he is so passionate about addressing climate change through his foundation, and why China is ahead of the U.S. to address the issue.
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Links from the Episode:
- 0:40 – Intro
- 1:33 – Welcome to our guest, Jeremy Grantham
- 7:20 – How he characterizes the US market in terms of bubbles
- 11:02 – The defining bubble of his career
- 14:03 – Tirade of A Dinosaur (Kirby)
- 14:12 – ‘Irrational Exuberance’ — again
- 14:41 – The state of global markets if you are worried about the US
22:22 – Argument for why you can’t use valuation to time the markets
- 22:30 – Stocks Are Allowed To Be Expensive Since Bonds Yields Are Low…Right? (Faber)
- 31:10 – Investor emotional responses to bubbles
- 35:05 – Reinvesting when Terrified (Grantham)
- 40:08 – Hussman Funds
- 40:33 – Being a contrarian
- 40:47 – The General Theory of Employment, Interest, and Money
- 45:44 – His approach to venture capital
- 55:40 – Power laws when investing in startups
- 1:00:08 – The massive amounts of innovation in the world today
- 1:01:40 – The Capitalism Distribution: Fat Tails in Action
- 1:03:06 – Most memorable investment
- 1:04:25 – Addressing climate change through his investments
- 1:08:43 – Having the most impact on climate change
- 1:11:04 – Freakonomics Podcast: Nathan Myhrvold: “I Am Interested in Lots of Things, and That’s Actually a Bad Strategy”
- 1:11:06 – Modernist Pizza
- 1:11:53 – The importance of the Manhattan Project
- 1:14:22 – Whether the innovation around climate change will happen in the US or outside of it
- 1:18:08 – Best way to connect with him: gmo.com
- 1:18:30 – Time to Wake Up (Grantham)
- 1:18:38 – Race of Our Lives Revisited (Grantham)
- 1:18:45 – Chemical Toxicity and the Baby Bust (Grantham)
- 1:18:52 – The Advent of the Cynical Bubbles (Montier)
Transcript of Episode 286:
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Disclaimer: Meb Faber is the Co-Founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, friends, extra special episode for you today. No intro really needed. Our guest is the co-founder and chief investment strategist of GMO. In today’s episode, our guest begins by talking about the current market, which he believes would be recorded as one of the great bubbles of financial history. He puts his bubble into historical perspective by comparing it to the Japanese bubble and then the U.S. technology and housing bubbles. He then addresses the commonly cited argument that low-interest rates justify high stock valuations. Next, we touch on why he’s so bullish on venture capital and has allocated most of his foundation to the asset class, making it, as he says, one of the most aggressive portfolios in the philanthropic space. As we wind down, our guest explains why he’s so passionate about addressing climate change through his foundation and why China is ahead of the U.S. in the race to address the issue. Please enjoy this amazing episode with GMO’s, Jeremy Grantham. Jeremy, welcome to the show.
Jeremy: Hi, pleasure to be here.
Meb: So, Jeremy, I grew up with a southern grandma. And she had a couple phrases, one of which was, “Lord have mercy.” And the other was, “What in tarnation?” And I think both of those could be applied to what’s going on in the markets today. So I’m going to start with a really technical hard question. And that is, what in the world is going on?
Jeremy: Yeah. What in the world is going on? I mean, the exciting thing is that we’re writing history. These are the stories of GameStop and so on. These are the stories that people will be telling in 30 or 40 years, like we tell stories about 2000 and even 1929. These are breaking new ground. And everyone has their favorite example. My favorite was QuantumScape because seven years ago, we made a very substantial investment because our foundation tries to invest in stuff that will change the world in a way that will help it to decarbonize industry. And nothing could do that better than an improved battery. And QuantumScape has spent the last 10 years working on a solid-state battery that will be half the weight, half the volume. So it has twice the power to weight ratio, which means instead of having 1,000 pounds of battery in a model three Tesla, which I own, wonderful machine, incidentally, it would be suddenly weighing 500 pounds. So you’d get rid of 500 pounds of absolute dead weight. And then in addition, solid-state doesn’t heat up. So you save 200 or 300 or 400 pounds of cooling equipment that goes with the battery in a Tesla. So now you’re talking 700 or 800 pounds of complete saving. You’re simply going to perform better before you even get to the battery. And then the danger of breaking into flame disappears to practically 0, which is pretty handy in a car because even if 1 in 1,000 crashes starts to burn away, that’s a public relations disaster. And it can be reassembled to recycle more easily than prior batteries. And it will charge in somewhere between 8 and 12 minutes, probably in the end. So it was a wonderful set of objectives. And seven years later, they have done it on a lab basis. And now they’re faced with another four years, which is a long time to wait another four years before they get it rolling along the production line. And they did a SPAC deal. And I’d already committed myself to saying that SPACs were a ludicrous speculative instrument.
So that was the great irony because this was about the biggest investment that we had ever made. When it came at 10, it was a very respectable four times our investment. So it was already significant to us but they’ve spent the mid-summer working its way or late summer working its way to 25 or so. And then when they got approval, which should have been worth nothing because they always get approval, it exploded to 40 and then kept going and took another couple of weeks or so to get to 110. And at 110, it was a 50% increment to the foundation, plus any of my own money added together. So it had become absolutely massive, but couldn’t be sold until May the 1st. So that brings up the second great irony is that I was writing about the bubble forming and the fact that by January looked pretty late stage to me, based on history that it would break in a few weeks. So I’m not really expecting that I will get to May the 1st when I could sell some of this, I think it’s quite likely that the bubble will break before that. As I say, that was one of the great ironies of my life. And of course, QuantumScape, then turned down from 110 to the day before yesterday, 44, which is the biggest wipeout of theoretical wealth, paper wealth that I have ever had by a multiple of perhaps 10. So I’ve been theoretically writing a little story about how I came to love irony around QuantumScape. But when you think here’s a company, that it’s a brilliant company, but it makes no bones about the fact there’s four years to wait. And at 110, it was selling for more than the market value of General Motors or Panasonic to take a battery company. Not bad, eh?
Meb: Well, I’m just looking forward to two things. One, I hope you’re keeping a journal because like you mentioned, we still have a few months to go and hope you’re having a fun cocktail party, although I don’t know what the right date would be. If it would be April 30th or May 3rd. We’ll have to check back in in a few months. You know, I have a similar story. We’ll circle around this later when we talk about venture capital, I had invested in an early-stage company in the space sector, which had been acquired, again, by a SPAC. The SPAC was actually supposed to be acquiring a cannabis company. So, you see these sort of wonky things going on. And Jeremy, like, you know, on one hand, we see the behavior, the euphoria, on the other hand, hey, look, you hopefully will end up with a world-class company that may be as awesome as GM and more one day. But also, you can hopefully be able to recycle those profits into other new and innovative companies. So it’s not all bad, but I think you are accurate in that it’s a good description of the times we are right now. And as a student of history, I remember one of y’all’s older papers, man, got to be over a decade ago examining over 300 bubbles. And from someone who’s lived through a handful, where do we, kind of, fit in right now with the U.S. markets? Is this one that’s going to be on the Mount Rushmore for the U.S.? Is it not even there yet or is this have a ways to go? Where do you put this one in the timeline?
Jeremy: The kind of old pros on bubbles, we have telephone calls with each other and we argue about is this worse than the tech bubble of 2000, the Internet bubble, if you will. And it used to be in the summer that some of us thought it wasn’t quite and some of us thought it was. But pretty much now, we all think every bit as bad as 2000 and maybe even more impressive. 2000 was in a league of its own. It blew through 1929. So 1929 was a genuine impressive bubble. And they have many characteristics, but one of which is they turn on the afterburners for the last few months and they start to rise at least twice the rate of the entire bull market since the previous real low. And 1929 certainly was doing that. 1928 and ’29 was just a warp drive move. And ’98, ’99 was particularly for the NASDAQ kind of doubled in the last half-year of ’99. And here we are where, you know, the NASDAQ is up about 100% since March. So that’s very impressive, more than enough to make the cut. And the Russell 2000 is up 110%. And the other characteristics are that you’ve got to have more and more interest in the market. You’ve got to have the market, kind of, go from the finance page to the front page. You’ve got to have crazy stories becoming part of the cocktail party conversation, and we certainly did in 2000. My joke then was at the greasy spoon lunch place that we used to go all those eight television sets that used to be showing reruns of the Red Sox were talking heads and MSNBC giving us the latest dot coms. And that hadn’t happened by the way throughout the long 11-year bull market. And there was a little flurry in late ’17, early ’18, which fizzled out and began to get some of the excitement but it never got the quantity or the quality. But this time it has. This time it’s become a real storyline. And the news talks about it and the front-page talks about it and one story after another. Electric trucks that have to be pushed downhill to take the photograph at Tesla becoming worth more than the next nine global auto companies added together and Musk, who, of course, is a genius, but nevertheless, you know, rapidly becoming the richest person in the world when a mere five years ago, he was sleeping on the factory floor wondering whether he was going to go bankrupt. It’s all terrific stuff.
Meb: You mentioned Musk, it’s funny because he himself said on Twitter hundreds of stock points ago that he’s stock was overpriced. So, when the CEO and founder says that, that’s an interesting perspective. You know, it’s funny because as I look around and see what’s going on with the Reddit and Wall Street bets and the Modern Social, I see myself in the mirror 20 years ago. I was a university student in the late ’90s, studying engineering and being totally swept up in that bubble. For us, it was e-trade instead of Robin Hood. It was the dot coms rather than, kind of, similar names today. But, you know, I recall my professors stopping their lectures in the middle and going and checking stock quotes. Like, not a joke, feeling this exuberance and then, of course, the aftermath that followed. Is there a particular bubble that you look back on in your career as being the defining one? Would it be Japan? Would it be kind of what’s going on now?
Jeremy: The one that was the most fun for me was a bubble that has escaped all but the most serious, efficient artists of bubbles, and that was 1968 and ’69, where tiny stocks went crazy, like they are today. I was in the out of business school and I was in a dopey general management consulting. And I asked around who of my classmates were having the most fun? And by far, that was the investment business. And so, I jumped ship and joined a mutual fund group in Boston. And we used to meet for lunch. And these guys were already a critical year or so ahead of me on the business. So I sat there listening to them and they would trade these, kind of, little rocket ship stocks that would go up 5 or 10 times in a few months, and then kind of explode and disappear. And it didn’t seem to faze them at all. They just considered anyone who got stuck in the exploding parts were just nitwits. And after a few months, to be exact three months after I got in the business, I was going to go off with my wife for three weeks holiday in Europe to see our families in England and Germany. And we love the story of the week, the week before we left, which was American Raceway. American Raceway had the world champion race driver, Sterling Mass on its board, and it was going to introduce Formula One Grand Prix racing to America. It’s always been a, kind of, European, South American thing, but it never has really caught on in the U.S. But it was, kind of power and danger and noise. It sounded to me very, very American. How could it miss? And it opened one track and it did brilliantly well because it was a novelty, of course. What did we know? We thought it was going to happen every time we had a race and it was going to be duplicated in 12 different places in America. Anyway, I bought 300 shares at 7 and went on my holiday. And when I came back, it was 21, which was kind of typical. And I was thrilled. And so I did what any good value manager would do. I sold everything else I had and doubled up. Okay? And it was 100 by Christmas. And I was rich. And that was enough to buy a house in Newton, a Victorian house next to an orchard with a BMW, only they turned down a bit. And so, we didn’t buy the house. And early in ’69, as my rocketship descended, I jumped ship into another one and that blew up and the next one blew up, and I was back where I started from with $3,000 or $4,000 left, licking my wounds. Anyway, so that was a thoroughly exciting and thoroughly a dense learning experience, and it had a lot to do with me being a more cautious investor for the rest of my career.
Meb: It reminds me, I read a piece this past week from Robert Kirby who is famous for the old coffee can portfolio idea called tirade of a dinosaur that was talking about that period that I thought was really thoughtful. You know, and it’s funny you look back at some of these historical bubbles, I was reading an old Shiller piece that looked at sector valuations. And in the booming 20s market, you had the utility sector, got to a PE ratio of 60. And in my mind, I’m thinking, you know, how you have, it doesn’t have to be necessarily an exciting asset class to be in a bubble. It could be something as boring as utilities.
Jeremy: And of course, the great bubbles of the 19th century were railroads, which sounds pretty stuffy to us.
Meb: People love to characterize you as a bit of a bear. And the challenge with where we are in 2021 already if you ask some of the quants is that during prior markets, there seem to be a lot of places to hide. Certainly in the early 2000s, you could hide just about anywhere, small cap value, REITS, bonds, dividend stocks, you know, many different markets did just fine. You guys are famous, and I know you don’t spend as much time there anymore at GMO. And we’ve actually had, I think more GMO podcast alumni than any other company. So kudos to your crew on the podcast. But what is the lay of the land of the rest of the world look like? Are foreign stocks any better? Are there any places to hide, you know, if this thing starts to turn south, sooner or later?
Jeremy: Yeah, this is kind of middle of the road. 2000 was a daydream. It was brilliant. There were whole asset classes, bonds were cheap. And tips had just come out, inflation-protected bonds. And get this, they yielded 4.3 real guaranteed, protected against inflation and guaranteed by the U.S. government, 4.3%. REIT yielded 9.1 right at the top of the market with the S&P yielding 1.6, which was the lowest in history. What a wonderful comparison. Incidentally, people said, “Yeah, but they grow much faster.” And we said, “You know, click next exhibit.” Yes, you’re absolutely right, the long-term growth of the dividend stream of the REIT is precisely 1.0% a year or less than the S&P. And for that, you get an extra seven points cash yield. I mean, give me a break, it’s seven and a half. That was heaven. And ’07 was not as anywhere near, and early ’08, not nearly as overpriced a market as 2000, as the tech bubble, but it was damn near universal. I had a quarterly letter, which started from the junkiest bonds to the greatest blue-chip from land in Mayfair, to downtown Tokyo, etc., etc. It’s bubble time and it was everywhere. And that made life difficult. 2000, you know, being the perfect one, real estate was pretty cheap, a whole asset class. And small-cap value was brilliant and REITS were up 30 when the S&P was minus 50, right at the bottom, just to pay you back for your patience. And we made money in a global diversified portfolio. We made money in 2000, in 2001, and even by the skin of our nose in 2002, when the S&P was down 22%. So that was perfect. ’07 was the most slippery one. To make money there, you had to get into the anti-risk that the classic anti-risk bet was long Yen, short Sterling. The opposite of the bad that everyone had been riding as a free lunch for several years. And it, of course, blew back in the opposite direction with a 20% gain on both sides of the trade in three months. So it was like a license to steal there as the market created.
But you had to do exotic things. It was not easy. This one is in between. The whole of the emerging market is a little bit cheap on a relative basis sensational. And the housing bubble emerging was higher price than the S&P 500 on a PE basis. It had the most amazingly successful run that we played, and played and played probably with hindsight overstayed our welcome. So that we for once, we’re jumping after the peak, instead of, you know, two years too soon. Anyway, back to today, even the rest of the world, equity markets are not too bad, which points out this interesting argument about low-interest rates. The argument goes, low interest rates give us no choice. That’s why the market’s so high, that’s why it’s actually cheap. To which we say, “Oh, wait a second, what are the rates in the rest of the developed world?” Whoops, they’re a bit lower than the U.S. and have been for a couple of years or so. And the PEs are much cheaper. So, it casts doubt on the sufficiency of that reason. I wouldn’t say the developed world ex-U.S. it’s cheap, but it’s not bad. It’s a little bit expensive, perhaps absolutely very cheap on a relative basis to the U.S. But emerging is a bit better than that. And then you have the, kind of, low growth or value and versus the high growth. And I don’t think that that low growth or value is a license to steal, which it was for basically 100 years, until 2000. I do think some of the dynamics of growth versus low growth has shifted, but still the parameter is so massively depressed against low growth in favor of high growth that you know it will usher in a period of several years of movement in the opposite direction, which should be good for 10s of points of outperformance, perhaps 30, 40, 50 points, I would guess. If you can add those two together, so if you go into the low growth end of emerging, it’s not only you might, you almost certainly will do perfectly well over 10 or 20 years. The question would be when the U.S. blows, will it take emerging with it? And I suspect, you know, history says, “Yes, it will.” But let me remind you of 2002. In 2002, the S&P went down 22%, as I said, but emerging went down 2%. And that’s a pretty handsome difference. Emerging had already become cheap. Cheap really matters.
It’s not just data. You know, you can have stocks that typically go up and down one and a half times as much as the blue chips, like small cap. The small cap was so cheap in 2000, you pretty well knew it would outperform, and it did. And small cap value was just about breakeven when the S&P was down 50, even though it had a high beta because it was so sensationally cheap. It’s not so sensationally cheap today, but low growth value is. And so that’s the play. Avoid the U.S., avoid the high growth. And there are some decent opportunities. Of course, however, unlike 2000, debt is ruinously expensive. You know, when the long bond back in ’82, my colleague Nick Mayo was making a personal killing, put all his money into 30-year U.S. Treasuries on 90% leverage, and took a deep breath, you know. It could have been wiped out. But it was a really heroic bet. And the 16% yields very quickly became 13. And the cost of carry, no became 10,11 and suddenly, you were making a 5-point spread on the 90% borrowed plus the 16 points on the 10% principal plus a capital gain, those were the days. And the 16% came down to 12 causes a bull market and the 12 goes to 8, causes another bull market, and the 8 goes to 4 and causes another bull market. And now it’s down to rock bottom at being around between a 0.5% and 2%. Where do you go from there? I mean, that game, it took a long time. It was great. It’s 38 years. Wow, sorry, 32 years. That’s game over. And it’s a piece of cake. You lower the rates, you’re going to tend to push up the price of assets, other things being even. And we’ve done that. Been there done that as they say.
Meb: There’s two sort of justifications or arguments I hear about people talking about U.S. stocks, they’re allowed to be expensive. And the first one you mentioned, we wrote an article about the fallacy of stocks are allowed to be expensive because of low bonds. The second one that people love to talk about and I’ve heard it, I don’t know how many dozens hundreds of times to us, so I’m sure you’ve heard it even more is along the lines of you can’t use valuation to timing. And they’ll say they look back on the same map. And I’m sure they say it to you too. You would have said this a year or two ago where U.S. stocks are expensive. And look, they went up. Therefore you’re an idiot and you’re wrong. And they’ve continued to outperform foreign. I know how I respond. But I’d love to hear your take on what do you say to those people? Because that’s probably the single most heard refrain I get on, “Hey, you said this and it’s still happening. Therefore, it’s of no use to have this information.” How do you respond?
Jeremy: On the interest rate argument, I think that’s pretty easy. I mean if you’re going to justify something as being cheap by picking the most overpriced asset and using that as a yardstick, you’re an idiot. I mean, you might as well say, compared to Bitcoin or Tesla, the S&P is incredibly cheap, would be, buy some more. Go on margin. I mean, you have to use an absolute standard. And the absolute standard would be the margin adjusted Shiller P/E. Shiller P/E is not enough on its own because for 20 years, we’ve been in an abnormally high U.S. profit margin era, not in the rest of the world and clearly temporary. But the share of GDP going to corporations has jumped up for a while, has a bit to do with monopoly and short-term circumstances. And I’ve no doubt it will tend to move back in the opposite direction. But I’m very tempted to digress on that point because one of the reasons we have low rates is because of the population profile. You know, you took 600 million young and middle-aged farmworkers in China, whose productivity was negligible, and you move them to the cities. And you took a couple of 100 million Eastern Europeans who weren’t really plugged into the capitalist system at all, and you plugged them in. And it gave you a jolt of cheap, eager in new labor, like of which we had never seen in history. And that, kind of, drove the game for 20 years. Globalization and pressure on the wages of the West, why wouldn’t it be? So they made it very easy for unions to lose all their power, for corporations to rule the roost and to increase their share of profits. And the government didn’t move against that. It actually changed the laws to make it even easier for corporations to increase their share of the pie. And of course, inequality went off the scale measure of inequality ratio became the worst in the developed world, only outflanked by the odd Brazil. So I think that was a fairly desperate, long-term consequence, which we have to live with. But now, the workers in China, everyone who wanted to leave has gone. And their population has entered one of the big bus of history and encouraged by the one child plan, but it’s pretty much echoed everywhere anyway. So, Taiwan, and Korea, and Japan have got the same bus that they have in Japan without any draconian one child policy.
And the baby cohorts that are coming down the pipeline here are just amazing. There was one the other day from South Korea, under the impact of COVID dropped from its well record 1.0 fertility rate. You need 2.1 to replace your population, and they had 1.0. And then when COVID came, it went 0.85 in being the world’s most efficient government, it seems. They reported on that first already, almost two weeks ago. And 0.85, it’s just amazing. It means that every 33 years, let’s say you have a generation, you’ve got less than half the babies you have before. And that’s been going on, of course in Japan. So, the young man appearing for military service in Japan are down by 30% already. And in 30 years, they’re about 1.5. So in 30 years, there’ll be down to half of what they were at the peak. And in the U.S., we just came out last year, not last year, the year before, 1.7, lowest ever recorded just below the previous low of 1931 in the depression. And this year, we may be down quite a bit. Because of COVID. We don’t know that, maybe 1.6. And China is going to be below 1.6. These are not insignificant countries. This is a huge shift. It means that almost immediately, we’re going to see led by Japan and Korea and so on. We’re going to see a shortage of workers. And instead of having extra hundreds of millions, we’re going to have a shortage. And so it’s going to put pressure on wages. Finally, it’s going to make equality look a little better. It’s going to put some buying power in the hands of typical workers, but it’s going to put pressure on prices. It’s going to put pressure on inflation. And it’s going to put pressure on real interest rates. And I suspect we will be moving back towards a, kind of, 20th century looking world with perfectly good GDP growth, maybe a little increase for 10 or 20 years on productivity of the workers. Because when they’re short, you finally you get into capital spending to keep their productivity rolling. And you can’t just easily displace it to China. Chinese wages, you know, have gone up 15 times over 20 years and they’re now running out of workers themselves.
So, campaigns everywhere will tend to be trying to compensate. So productivity, which has been settling down steadily everywhere for the last 50 years, you know, when I got here, it was running at 3% a year. And now we’ll be lucky if it was half that. And in addition, employment was rising at over 1% a year. And now we’ll be lucky. If it stays positive at all, in the next 10 years. In the U.S. and in Europe, it will definitely be negative. So there’s a big downward pressure on GDP growth. But there’s a big shortage of labor and therefore probably a push up on productivity. And it takes us way back into the world we all grew up with as older people grew up, which is a more normal return on investment, a more normal interest rate, a more normal rate of inflation. And one of the consequences to that you will bid down the price of assets over the next 20 years. And maybe starting per user and maybe the recovery from COVID will run straight into the changes in the pressures on wages and so on. And that’s the pressure on profit margin. So, other things being even that drift back down where it came from to more normal levels of GDP. Anyway, that would be a very powerful shift and would be a major downward pressure on price earnings ratios going forward. I think it would work out pretty healthily. Actually, it would mean that the new acquirers of wealth would be able to, kind of, get into the game at the moment with the return on most assets, half of what it used to be. It’s very hard to compound wealth. You know, if you have a 6% return on your asset, whether it’s stocks or a farm or a forest, or a bond, or a junk bond, I might say, if you’re compounding at 6%, you know, you’re doubling every 12 years. And if you’re compounding at 3, which we do today, it takes 24 years. So in 48 years, you’re down to a quarter. And then 36 years, I’m sorry, in 96 years, you’re pretty well disappeared. So it’s a hell of a hard way to get rich compounding with high asset prices and low yields, low yields on every asset you could think of. So drifting back is painful at one. In one way, it’s painful on your portfolio price, but it’s great for your compounding ability.
And it’s great particularly for the young who have to get in and start acquiring assets and who can’t afford a house because house prices will come down. As the population profile changes and there are fewer babies, that then 20 years later, there are fewer workers, there are fewer house buyers, and the housing stock becomes generously over supplied as it is in Japan. And the prices of land and houses relative to GDP start to drop, which is great for the young. And you just have to be braced for it. I know this is a long argument than you’re probably bargaining for.
Meb: Jeremy, I think it’s good because I think what you described seems like incredibly healthy playbook. I mean, look, if you had to rewind back 10, 20 years, and ask me say we’re going to be in a world of negative yielding sovereigns, I would have said, “You’re crazy. They didn’t teach that in an undergraduate.” And in a world… I said this on Twitter the other day, I said, “Look, young people…” And I was talking specifically to, kind of, everybody getting caught up with the trading of stocks. In the last couple of weeks. I said, “This is an unpopular take but the best possible thing that could happen to you is the broad stock market goes down 50% to 80% because you have a much better starting point as a saver and investor to put money to work, where it’s trading today. Josh Wolf said on Twitter, he said, “Unfortunately, this feels not like the bell at the top but a dinner bell,” which is just bringing more people into the markets at probably the worst possible time, particularly in the U.S. but it gave me a little bit of chills and a shutter. Because right now, Schroeder’s had a survey that asked U.S. investors what they expected, their stock market returns, and they said 15%.
Jeremy: You may remember it’s almost identical to the surveys of 2000. And I don’t know if they even did a survey in ’29. But I’ll guarantee that had they done, they would have had the same result. They certainly had this famous article in “Ladies’ Home Journal, pointing out how all you had to do was buy stocks and compound, and you would get rich, and you only had to put aside, you know, $1,000 here and there, and pretty soon, you could retire. And that was the defining article of the era. So, every cycle is the same. You only just have to go through the thought experiment of the last month of any great bubble, ’89 in Japan, February, March of 2000 in the U.S., September 1929, and the Housing Market peaking. The Housing Market actually peaked pretty early in 2006. And you think, what is the attitude in that last month? It isn’t people a month from the peak, it isn’t people saying, “Oh my, it’s overpriced.” That last month as it goes to the peak, every day has a higher level of optimism than the day before by definition. Just think about it. That’s what it means to have the highest price, the highest P/E. It means you have the highest level of optimism about the future. So, as you approach the peak, your estimate of your future portfolio return goes up, not down, which is the math involved. It goes up with the psychology involved. Always it’s an equation. It’s how you hit the peak. You hit the peak because you have the highest level of optimism. And what day is the highest level of optimism? It’s the day the market hits the peak. So the day before is higher than any other day, except the last day. The week before is higher than any other week except the last week. It doesn’t cool down until the final day. And then it starts to cool down. And that’s deceptive too because the market doesn’t end by hitting a brick wall. The day after the peak is the second highest optimistic day of the entire cycle. It just isn’t quite as optimistic as yesterday. And a week later, it’s way over trend optimistic but less than a week before. And that’s why it’s so damn hard to pick and the same at the low, you know, people think, “Oh, there’s light at the end of the tunnel.”
And I say, “You know, forget it.” That’s not how the market bottoms, the market bottoms in a complete pit of despondency. It just isn’t quite as bad as the day before. And so the selling pressure laps up a teensy little bit and the market starts to drift slowly up from terrible prices. And by the way, no this is what I wrote in “Reinvesting When Terrified,” which you can find on our website, which is one of only two pieces I ever published that was not a quarterly letter because I thought it was important to get it out. And there’s only one page. And it says in March of 2009, it says, “Reinvesting When Terrified,” you are not going to call the low, don’t think about calling the low, just look at the prices. Today, you’re going to get a double-digit return for at least the next seven years in almost any asset you can think of it. Get your act together, and grit your teeth, and start to get back into the market. If you’re an institution, present to your committee, a program for phasing back in and do it now. But do not let inertia overtake you because that’s what happens. You feel so good about the cash reserves you’ve had and so bad about any money you put back in the market, that you begin to suffer from what we used to call in 1974, kind of, terminal paralysis, where both parties are frozen. The guys in the market can’t move, they’ve lost so much money. The guys who have cash can’t move, they’re so thrilled to have the cash, they didn’t want to give it up. And so everyone just sits there doing nothing. And finally, the pessimism is relieved a little bit on the market turns. Anyway, the day we posted that happened by sheer coincidence to be the exact day, not three days earlier, the exact day of the low, 666 on the S&P, what we call the devilish number, which marked the low and we posted that day, just so you know, not being utterly bearish on my life. That’s my one heroic bull paper, which is on public record, can be seen at gmo.com. And ironically, of course, I did call the low on that one, but you can’t do it. And you can’t call a high for the reasons we’re talking about. It’s almost always a kind of rolling top and a rolling button.
For weeks in either direction, you have a pretty high level of optimism or pessimism, just not quite as much as the peak. What you can look for, though, is you can look at the great bubbles and you can say, “What are the conditions of breaking?” And you can’t say it’s overpriced. Of course it’s overpriced. But there are many markets that are overpriced for years. That’s a pretty painful way to look for a market peak. But you can say that when you get rapid rising at the end of a long bull market, when it goes into warp drive and when the speculation starts to dominate the front page of the newspaper and the crazy stories are, kind of, being talked about everywhere, and you can prove for yourself, and when the bulls like I was in 1969, you know, you’re being crazy as I’ve said. In your heart of hearts, you know, this is far and away the most risky you’ve ever taken. You never thought you would take that much risk but you are. And it’s a heady trip and you’re winning, what the hell? Let’s go. Then a little voice at the back of your brain is beginning to say, “This is too good to be true.” And you squash it because it’s so much fun.
Meb: The sentiment, you hit the nail on the head, my favorite is the AAI allocation survey and sentiment. They asked people, but they both said the same thing. They said when were people most bullish on stocks? And it was literally over 35 years, January 2000. And when were they most bearish? March of 2009. And it was also reflected in the allocation survey. They had the most stock exposure in January 2000 and at least in March… Like, you can’t make that up. I mean, it’s the most perfect contrary indicator. And AAI hasn’t gone too crazy this cycle. It’s a little bit older crowd. I wonder if they have the scars from 2000. But if you look at investors intelligence, Leuthold does this and they take this back to the ’50s. And they actually use an average of the entire year of sentiment. They have this wonderful study that shows the top 10 sentiment years in history. And this is like 70 years worth. And the top 10 highest sentiment, the future year of stock returns is around 0 and the 10 worst years of sentiment, the next year stock returns were like 15% or 20%. I don’t have the numbers exactly, but directionally correct. However, 3 of the top 10 sentiment years in the entire sample are the last three years, and maybe one of the years was out of order, but just goes to show that the cycle has, sort of, had this consistent, and maybe ending in a crescendo now. But your coworker had a nice chart a few years ago that showed valuations and then future three to five-year drawdowns in those markets. And the more you pay up, it seemed like the big fat drawdown you have in your future. But look, you and I are talking, you referenced earlier 10-20 years. I think most of the people listening to this nowadays are talking in terms of minutes, days, and weeks. So, we’ll be fun to see how this plays out.
Jeremy: By the way, Haussmann, of course, on his website with two s’s has magnificent data, clean, clear, and very thorough, and very alarming if you happen to be a bull, but yeah, with the same result as James Montier pointed out. Of course, I did want to add that I can say with a clear conscience that we were at our maximum bearishness in March of 2000. And at a maximum all-time bullishness in March of ’09. And a very interesting question is does that make it a viable business strategy? I’m not so certain. Because being a contrarian, as Keynes pointed out in his famous chapter 12 of the general theory, “It’s a hair raising business because if you’re right on your own,” he would argue that the committee pats you on the head while you’re in the room, and then describes you, as you leave the room as a dangerous eccentric. And if you’re wrong on your own, they showed you out of hand bang. Whereas if you’re wrong together, nobody gets shot. You go off the cliff together, endless banks doing the wrong thing at the wrong time. And maybe they find a complete idiot who’s been actually cheating a bit. And they showed him that basically, there’s huge comfort from company in terms of career risk. And that’s why you never hear a good bear case from Goldman Sachs, or Morgan Stanley, or whatever. You may hear it from one individual once in a blue moon, but you don’t hear it from the enterprise in total because it’s lousy business. They’re not in the business of engaging in lousy business. So, since you can never get the timing perfectly, otherwise, whoever could don’t have the will as well. Since you can’t get the timing right. You know, in general, you’re going to be too earlier, etc. So why not just tout the bull market and say, “It’s cheap. It’s cheap. It’s wonderful. Jump on. Jump on.”
It’s hugely good for profits and hugely encouraging massive IPOs and spikes, and every SPAC guy races around the countryside for six months and takes 20% for himself and, you know, it’s a wonderful way of making paper wealth. And then it blows up, fine, you take a hit, but then you start the game again. And bear markets tend to be pretty short. And once they get going anyway, you can make good money and then you get another drawn out 5 or 10-year bull market. And that’s the way to make money. They know that very well. They’ve been through cycles and they’re never going to fight a bubble. They never did. They never will. It doesn’t matter if it’s Japan, and it goes to 65 times earnings. It’s the big wirehouses in Japan. We’re not saying, “Whoops, we’ve never been above 25 before,” which they hadn’t. And here we are at 65, this should mean that you’re going to have to regress to the mean for the next 30 or 40 years, which they have, incidentally. They’re still not anywhere near the high of 89. Just think about that, 31 years later. And real estate prices are worse than that for land. You know, the land under the Emperor’s palace really was worth the entire state of California, which is great, but the consequences decades go by to absorb those aberrations. The bigger the aberration, the bigger the ensuing pain. So 2000 was 35 times trailing earnings. It had never been above 21. It broke out above 21 at the end of ’97. Luckily, we were still perfectly optimistic at 21. With hindsight, I’m not sure why but we were lucky. But as it moved into terra incognita, you know, 22, 23, we became fairly rapidly more conservative. And it went all the way to 35, which is, of course, brutal. And then it gave it all back. And since we’ve doubled down somewhat and since there were wonderful places to hide, it was easy to make a lot of money. And we made a lot more than we gave out. But it’s fairly brutal as you find a bubble.
We kind of learnt that being three years too early is a little painful in Japan. So we were only two years to it in 2000. And that was brutal. And we lost tons and tons of business. And by the way, let me just make the point that 2000 was mainly an institutional bubble. ’29 was institutional and everybody else, individual, the kitchen sink, everyone was in 1929. 2000, the individuals were not. They were optimistic and they played the game a bit. But it wasn’t a real individual frenzy. It was an institutional frenzy. That’s what was so heartbreaking for an institutional manager like us. Every committee that I can think of, every committee had a lot of members who bought into the new golden era of Alan Greenspan. They really thought productivity is going to be higher forever and the market should be 35 times and we saw 30 times earnings. All complete nonsense, of course, but they believed it. And the housing bubble was different. Individuals at the top end of the wealth distribution, kind of wealthy individuals played the housing market and one tended to know people who’d bought a house or two and speculation for renting. And the stock market wasn’t that bad in comparison, but it wasn’t an individual frenzy in the stock market. This one is. This isn’t 1929 like the mini bubble I described of ’68 and ’69. Nothing to do with institutions really, that was a little individual bubble, and we all lost our shirts. Everyone lost their shirt in ’29, the institution’s lost their shirt in 2000. And this isn’t as much an institutional bubble as it is an individual bubble. So the individuals are going utterly crazy. And institutions are picking some of it up, and they’ve become much more than averagely optimistic. The flavor of this one is very old fashioned in the individual frenzy.
Meb: Jeremy, talk to me a little bit about, you know, you have personally been involved with your foundation for over 20 years and the allocation there is what I’d call a bit more atypical than your average investor or institution. And in a way, having for a lot of people listen to this conversation. It’s really the flip side. It’s like the most optimistic view of the world, at least of potential innovation, and disruption, and creativity, and hopefully, capitalism. Can you talk to us a little bit about your approach to funding venture capital and the focuses in areas that are thematic there?
Jeremy: Yeah, this is full of irony, too because we decided on a very long-term argument that venture capital was the place to be. It is the highest returning asset class in the long run. And it should be as you go up the risk profile. Obviously, early-stage VC has the highest failure rate. And on average, it should have the highest return. And it does. And that’s a pretty decent argument for doing a lot of it anyway. But I had my own argument that was quite separate from that. And that is, I’ve become increasingly disillusioned with the, kind of, general effect of U.S. capitalism. I describe it as fat and happy. It isn’t as aggressive as it used to be. Now I grant you, there are a handful of dynamite aggressive companies. But when you think about it, these are all the product of the last few decades of venture capital. These are not the Coca Cola ‘s and the IBM’s, who were around in 1929, of which there are quite a small army. These are 20-year-old, 40-year-old. You know, when we were starting GMO, we hired away from Microsoft, employee number 25. That’s how relatively young they are. And Apple’s the same age approximately, and the rest, you know, 20-years-old? You know, it’s practically the other day that Bezos was taking his drive over from New York to Seattle, and becoming the richest man in the world for a long while and so on. And you could argue Tesla. You know, it’s just a few years from making his first car. So, that’s all kind of venture capital-ish, isn’t it? The facts, they feel like venture capital. The point is, the U.S. has, in my opinion, a lot of problems. Americans love to think of themselves as exceptional. It’s a long tradition. And, you know, for a big chunk of American history was absolutely true after World War II, you name it, America was it. You know, it was exceptional. But the last 30 years, maybe even a bit more have not been that great. And America has been sliding down the ranks of almost everything that matters.
You know, you could start math skills and verbal skills. And we’ve gone steadily from number 7 to number 25. You could say, “Well, number 25 is bad.” But it’s a long, slow slide. Life expectancy, we’re the worst in the developed world in the last four years on average, have gone backwards. Morbidity, you know, just how sick we are as a society. And we have the sickest, developed country society. And we spend six points more than any other country on GDP on health. We have more people in prison by a factor of, you know, 4 or 5 times, the others and 10 or 20 times Japan, and children to 16 year olds, you name it. Inequality, the Gini index, it’s the worst, not one of the worst or absolutely the worst of the 25 or so developed countries. So, it’s all very depressing. And I have a stump speech I used to give on this topic because the typical, well-informed Bostonian businessman really thinks that we’re the best at everything. And, you know, I’d have a series of little slides and it would start with a proposition and the opening salvo was a quote from Mark Twain, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so. And each of these propositions would say, you know, kicking French buttons, and we’ve been kicking French bottoms. If you read Businessweek for the 50 years I’ve been in America. So how come since 1975, the average hour paid to a worker inflation-adjusted is up 160% in France, is up less than 10% in the U.S., and the poor ol Brits are up 67%. So for the average worker, this has just been a diabolically bad time, etc., etc. How about, you know, I wish America wouldn’t be so generous to foreign countries, particularly when times are bad? That’s the proposition and then click, it shows the developed world gives away about 0.4% to 1%. If you’re a goody-goody, like Sweden. And then the final click is the U.S. 0.2% for the last 40 or 50 years dead last right across the board.
And the amazing thing here is not that we’re dead last, it’s that everyone in the room thinks we’re one of the best. And they’re wishing we wouldn’t be so generous when we’re the cheapest developed country by far. No, trust me, all of these facts are triple checked. So, finally, I make it to the D.C., and I say, “Now, that’s what I call exceptional.” America is the dominant D.C. player, by far. It’s huge in scale. It’s huge in competence. It has armies of good teams. And better than that, if you say, “Where does the brightest and best go today?” They don’t go to management consulting. They don’t go to marketing for Procter & Gamble, as they did in the ’60s, ’70s, ’80s and ’90s. They don’t go to Goldman Sachs to write fancy trading models as they did in the 90s and even into the 2000s. They go into startups and venture capital, either picking venture capital or running the venture capital firms. Anyway, they are the driving force, the last super vital part, I believe, of American capitalism. So, that combination with the fact it has the highest return, provably the highest equity returns with the fact that it’s so dynamic and, kind of, dominant on a global basis, left me saying over 10-years-ago, why the hell shouldn’t we put virtually all the money we can into professional VC portfolio? And then, as I became a green fanatic, we said, “Well, why don’t we build our own team and put 20% of the money into green VC, which we’ll do ourselves because there isn’t much of an infrastructure yet?” There’s one becoming now, but there wasn’t there. And so that’s what we did. And we had the 80% measured separately and our 20%. So we had no conflict of interest. And we’ve had a very good consulting firm, Cambridge Associates lived up the road, and I’d worked with for years and years. And we had some of the best people there, if not the best people. And we set them put as much money basically, as you can steadily into the best VC players. And they did starting a dozen years ago, we started very small.
And now we’re about 60%, D.C. And it’s done 18%, 19% a year compound. And so it’s been great, much better than the balance of the portfolio, I might add. And then our 20% has been interesting because we were in their early stages of green investing before our relationship started with Cambridge. And we were doing the same disastrous, early-stage, green investments that Kleiner Perkins and everybody, we were all getting sandbagged by early-stage green because they weren’t competitive enough and we thought the government would get behind it, and it did. So, we were disappointed. But the second way for the last 10 years has been very interesting. And it was the last of our early big investments that was in QuantumScape. So that with any luck is going to make up for all of the disappointments. If it can hold its current price over 40, that is, it will leave us in splendid shape. It will also make us a total of 80% in VC and closely related investments, which, of course, it’s ludicrous by any other standard and no one does it. And one of the reasons they don’t do it is being revealed. And that is it takes away all your flexibility to jump in and out of the market that a market specialist like myself might aim for. And so I can fit my children’s accounts and I can make them very defensive now. But I can’t do that with the foundation loosely speaking my own money. We’ve put everything you see that in are committed to a foundation for the protection of the environment and the public trust, the same thing. And we always keep some in my name because if it’s very risky, we feel it’s not politically correct to put it into the foundation. So, I do it. And then if it succeeds, we give it to the foundation. And if it fails, I take a tax write off some benefit. And so that’s very efficient and has worked out extremely well. And I recommend it. Anyway, to get back to the story. So we have this astonishing 80% D.C. portfolio, which is doing very well on the professional side and subject of QuantumScape pretty well on the formerly amateur side, we’re getting a little more professional now, a lot more professional.
But we’ve had to give up the ability to jump in and out because VC, you make a commitment for n years forward and they can call the money when it’s inconvenient to you. And you don’t know when they’ll sell them at a profit and flow it back. So you have to allow quite a large safety factor and you can’t do things like have a big short portfolio because a big short portfolio gets marked to market. And where do you find that money if you’re wrong? So we have a very modest short portfolio. So we have one of the most aggressive portfolios in the philanthropic world, if not the single most aggressive because we have 80% in VC and a short position of 12%. Anyway, so that makes for an interesting story. And the moral here is you can play a long-term argument or you can play a short-term argument, but you can’t play both.
Meb: You hit on two things I think are extremely important. We’ve been talking a lot about, sort of, startup investing for the past five years on this show. And something that I think most really considered to be a bug is actually a feature. And this cycle, and last few years and months and weeks, I think illustrate that which is you can’t sell something. At the end of the day with stocks, what you want is investments in great growing, cash-flowing businesses, hopefully, good prices. And investing in a lot of these startups, like you mentioned, you don’t get to choose. You’re going to be in there for 5, 10 years, maybe more. But that’s a good thing because how many of us would sell out if something doubles or if something is going nowhere only to do well. And then the secondary because you’re usually starting from lower valuations, the power laws, which apply to public markets, too, of course, but are even more extreme, and private markets really have a chance to really play themselves out. So I think it’s an amazing combo and you combine that on an individual level with some of the QSPS rules and everything else. And we tell investors say, “Look, even if you’re 20 and you got no money, go sign up for Angel list, Republic, review all the deals. Worst-case scenario, you get to see thousands of innovative, amazing companies. Hey, you could go work for one. Best-case scenario, you could start to invest in some and hopefully have a life-changing event and portfolio that 5, 10 years from now ends up being lots of wonderful companies, hopefully, some public, maybe not necessarily through SPAC but it’s public one way or the other.
Jeremy: You know what? Let me just say I think that’s wonderful, a wonderful idea. And I should also add that Boston has been a great place and San Francisco would also do very nicely. But Boston has been great. We have more new enterprises than you do. It’s just that the dollar volume of some of your, kind of, social app outweighs us, which tend to be a little bit more diversified, and engineering, and so on. Actually, we make things in a lot of IBC companies. But it’s been unbelievably exciting to meet with these entrepreneurs and scientists, sometimes both in the same person. And the degree of technology, the promise and some of these new ideas is just remarkable. We have an investment and a company that can produce messenger RNA that is used for the two leading vaccines, for example. It’s a great research medium and has huge potential. It had a bit of a problem though. It was $1,000 a gram to produce. And our guys, I say stumbled in the very, very clever, but in the end, the great breakthroughs need a bit of luck. They stumbled on a way of making it the 35 cents a gram instead of $1,000. I mean, holy cow. And there’s another one that takes nitrogen out of the air, and microbe and fixes it in the ground, as a clover does or some nitrogen-fixing trees, but it replaces the need for nitrogen fertilizer. Half of the world’s population is kept alive by nitrogen fertilizer, which comes from the Haber-Bosch process developed in World War I from munitions. And it’s an enormous tour up of energy. And if we can get this bacteria to do its thing. It does use energy, but it uses a tiny fraction of the Haber-Bosch and would be therefore huge for the environment. Then we have another one that develops a biomodified insecticide. This one and it only addresses its RNA derived. It only addresses the Colorado potato beetle, not even a cousin beetle is affected. And you put a gram in a gallon and you put a gallon over an acre. It goes a long way. And it tells the Colorado beetle that it can’t digest carbohydrates. So it’s the potato and dies of starvation and drops to the floor of the field and is cheerfully eaten by the other insects without Ella factors totally non-toxic. I mean, these kinds of things can change the world.
Meb: I 100% agree with you. And I’m consistently surprised every morning when I read some of these companies on occasions just stop me in my tracks and say, “Oh my God, that’s brilliant.” And I think a lot of people that would be critics say “Hey, all these startups are just trying to optimize the way Google is selling ads” but as you just heard, there’s world-changing science going on. And it creates an optimist to balance out the public market pessimism. Jeremy, you know, as a good analyst and a student of history, is there any part of you that thinks that this massive amount of innovation? And I know VC is still small in the scheme of things.
Jeremy: Let me just interrupt there for a second. If you look at the fangs, they are not small by any definition. They are huge dominating global presences, kind of, instant monopolies. They are really all spinouts from earlier generations of VC. If you had, for example, a buy and hold VC, instead of just routinely selling them every time they go public, and you’ve done it for 50 years, just think of the returns. You own all of the Apple’s and Amazon’s, you know, in the entire dominant part of the S&P back then in the IBM’s, and the Merck’s and the Lilly’s and the Coke’s, and also the GE’s, and people who haven’t done that well, in comparison, a much, much less. So I think we underestimate VC because we don’t realize how a handful of winners quickly turn into mass of market cap.
Meb: You know, speaking to that, I had a friend do a study that he was trying to do for a while. And I could get this slightly wrong, but I’ll post it in the show notes, listeners. But he basically said if you could go back even during the bubble of the late ’90s and purchase the entire class of IPOs, despite the fact that most of them just did a dirt nap to zero and lost all their money because of what you just illustrated, some of the massive winners, you ended up usually having a pretty great performance over the full period. We’ll add the link to the show notes, listeners. I could be getting that wrong, but I think it’s directionally correct because of what you mentioned, what an old friend wrote about called the capitalism distribution, where you have academic paper that talks about, you know, it’s the 5% or 10% of stocks that deliver all the return in the stock market over time.
Jeremy: And maybe the 1% or 2%. You either have to do a really good job of annual turnover of bargains of cheap stocks for what you get or you’re in the business of trying to pick the winners and hold them forever. And I do think they’re both they’re both viable strategies. And some people have a talent for picking stocks that may really have something by the tail, a Tesla. I’m not recommending Tesla, by the way, but some people have a talent for sniffing them out and some people have a talent for working the portfolio hard and, you know, whipping it and moving it around and buying the bargains. And when they go up selling them too soon, if you will, and buying something much cheaper, rotating around, which worked brilliantly for 100 years when the growth managers were hiding under the table basically for less than 100 years. And then for 20 years, the growth managers have done brilliantly and the value managers are hiding under the table. But I think those are the two viable ways of making money.
Meb: Yeah. Jeremy, when you look back on your career, what’s been the most memorable investment, good, bad in between, anything come to mind?
Jeremy: Well, I’ve got to say, back in the mists of time, American Raceways, I told you that story and now, QuantumScape because I can titillate you by saying that for a second there, my holding of QuantumScape was $625 million. I mean, give me a break. I mean, that is enough to concentrate anyone’s brain other than the 30 real fat cats out there, whose wealth is measured in 10s of billions. And sorry, scores of billions would be a better description these days. And anyway, so that leaves me with some interesting feelings that I’ve lost more money in the last five weeks on paper because I’m not allowed to sell. So it’s all relevant. But I’ve lost more money on that one issue than I made in the first 50 years of my business life, first 40 years anyway. So QuantumScape is going to go down one way or the other engraved on the back of my head.
Meb: We’re all cheering for you. I’ll give you a fingers crossed in the next few months, and hopefully…
Jeremy: And we can really use the money. Everything goes into the struggle for greening the economy and saving our bacon. And we could really use every penny we can get our hands-on.
Meb: Jeremy, I know addressing climate change is something you’re passionate about. So I’d love to get your thoughts on it before we go.
Jeremy: It is so critical that I would feel ashamed to have, kind of, left without making at least a point. The point is that we are not winning what we call the rest of our lives. The amount of carbon dioxide extra in the air last year was the highest ever increment. And we don’t start winning until A, that gets to 0. And then we have to backtrack and we have to find a way of pulling it out of the air to take it over the following several decades back down to 280 parts per million. We’re currently at 415 and we’re surely heading for 550, 600, and I hope not 700, 750 but something like that. And we’re going to have to take it out of the air by direct air capture or by biological means by planting trees and by growing seaweed and doing many exotic things, and hopefully, getting paid a carbon credit for doing it, and hopefully, having technological breakthroughs so that the credit we need is only $25 a ton and not $250 a ton because we can afford $25 a ton to get the job done. But we are going to have a lot of pain from the damage we’ve done to the environment, mainly in terms of greenhouse gases. And it’s going to be very expensive and very difficult and highly probably a big chunk of the world, something like 15% will basically become uninhabitable that currently is habitable, which a lot of it is the kind of Saudi peninsula and parts of the Sahara and so on, sub-Sahara, which are bad enough. But the really bad news is that it’s most of the Indian subcontinent, which will in 50 years when the really bad news occurs, will have 2 billion people on it. And a big chunk of the world’s population, which will probably be about nine by there. And then parts of Indonesia, that just unlivable, that the combination of humidity and heat will mean you can’t go out and do your farming, and how much that will stress out the rest of the Indian subcontinent where they still can’t function, I don’t know, but it won’t be pleasant. And Africa is already being stressed, has the worst soil and the worse governance and so on.
And climate change is hurting that. So we have to change our farming all over the world to make it more sustainable. And better than that we have to regenerate the quality of the soils, which we can do. But it takes complete changing of the practices. And you’ve got a vested interest that’s making a lot of money selling pesticides and so on, and fertilizer, and doesn’t want to change, and has a lot of influence with the agencies, and a lot of power in American government courtesy of the laws of the land that enable you to spend as much money as you want influencing politics, which is a crazy way to run a ship. And we’re going to have a lot of pain. And what we’re racing for is these new technologies that will allow us to keep the pain to bearable levels. It’s a huge payoff and every day counts, and everybody’s help is needed. But I don’t think we’re going to do it on the strength of our good common sense, I think we’ve proven in COVID and climate change, that’s extremely limited. We’re going to have to do it because we’re blessed with a plentiful supply of brilliant new technologies. And we’re going to have to make damn sure we don’t waste them. And we develop them as quickly as we can, as effectively as we can. We make the money available for research and development which corporations are so stuffy, they basically start doing. They’d much prefer to buy a VC company, the one out of 5 or 10, that has proven itself rather than take the risk themselves. It costs them money, but it smooth’s out their income stream. When they buy a VC company as a capital transaction, when they do it themselves, had sat deplorable, kind of, ebb and flow of income, which comes with career risk, so they don’t do it. So, we need R&D money from the government, we need good policies from the government to encourage it. Some of the new industries need to be jumpstarted the way they always have done so profitably. Tesla was a big recipient of some government money, and it can make all the difference in the world. And some great VC successes can make a huge difference. So it’s absolutely critical that we get into full-court press, greening the global economy,
Meb: What’s the big muscle movement? So you’ve been doing this for 20 years? And is it a scenario where you’re like, “Look, we got to try 1,000 different approaches,” everything helps or is there one or two specific areas that you think, you know, say, “hey, if we could do, like, a Manhattan project focus on these specific areas, this could have the most impact? Is it that black and white?
Jeremy: Yeah, I don’t know. Of course, how do I know, but it might be. And, you know, our temptation is to think we should only invest in things that can change the game. So, I think fusion will work. And I say, I think it will. I think the odds are better than 50% that one of the two or three dozen new second-generation fusion will work or that the giant billion-dollar sucking ITEI, I-T-E-I enterprises and so on that many countries have backed that will work. One or the other will eventually come through. And it may take a few decades and 30 years is a lot better than 70 years. And eventually, we will have lots of cheap green energy. And we’ll either have it because we have battery storage to go with wind and solar, which is already heroically competitive and will guarantee to fall in price. We’ll either have it down that road or quite possibly we’ll have it from a new generation of nuclear fission. They’ll finally get their act together after 70 years of messing up or a breakthrough in fusion. You add them all together and seems absolutely certain we’ll have plenty of cheap energy. And we will green cement, and steel, and shipping, and aviation and everything else, the difficult ones. The problem is time. We’re going to do all this, but are we going to do it in 40 years or 100 years. And 100 years, we’re going to pay an incredible price and destabilize perhaps the global civilization that we have learned to live with, and ruin a lot more of the planet from an ecological point of view and drive a few million creatures out of business or we’re going to do it quickly and save a lot of that pain. And that’s the game we’re playing now. And who knows how it will work out. I just think it’s going to be a rather closely run affair and that our hold on, on the stable future is not a very strong one at the moment.
Meb: You know, I was just doing a podcast with Nathan Myhrvold, the old CTO of Microsoft, who now does all sorts of things like dig up dinosaur bones. And he wrote a book on cooking pizza but also has designed a bunch of reactors. And it was small scale. And it was so frustrating to listen to because you get so many governments involved and basically, you can just, kind of, put the kibosh on projects like that at will, and so many PR sort of powers between countries and everything else, and it gets frustrating. But the engineer in me and the investor is hopeful that a lot of this early-stage… I’ve seen some really absolutely crazy ideas come across my plate, which makes me even more optimistic because often those end up working out working out too. So who knows?
Jeremy: Yeah. Isn’t that the truth? I got to tell you a story about the Manhattan Project, which is a perfect example for people who think government can’t do anything. Listen, guys, if government couldn’t do anything, we would not have won World War II. America went from producing cars to producing tanks, and jeeps, and destroyers pretty damn effectively. And it was all done at the top. It was all planned. It was Galbraith, the economist was minister of this and that, you know. It was done by a heroic effort. But the Manhattan Project is unique because I knew a fellow who was on an Investment Committee of a mutual fund that we ran. And we used to meet them four times a year as obstreperous committee of scientists and so on used to grill us. And eventually, I discovered that one of them had won the Nobel Prize, I’d met him through the fund, for working done decades before I even met him. So he got the prize after six or seven years of working together for work he’d done decades earlier. He’s been taken out of Harvard, as an undergraduate physicist, and he’d been stuck in the desert as a 19-year-old or a 20-year-old, working side by side with Italian Nobel Prize winners and things. What amazing demonstration of out of the box thinking and risk taking that was going on in the Manhattan Project, I had no idea. And to prove how good it was, he did indeed get a Nobel Prize himself, you know, 50 years later for work he’d done 30 years later. The Manhattan Project took a job that would have taken 15 years easily and then crammed it into three-and-a-half years by dint of money and brilliance and gathering these people together and using any talent they could get their hands on, like this kid. And if we could do half as well, we would be in great shape. We would definitely make the cut. And the fact is that governments can do it if they get their brains together, if they get their act together. The race of our lives will be decided by the difference between what humans are capable of doing and what we will actually do. We can win this race and along the way, get rid of poverty and so on, if we put our best foot forward. But given half a chance, we mess it up. That’s what they say, never underestimate the power and creativity of the homosapiens, and never underestimate his ability to foul it all up.
Meb: How much of the story is outside the U.S. by the way? Is this something that hard to coordinate amongst countries, but also the scientists and engineers and the 19-year-old may very well be from India, or Africa, or China, or Canada?
Jeremy: I have great confidence that the real breakthroughs that the U.S. will play a hell of a role. And by the way, the great research universities are the other true exceptional feature in the U.S., which is closely correlated with the success of the VC industry. Of course, I mean, the U.S. has a death grip on the great research universities. And those that we don’t have the UK is well-positioned too. And then, of course, as always increasingly China. But, you know, China is a monster, of course, in the future in everything. And we’ve documented how it changed the world by going from, you know 5% of cement use to 50% in a 25-year window. I mean, the growth rates of the type that the world has never seen and on a scale that we have never seen. And on the green front, they’re moving like a rocket ship. Everyone says, “Oh, they do this pollution stuff.” And I say kind of get a grip. Of course, they’re trying to grow as fast as they can. They had to catapult the biggest country in the world into the haves from the have not’s. And they have done it. They are now in the haves list of countries, not the have-not’s dealing with a perhaps difficult future. But when you break it down, they have 80% of the world’s production of solar panels. They had up and running 400,000 electric buses. And the U.S. a year ago had 400. It’s more like 1,000 now. But by now China’s kind of moving towards 500,000. The other day, they sold 1,500 to Bogota, capital of Colombia 1,500 electric buses. And the battery efficiency of that is higher even than Tesla in power to weight ratio. And they put in more wind, actually, they put in 75% as much wind last year, as America has put in, in 40 years, cumulatively. And we are allowing the Chinese to completely dominate the future industries. They sell more electric cars than the rest of the world added together. And, of course, Tesla is out there cranking out cars already in China. And they have more fast trains than the rest of the world added together.
And we have none. What the hell is going on? So, yeah, we have lots of technology, but they have a battle plan and a determination to grind forward. And you may completely deplore their politics and who doesn’t? But in terms of the green reality, as opposed to the myth, they are driving the system and they are driving a lot of the costs down for solar and for electric buses, and for electric cars, and for batteries, and so on and so forth. They are a vital role. So, I don’t care if they build it on the back of our technology, the stakes are too high here to be too picky and choosey. I don’t mind if the Chinese are the ones who get a lot of the benefits, either. But it’s a pity that we would not participate more and that we would not be a player in these markets. These markets will be the most important industries and new markets and growth rate of the next many decades. We will have to spend trillions of dollars completely reconfiguring, decarbonizing our future, and it will dominate our portfolios. Why would we not want to be one of the first pushing on every industry quicker and better? We have the old Tesla, but basically, most of the chips here are in Chinese hands and we should be nervous about that.
Meb: Well, nothing helps spur innovation like a little competition. Sounds like a good thing. It’s been a blast. People want to follow you, is GMO the best place to go?
Jeremy: Yeah. Yeah. I haven’t advanced any further than that. We have some good papers on our website. I have one on resource limitations called “Time To Wake Up,” which is probably the best paper we ever did. And we have a couple called “Race of Our Lives 1” and “Race of Our Lives 2,” which covers everything with a lot of exhibits and a lot of data. And we have a decent paper on toxicity, which is hugely under-recognized as a problem and how to deal with that. And then, of course, I have a recent paper on the bubble.
Meb: You know, Jeremy, just to wrap a bow on this conversation with the weirdest possible ending. I’ve invested in over 200 startups, this week invested in when you talk about the toxicity was the largest sperm at-home analysis clinic that’s now at home versus going into a clinic startup is when, again, one of the most obvious ideas that I think probably has a lot of potential.
Jeremy: I tell you what. Will you do me a favor and send me the data?
Meb: I will. It’s an obvious one, but also one that has a huge pharma angle as once you build that database and have all the information. You can start to do things like cancer screening and on and off. We’ll take that offline. Jeremy Grantham, thanks so much for joining me today.
Jeremy: Pleasure. Thank you for having me.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us a message at firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe the show anywhere good podcasts are found. Thanks for listening friends and good investing.