Episode #397: Jeremy Grantham, GMO – Short-Term Pessimist, Long-Term Optimist

Episode #397: Jeremy Grantham, GMO – Short-Term Pessimist, Long-Term Optimist

 

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: 3/1/2022     |     Run-Time: 50:26

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Summary: It’s been about a year since we first spoke with Jeremy (click here for that episode) and given his knowledge of financial history, there are few people who are better to hear from about what’s happening in the world today than Jeremy.

We start by touching on his investment in QuantumScape, which he saw grow to $500 million on paper and later decline by 80%. Then Jeremy shares what he thinks the societal implications will be from a huge potential write down of perceived wealth in the US if this superbubble bursts. He also touches on some of his biggest concerns at the moment: the conflict between Russia and Ukraine, labor and materials shortages, poor demographics, and rising inflation.

While Jeremy is frequently referred to as a bear, one of my big takeaways is his optimism and excitement to solve some of the longer-term problems faced around the globe.

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Links from the Episode:

• 0:40 – Sponsor: MUD/WTR – Use code “MEBMUD” for $5 off
• 1:50 – Intro
• 2:52 – Welcome back to our guest, Jeremy Grantham; Episode #286: Jeremy Grantham, GMO
  
• 3:32 – What’s transpired in the past 12 months since he first appeared on the show
• 6:14 – Update on his investment in QuantumScape
• 12:57 – The impact of the Russian invasion of Ukraine on wheat prices
• 19:32 – Would we be better off with robots instead of the Fed?
• 22:00 – Societal implications of a possible write down in perceived wealth
• 25:35 – Not being able to rely on bond diversification (Ben Inker 4Q21 Letter)
• 26:54 – Jeremy’s thoughts on commodities and emerging market value today
• 29:53 – Triumph of the Optimists; Credit Suisse Annual Reports
• 33:02 – Why Jeremy is as a perma-bear but largely optimistic; Reinvesting When Terrified
• 34:59 – What Jeremy is thinking about in the VC world
• 38:02 – Jeremy’s take on nuclear power
• 45:38 – The cost of capital and inflationary pressures in the coming decade

 

Transcript of Episode 397:

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Sponsor Message: Today’s episode is sponsored by MUD\WTR. MUD\WTR is a coffee alternative with four adaptogenic mushrooms and ayurvedic herbs. With 1/7th the caffeine as a cup of coffee, you get energy without the anxiety, jitters, or crash of coffee. Each ingredient was added for purpose, cacao and Chai for mood in a microdose caffeine, lion’s mane for alertness, cordyceps to help support physical performance, chaga and reishi to support your immune system, tumeric for soreness, and cinnamon for antioxidants. If you’re a long-time listener of the show, you may have heard me say I’m having a couple of MUD during an episode before. My current favorite is the new :rest Blend, a non-caffeinated tea, which has become part of my evening routine. And not only am I an avid customer, but I love the product so much I became an investor in the company. If you haven’t listened already, check out Episode 259 when I spoke to the MUD/WTR founder and CEO, Shane Heath, about why he started the company. MUD is Whole30 approved, 100% USDA organic, non-GMO, gluten-free, vegan, and kosher certified. Go to mudwater.com/meb to support the show and use the code MEBMUD for $5 off. That’s mudwater.com/meb and use the code MEBMUD for $5 bucks off. And now, back to the show.

Meb: What’s up friends? We’ve got a huge episode for you. Today, we welcome back GMO’s Jeremy Grantham. It’s been about a year since we first spoke with Jeremy. And given his knowledge of financial history, there are a few people who are better to hear from what’s happening today than Jeremy. We start by touching on his investment in QuantumScape, which he saw the growth to over $500 million bucks before later declining and liquidating. Then Jeremy shares what he thinks the societal implications will be from a huge potential write-down of perceived wealth in the U.S. if this super bubble bursts. It feels like it’s already started. He also touches on some of the biggest concerns of the moment, the conflict between Russia and Ukraine, labor and material shortages, poor demographics, and rising inflation. While Jeremy is frequently referred to as a perma-bear, one of my big takeaways is his optimism and excitement to solve some of the longer-term problems faced around the globe. If you want to hear our conversation with Jeremy from February 2021, check the link in the show notes. Please enjoy this episode with GMO’s Jeremy Grantham.

Meb: Jeremy, my man, welcome back to the show.

Jeremy: Howdy, good to see you again.

Meb: We had you on almost a year to the day, beginning of February, a year ago. And we thought we’d have you back on because it was just this quiet year. Nothing has transpired in the year since we had you.

Jeremy: Boring, boring.

Meb: As always with markets. But I thought I’d let you walk us forward a little bit from last year because we talked a lot about the crazy times that were going on. And then fast forward a year later, the last month notwithstanding as much, the market kept going up, or at least the U.S. stock market did, the broad-based. Maybe tell us a little bit about what’s transpired in the last 12 months in the world of investing.

Jeremy: Very quickly, I don’t think it was the broad-based that went up. Almost half of the NASDAQ stocks are down 50% from their high. And the one or two of the superstars of the craziest ones that already started down when we spoke, my favorite, QuantumScape, a spike that came at 10 went to 130 worth $55 billion with four years still to wait before they had any revenues, forget profits, and the biggest holding I’d ever had in my life. It made me personally, to be blunt, a quick $500 million on paper. But it couldn’t be sold for six months. And I opined that it would probably not get to the six months. And by the time the six months was up, it was down to 25. So it was down 80%. Today it’s 15. And that has led the charge. But by the middle of last year, it was joined by a lot of the AMCs, the Bitcoins, and the Game stocks, the meme stocks in short, the meme ideas since Bitcoin isn’t a stock. And they peeled off and joined in. The whole SPAC index was a disaster. Cathy Woods, ETF went down 50%, 60%. And they were the more exciting stocks of the previous year.

And this is eerily like 2000. In 2000, the growth stocks, the TMT as they call them, technology, media, and telecom, they peeled off starting with the flakiest and most speculative first, the ones who triple the year before. And then it worked the way through the system until it finally got to CISCO. But by the fall, they were down badly and the rest of the market was still up. So the S&P. On September 1st to be exact, I looked at it yesterday, got back to where it had been in March. And the NASDAQ itself, off a big hit, had a big rally in the summer. And then the whole thing rolled over and everything went down 50%. Incidentally, the ones that had been hit by 30% or 40% also went down 50% from a worse starting point. So the NASDAQ ended up -82.

And that pattern has been creepily like the one we’ve been watching. So 12 months ago, yes, the S&P is still up 16%, but the Russell 2000 is down. And that’s the one we short against our huge holding of VC. And so that hasn’t been nearly as painful as you would suggest.

Meb: I think that you and I had almost nailed to a tee. I mean, you and I were talking about sentiment and how at the peak of the bubble it’s like the most euphoric time. And last February, when we were talking about this, it was up there. And then even in the ensuing months, you talked about this where it’s still euphoric, just a little bit less so. But a lot of those names, I tweeted about this, I was like, “This feels like one of those times when you blink and a bunch of these high flyer names are down 40%, 60%, 80%.” But most importantly, Jeremy, did you get liquidity on QuantumScape? Are you still holding it?

Jeremy: We sold 75% the first week or two that we could and we got 25, and then more recently had had a bit of a rally and we sold 20% of what we had left, and about 15 or 16, I guess, were in no man’s land. Below 10, we might even start to buy it again. It’s a brilliant little company. And it could one day be a complete monster with solid-state batteries. Everyone has talked about it. No one’s done it. But these guys are packing their way step by step through the problems, I think, with any luck.

Meb: It’s funny because as you look at the career arc, you mentioned at one point on paper by far the biggest gainer but also the biggest loser.

Jeremy: Biggest gainer, the biggest loser. I’m trying to think what the one in 2000 was called, but it tripled or quadrupled in ’99 and then lead the parade down.

Meb: I have too much PTSD from that time because I owned all the names. I was in university. I had CMGI, I had Lucent Technologies, like all the way down, I was the owner of all of those. But I still viscerally can feel the experience. I was talking last year because I had done startup investing and a startup I’ve invested in, there was an aerospace, went public via SPAC at a crazy valuation, in a much smaller scale of course, but did the same thing. It went from 10 to 20 something, and I think it’s hit like 2 now. So it’s still up from the Angel investment but not a 50 bag or whatever it might have been.

Jeremy: Yes, the guy who runs our foundation for the protection of the environment, he and I were sitting around spending those hundreds of millions that slipped through our fingers. So anyway, suddenly the world has changed a bit. And as a historian, I can say with confidence that these geopolitical events are murderously difficult to predict. If you could tell me how long it would last, even then it would be difficult. But in a month, they could have a regime change in Russia and we could be in a honeymoon period again, or this could drag on to be absolutely the start of a multi-year super Cold War and it would have repercussions everywhere. Wars are not obviously bad for stock markets. But they do set in process a lot of CapEx, a lot of new products, a lot of war profiteering if you will. So it isn’t necessarily doom for the stock market. It’s a miserable time for everybody else, but in wartime, people do work harder and produce more.

Meb: It reminds me the old Rothschild quote. It’s like “Buy on the sound of cannon, sell on the sound of trumpets.” But we talked a little bit about this during the Coronavirus, during March. I had done a post, which said, look, you could very easily make a bull and a bear case. Like, the bear case is there’s variants, the vaccines don’t work, health systems are overloaded, markets are already expensive they keep going down. You could make the bull case, which is kind of what transpired, that the vaccines work, things progress and the stock market is hitting all-time highs again. But when I posted that, I remember people were just like, “Oh my God, that’s crazy. That will never happen.” But here, you find yourself, it’s like with the Russia thing, which is probably even more unpredictable. But you see a scenario, very easily, like, what’s the most likely outcome, what are the possibilities on each side, and I think the one that you mentioned is a real possibility. But who knows. Like, that’s the future. It’s unpredictable.

Jeremy: From my point of view, we had enough unpredictability anyway without this. I had become pretty confident that we were, from a psychological point of view, running through the usual game. And we were losing confidence in the high-flyers, losing confidence in the super specs, and I thought the probability of a recession in the next year or two was pretty high. And I thought sooner or later with all the debt around, that is going to trigger at least a partial financial crisis. So you have a plentiful supply of big negatives that could happen. And as you get out a year or two, you get into this field where I think the long-term outlook for inflation is really quite bad because we are basically running out of resources. We’re getting very tight on both labor and important raw materials. The cheapest copper ores and lithium, cobalt, nickel, the stuff you need to electrify the system, they have all gone. We’ve no great CapEx projects up our sleeve. We’ve actually, since China slowed down in 2011, the CapEx has dwindled way down. There aren’t plentiful reserves. So as we gear up to decarbonize, we’ll be bumping our head, almost guaranteed on shortages from time to time of these critical metals.

And then you have the problem of labor, which, in the short-term basis, everyone’s saying, “Where have they all gone?” But in a long-term basis, I can tell you where they’ve gone, they were never born. There is no improvement in the baby output over the last 20 years, We have slightly been declining. So if we can guarantee, since they’re already alive, that the supply of 20-year-olds entering the market in the developed world, in the U.S., and in China, will be declining. This is totally unlike the Goldilocks era of the last 20 years, or indeed the post-World War II era. We’ve had a plentiful supply of new labor. And in Japan, of course, we had all those semi-redundant farmers plowing into the cities and getting plugged into, frankly, a very efficient, hard-working capitalist system, 500 million of them, and then 200 million Eastern Europeans actually starting to seriously work. So that completely cluttered, if you will, the global labor market and put pressure on labor everywhere. And now, you wave your magic wand and you find quite abruptly, China has gone from an excess labor supply to a shortage around the corner.

Meb: I keep an eye on Ag prices a lot. We have some farmland and wheat is darn near pushing on $10 a bushel right now. The last time we were here, Arab Spring was going on and the food prices certainly created a lot of stress around the globe. I feel like that’s been a little bit lost. And what’s going on this year, certainly dealing with the Russia invasion, but no one seemed to really be talking about that much at least in my feed.

Jeremy: I’ve been talking about it all the time because the UN food index is back to those highs of 2011. And Ukraine is not a bystander. Ukraine is part of the great breadbasket of Europe. It’s where wheat comes from into the export market. So if you’re an Egyptian, half your imported wheat comes from the Ukraine. This is entirely relevant. And you add together the change in the weather. At least in the Arab Spring, people weren’t obsessing about floods, droughts, and higher temperatures. But that has become painfully more obvious in the last 10 years. And it’s making agriculture very difficult.

Jeremy: What do you think this analogue, as we look back, is this a slight early ’70s vibe, is there another period that feels similar to you or whether it’s in the U.S. or globally or anywhere that’s a similar market setup that we have today.

Jeremy: Every system is so complicated, they’re always different. But I think the last 20 years has been completely different. Indeed, I wrote a quarterly letter in 2017 saying, “I couldn’t find anything that wasn’t different.” The four most dangerous words in investing were not “This time is different.” But really, the five most dangerous words were “This time is never different,” because from time to time things absolutely change. And they changed in the early 21st century. And we went to a regime of corporate paradise where PEs were not just higher than the previous 60 years, they averaged 60% higher. Profit margins were not just higher, but they average close to 40% higher. So profits as a percentage of GDP went up several points, and wages as a percentage of GDP fell a few points. So these are profound differences. And they were accompanied by the lowest interest rates in the history of man, which declined…well, they declined for 50 years, but they declined the entire 21st century. And the supply of debt rose more rapidly than probably any other 20-year period outside a major war.

So everything had changed. I think what is going to happen is that it’s changing back. We’re going back, in many ways, to the 20th century. Inflation has been a non-issue in this Goldilocks era for 22 years. I am proud to say I wrote 20 years of quarterly letters and I never featured inflation. It was completely boring and out of my interest zone. And in the 20th century, in the ’70s, ’80s, and ’90s, as investment managers, of course, you could not ignore inflation. I think inflation is always going to be part of the discussion once again. It’s not always going to be 7% or 17%. It’s going to ebb and flow. But it will always be thought about. Again, the last 20 years, we forgot about it. And PEs depend on two things, profit margins and inflation. Profit margins are high, inflation is low, you have a very high PE.

You go back to the 70s, you have high inflation, low profit margins, you sell at 7X depressed earnings. And then in 2000, you sell at 35X peak earnings. This is double counting of the worst variety. And we have been selling at peak PE of peak profit margins recently. That is not a point that you want to jump off if you have the choice. You want to start a portfolio in 1974, PE is seven times, profit margins are about as low as they get. Paradise, how can you lose money? You do not want to start at the opposite where we were a year ago.

Meb: I posted on that topic this past year. And it’s probably the number one angriest responses I got on Twitter. And I said, “Look, this is even my work.” I mean, you can look at Rob Arnott, you can look at GMO, a million other people have talked about this, it’s very easy to see in the data. But you guys have a beautiful chart. I think it even goes back to 100 years or so. But overlaying a predicted PE based on the inputs you discussed, and there’s really high correlation. But there was two periods that really stick out, you know, now and 2000.

Jeremy: I’m shocked that you say 100 years. But of course, 1925 is suddenly, almost 100 years. But it tracked 1929 beautifully, and the ’30s with low PEs, and the ’50s recovering. And the only thing I got materially wrong as you say was 2000. In 2000, we predicted profit margins and inflation predicted the highest PE in history. And we had the highest PE in history. Only it wasn’t 25, it was 35. They went 40% higher. And for two years, that was possibly the only really crazy psychology ever because it took perfect conditions and then inflated those, if you would, by 40%. And now, starting just after we spoke a year ago, the thing diverged again. It was beautifully on target when we spoke. And then a month or two later, inflation started to rise rapidly. And the PEs, instead of going down, went up. And I can say with a clear conscience nothing like that has ever happened since 1925. When PE goes from 0 to 1, 2, 3, 4, 5, 6, 7, the market crashes. You can explain the PE of December 31st. You can explain it by saying not that it’s 7% inflation, but that it’s perfect inflation. It’s 1.9 and stable, not 7% and unstable. That has always been a bane on PEs. But not this time. This time the world 100% believed that the Fed was right when it said it was temporary, which is remarkable, given the Fed’s record of getting nothing right, I find it bewildering that the world would believe them. But they do.

Meb: You mentioned inflation. I had a joke, where I said, “What if the Fed gets together…they write up all these fancy notes. But well, all they really do is they drink some beers, watch “Seinfeld,” and then just peg the Fed funds rate to the two-year.” I say you’d probably be better off. It’s a pretty close series, they just don’t tell anyone they’re doing it and just peg it to it. But they’re consistently been under it the last few years. We’d be better off of the robot, what do you think?

Jeremy: I think we’d be better off if the Fed had the simple instructions to keep a very steady supply of money available, commensurate with the growth rate, the provable growth rate, the intermediate trend line growth rate of the economy. But they have all of these delusional instructions, control the growth rate, control inflation, control this, control that. It’s all outside their capabilities. But they have learned that they can stimulate the stock market. It’s not clear that they’re that good at stimulating the economy. But they can certainly stimulate asset classes, particularly the stock market. In the short term, they can cause the economy to do well, but just reliably for a quarter or two. And then anything can happen.

I do sympathize with them. When COVID struck and the economy goes into free fall and confidence collapses, you know that you need some strong action from the Fed and you know you need some strong action on a fiscal basis, from the government. And the question is not trivial, how much? And guessing how magnificent that it has to be to do a good job without guaranteeing several years of inflation is a pretty tricky job. And with hindsight, it’s fairly clear to me that they probably put in about twice as much as they had to, twice as much stimulus of all kinds as was necessary. But how are they to know? The Europeans and the rest of the developed world probably put in a little less than half as much as the U.S., and they did fine. But the U.S. bounced back faster, but also they have the highest inflation and they have the most intractable-looking inflation of any developed country. And they’re probably going to keep that way for quite a while as that huge unprecedented spike in money flows through the system. And where that will leave us with these debt levels, if there is a crisis, we will find out one day perhaps.

Meb: One of the things you talked about that I think is interesting implications, you referenced it jokingly with your QuantumScape holding, but this concept of like a hedonic adaptation to wealth and we have the highest net worth in the U.S. relative to GDP and many metrics, but much of that simply due to stock valuation on your balance sheet, personal balance sheet of all individuals in this country, right in line with housing. That goes down, let’s say theoretically, like a normal bear market, you know, we go down 40%, 50%, 60%, no big deal, it happens all the time. Are there any different society implications this go-round versus prior go-rounds? Is it something you think has a different impact this time?

Jeremy: I think this chain of lower interest rates and higher asset prices has gone on so long that it has obviously made worse the inequality. There’s been enormous wealth increment. But the income has not done nearly as well. The GDP growth of the U.S. has slowed way down. This is not me, this is just a question of fact. I’m happy to say I wrote a quarterly letter in ’09 called basically seven lean years. And it featured, of course, the ancient Egyptians and Joseph and the seven lean years. The seven years after that were, in fact, way below trend. What I underestimated was that the 12, 13 years after that were all way below trend. Our productivity basically has gone to hell since the great financial crash or whatever we call it. So people have gotten rich on asset prices.

But the underlying reality, the supply of goods and services has been disappointing. So you have created a situation where the price of houses is selling at a higher multiple of family income than even the housing bubble. Stocks are selling at a higher multiple of price to sales than 2000. Every single decile of most expensive to cheapest are way above 2000. And if you’re a beginner, you can’t really buy a house. You’re being offered assets of all kinds, stocks at pathetic yields lower than any other time in history. And if you want to save your money in the piggy bank, of course, you pay for the privilege.

This is absolutely dismal for the people without assets. For the bottom half, the bottom three-quarters have not benefited from the great inflation of asset prices. Quite the reverse. They suffer because they can’t participate. Their parents could afford to buy a house at 3.5 times income. They can’t afford to buy a house at 7 times income. Or if you have the misfortune to live in London, or Paris, or Vancouver, 10, 11, 12 times income. This is unusual in that the U.S. appears to be bubbly prices in real estate, but it’s one of the lower places in the developed world, whereas in the stock market, it’s the other way around. And most non-American stock markets are curiously reasonable. They’re overpriced but no big deal, whereas the U.S. is super crazy. And then of course, in other assets, bonds are uniformly ridiculous and rates are uniformly ridiculous. But even farmland and forest and so on, they’re all selling way higher than they used to. But stocks are not too bad.

Meb: And some of them painfully so I have been getting even cheaper this past week. Your colleague, Ben Inker, wrote a thoughtful piece recently that touches on what you’re talking about, bonds not being a good alternative in the U.S. They had a piece that showed during the pandemic, largely due to the yield starting at zero and negative in a lot of countries. One of the most common assumptions you hear from investors in the U.S. is that bonds will help in a downturn. But the example they gave was during the pandemic bonds didn’t help in the countries where the sovereigns were trading at like -1 already. They actually hurt. They had negative yield. So that concept of bond diversification isn’t one you can count on.

Jeremy: That happened, of course, in the ’70s. We were running a value portfolio and bonds dropped like a stone and stocks dropped like a stone, and everything went down. And the blue chips went down just as much as the junk. It was a horrible even markdown of everything. We were in small-cap value. And that went down the same 50%, or the Coca Colas went down. The difference was then on the recovery. We were leaping up 20%, 40% a year and they were creeping up 5% or 10%. And that became a massive divergence in favor of the cheap stocks.

Meb: You mentioned commodities certainly or real assets in general. We do polls on Twitter on occasion just to check sentiment. And we asked investors, “You know, are you invested in real assets, whether it’s REITs, commodities, tips, maybe?” But it was a very low percentage. I mean, vast majority was less than 5%. And then there was like a barbell. There was like 20%. There was, you know, a huge percentage. But that’s a joke that’s all Canadians and Australians, no one else probably.

Jeremy: Well, you can’t have too much money in commodities because it doesn’t exist. You are locked in by how big those sectors of the market are. And commodities have never been a huge component, a huge percentage of the S&P. But they have behaved beautifully in inflation. And they have this unique characteristic that over long-term, they go in opposite directions. So if you have a decade with strong inflation, they do well and the rest of the world does badly, and in reverse they do badly and the rest of the world does well. So they are real diversification, much higher quality diversification than any other asset you compare.

Meb: The challenge I think a lot of people are facing this year, everyone wants to focus on what to buy, what to sell. But we say one of the ways to think about portfolio construction is also to think about position sizing with whether it’s individual security or an entire category. One of the areas that you and I both think are a better opportunity set certainly has been emerging value and foreign markets in general. But as we see with geopolitical events, sometimes they can wake up and spring something totally new on you. Walk us through how an investor could, should think about events going down now with respect to an asset class like value in foreign and emerging markets and anyways think about it from somebody who’s been through it.

Jeremy: It’s clear that in any drawn-out setback in the market, a value has been a great help. And in any category, the cheaper ones do better. And the cheaper categories tend to do better. The trouble with geopolitical events as they can cut across that, if you go back to the 1920s and suddenly you take out Russia as a capitalist country, bang, your Russian bonds are good for nothing other than framing and hanging on your office wall. And Russian stocks, the same. And the same with World War II. Your Japanese and German holdings, you wipe out a couple of decades and then you start again. And they did remarkably well. Of course, postwar recoveries are brilliant. They got back most of what they had lost. But they very seldom get back everything, and those two never did. It’s highly unpredictable and wouldn’t wish it on a dock in terms of portfolio management because it can bounce either way and it can bounce quickly, in this case.

Meb: It’s a hard thing to game plan for, where we always say, and China being another one that shut down markets for a while as well. But looking at that history, we talk about one of our favorite investing books, “Triumph of the Optimists,” and others like it, that give at least a historical perspective. And by the way, listeners, we’ll put it in the show notes, but Credit Suisse puts out a yearly update that’s free. We’ll tag it so you can take a look. But it’s fun to look through because you can check out some of these periods. And they actually this year is they talk about inflation and how that impacts both stock and bond returns over a period.

Jeremy: A close reading of that book would suggest a better title which is “Triumph of the Lucky” because those people who avoid getting wiped out in a major war have simply done a lot better.

Meb: It has a good chart this year that shows the benefits of diversification. It says, well, theoretically, a U.S. investor could have been just fine sitting in U.S. stocks and bonds. But then it shows all 40 countries and say by the way, the vast majority of countries would have been better off by diversifying because like you mentioned, you know, almost everyone has gone through something that’s worse than the U.S. situation. And extrapolating from the past, particularly with valuations where we are now, you could end up with quite honestly probably the opposite scenario.

Jeremy: I think one of the handful of countries that beat the U.S. is Sweden, who very carefully avoided both wars.

Meb: Switzerland, you could probably put in that category. They had one of the lower drawdowns if I recall. But in general, if that’s something anybody wants to bet all their money on, to me it seems challenging. So I’m not sure.

Jeremy: It wasn’t just that the U.S. didn’t get wiped out by invading armies. It absolutely prospered from war. The Japanese made one of the craziest decisions in the history of man. They attacked a country whose operating rate on the day of Pearl Harbor was as bad as low as it’s been ever. So I think the operating rate in the U.S. was like 70%. In other words, by moving up to full capacity, they could fight a war and maintain the living standards that they had had simultaneously, which is exactly what they did. In fact, to the poorest 25%, they were better fed and better everything during the war than they had ever been. And they came out, of course, as the manufacturing base for the world and much stronger on an absolute basis than they had ever been and much even stronger than that on a relative basis because the competition had been whacked. And a lot of the competition had been whacked 30 years earlier in the First World War. How to get ahead is to have all your competitors have two world wars and end up supplying them with goods and developing your industry. But if Japan had attacked at a time of maximum economic activity, then of course the U.S. would have asked for a massive concession on the part of the average person. They’d have had to go back 20%, 25% like they did in England to find the resources to fight the war. And that’s a very different state of affairs.

Meb: People love to describe you as a bear or even a perma-bear. But I like to describe you as arguably one of the world’s most optimistic investors because of your foundation portfolio with venture capital and everything else that’s going on there. Give us some updates.

Jeremy: Let me plug my one and only writing that was not a quarterly letter, which was “Reinvesting When Terrified” that I insisted on putting out a very short two-pager because I didn’t want to wait. That came out by sheer luck on the day the market hit its low, saying “get your ass back in the market.” My only other claim was that there used to be something called the portfolio letter that’s long gone. But the issue in early July of 1982 quoted me, and that was the first quote I had ever had anywhere. And it said that we were close to an unprecedented rally in both the stock and the bond market, which is a pretty nice quote for July 1982. So those were the two real bear market lows, 1982 and 2009. Everything else was an intermediate low. And that looks pretty good to me. And as recently as 2017, I was the guy debating Jim Grant on the topic “This time is different,” with him taking the value case and me taking the “Dudes, this time is really seriously a different” case.

Meb: As we think about that, what would be the distance down where Jeremy would write “Investing When Terrified” part two? Is that about 30% decline from here or 40% decline on the S&P?

Jeremy: About a 40% decline would probably have me write that letter. And it might, next time, it will turn out to be 20% too early. So what the hell? If you get close enough, you don’t have to worry about that.

Meb: On those sorts of things, it tends to be we’ll be calling you the lone bull there. But talk to me about the VC world. What’s going on? You guys still looking at the same themes, you’re still thinking about the same things over the last year, or are you guys turning your attention to other ideas? What are you thinking about?

Jeremy: We were thinking about having marginal liquidity. We were thinking about the fact that everything is likely to be marked down. And that certainly includes early stage, new issues, particularly SPACs, of course, but even IPOs are all vulnerable because they’re all at the very growthy end of the game. And they’ve had enormous enthusiasm. And therefore, of course, the VC portfolio has embedded in it one of the higher levels of enthusiasm the way it did, let’s say, in ’98, ’99. We hope it’s much better off this time than 2000 because there’s so much money further down the pipeline whose job description is investing as these new ideas get going. And that money may bail out quite a few enterprises. What happened in 2000 was that a lot of them were good companies, and they failed because of the change in attitude and the liquidity had gone. And there was no money to be had. And they work on fairly short leashes, a lot of them, which you could argue is a mistake. But it’s the way the VC industry functions. It has a time horizon of the year, 18 months, and it raises some more money.

When pessimism comes, you have to hang on by your fingernails, and sometimes you can’t. So there were quite a few cohorts by year that didn’t do very well in 2000. And this time, I think green is very promising. The countries of the world are getting behind the reality that they must decarbonize. They must have alternative energy supplies. And the one thing about this crazy Russian behavior is that it’s going to completely underline that Europe, in particular, can’t depend on Russian gas or Russian oil much longer. It’s going to force them to spend much more money and take energy diversification much more seriously. But they haven’t put nearly enough into R&D behind improved nuclear, whether that’s fission or fusion. I am very optimistic about fusion, and we have a couple of investments in it. I think it’s at least 50/50 we will end up with fairly cheap fusion. I say fairly cheap because the capital intensity of these things is so big that by the time you’ve amortized it over its 40-year life, that guarantees it ain’t that cheap. This is not the nearly free energy one you used to dream about in the 1950s. It could be as cheap as wind and solar and be deliverable day and night, 24 hours. So it would be very nice to have around. And there are a lot of very exciting new ideas like fusion on the green side. Agriculture, full of interesting new concepts.

Meb: It’s funny, there’s a quote you see a lot on…what is it, there’s decades when nothing happened, weeks when decade happens, and this past week certainly feels that way. It feels like the narrative and shift around energy has totally changed, whether it’s in Europe, in America, but people’s attitude for a long time towards nuclear and towards a lot of ideas seems to, like, seven days later it’s a new world we’ve all woken up. And it’d be curious to see. We actually talked about nuclear on the last show a year ago. And you see TerraPower getting approval in Wyoming. And I wonder how much this accelerates at.

Jeremy: What you can do in the short term is you can get countries like Germany snap out of their crazy daydream and not shut down the several nuclear plants that are due to be shut down pretty soon and extend their life for 10 years and so on, which is probably an option. That alone makes a big difference on the margin. And you just have to start producing wind and solar and storage and upgrading your grid. America has practically a medieval grid. It’s odd what is happening in the U.S. because last year in Europe, 14% of all the cars sold were electric cars. And in China, it was 11% and here it was 3%. Find me another dramatic new idea where the U.S. has not led the charge. If you back up 30 years, surely we would have been 20% to Europe’s 14%. That’s what usually happens in a brand new idea with lots of venture capital and lots of innovation. And indeed, we have Tesla. Tesla is like a reminder of where we should be. We should have three Teslas. We should be ahead of the world, not running along at a miserable 3% electric vehicle.

Meb: Well, you know what it is here. I’ll tell you the Americans love their pickup trucks. So when Ford launches this electric lightning, I’m telling you, that thing is going to sell a bazillion. If Elon just put out a normal pickup truck, he would be worth a trillion-dollar market cap, I think.

Jeremy: Hey, even his abnormal one has a huge order list. He just doesn’t have to build it. He’s making so much money. He’s building cars as fast as he can sell them. He’s charging more than he ever dreamt he’d be able to charge. And he’s going to crank up another 50% increase without risking a fancy new pickup truck. And then he’ll do a pickup truck and it will be the best probably, and so on and so forth.

Meb: Normally, I would ask you, as we’ve been kind of wrapping about everything, say what sort of risks are you seeing? What are you thinking about? But that seems quaint given the news flow we’ve had over the past week. So I’ll ask in a different way, what else is on your brain, this crazy world we’re living in? Is there anything else, in particular, you’re thinking about that we didn’t talk about today that you’re either excited, depressed, curious, confused about?

Jeremy: I’m excited about the opportunities that the longer-term problems will present. The longer-term problem is we’re going to be short metals, short food, short resources, short people. But then you flip that and you say, “What do we have to do?” We have to recycle much more. We have to redesign our products so that they’re more repairable, that they are longer lived, they are more economical with their use of metals. We have to find alternative materials. Biomaterials would be perfect in the sense that you grow them. And you create micro cellulosic fibers with strength like carbon fiber, better than steel, and lightweight materials that can replace cement and steel.

And the list of innovations, we will have to get our brain around. We’re going to have to redesign batteries in particular. We don’t have the lithium to produce the batteries for the cars we think we’re going to produce. We barely have the copper, and we certainly don’t have the cobalt, and we probably don’t have the nickel, a lot of which comes from Russia, by the way. And the price of all of those has gone through the roof because they recognize that we’re in pretty miserable state already. You try quadrupling the fleet of electric vehicles and we have real problems.

But it is begging for a redesign, a new battery that doesn’t use cobalt. Yes, done that. The batteries that use iron, which there is a lot, yes, we’re doing that, which was surprising everybody. But we’re going to have to keep redesigning, rejigging, replacing, and inventing new materials. And this is pretty darn exciting. We’re going to have to find ways of retrofitting buildings cheaply, not the miserable, labor-intensive, high-cost ways that we do it now. We’re going to have to build higher quality buildings that are on day one hugely more energy efficient. This is going to take trillions of inventive dollars, not regular business as usual dollars. So this will be one of the great challenges. And it will be an absolute godsend for the VC industry. And the great research universities, their research labs will have more ideas and they can shake a stick out for the next few decades.

Meb: We often tell investors, the public markets are so full of negative news flow consistently, whether it’s geopolitical, whether it’s just like the noise of CNBC and everything. The startup and research-based companies, it’s like the most optimistic thing in the world. And we tell investors, “Hey, look, even if you’re not going to do Angel investing, just go sign up and read some of these decks and listen in because it puts you in a better mood.” And there’s nothing I’m more optimistic and bullish on than human ingenuity and the ideas that come out of some of our great thinkers and scientists and everything else. So it’s a lot of fun and puts you in a better mood than watching the tickers all day for sure.

Jeremy: We sold one in the last month that is going to replace industrial nitrogen by supercharging bacteria that goes in the soil and grabs the nitrogen and fixes it like a plant. And instead of dying in a few hours, it lasts a couple of weeks and can really, with a bit of luck, really substitute for most of the industrial energy-intensive nitrogen that we produce. And last Friday, we saw a startup nuclear that just leads us to think that in 15 or 20 years we may have the first generation of fairly small fusion reactors.

Meb: It reminds me of an old Asimov book, it might have been “Foundation” that was talking about one of these topics with the populace and there was an invasion and said when people really started to give up on the invasion is when their personal energy devices stopped working. I got to look up which book that is. Anyway, unrelated to what we’re talking about, but a good book nonetheless.

Jeremy: So we’ve been talking about what’s exciting. And the answer, I suppose with any bad time, with any big challenge, is the opposite side of the coin is, of course, it comes with the great opportunities. World wars created such a surge of technological improvement. World War II really pumped up the U.S. in particular for the next 20 years.

Meb: The challenge is we just got to make it through the period, the threats of nuclear war to get through on the other side. Hopefully, we can be doing this in a year and look back and talk about how this worked out. Jeremy, it’s about dinnertime there, happy hour time. Best ways to keep up with your writings now, still GMO?

Jeremy: Yeah, we’re trying to get a paper out on the long-term shortages that will, in my opinion, create longer-term inflationary pressures, and therefore change PEs and change the rates, and hopefully balance the books a little bit back towards labor from capital. I’m not anti-capital, but I am when it starts to crush the rest of the society the way it has done and more recently, in my opinion.

Meb: I agree with you. I think that’s a trend that will probably be secular for quite some time.

Jeremy: And people are all focused as they always are on the next year or two. I get that. But I’m much more interested in a period beyond that. What does the next ten years look like? It looks like a period of shortage, invention, challenge, inflation, and cheaper assets. Whoopie for those people who are acquiring them, not so good for people who are selling.

Meb: That’s right. Well, if you’re a young person, that’s the best thing you can cheer for is a nice, big, fat bear market.

Jeremy: Absolutely. Oh, and by the way, just let me make the point. People don’t realize that when you have cheap assets, that 6% yield that you’re reinvesting…a forex is a good example. You pay 6%, you buy another forex, 6% increment a year. When it doubles in price, what are you doing? You’re now compounding at 3% a year. In 48 years, you’re down to a quarter of the wealth you would have had in the 6% world, a quarter. And yet we all love high-priced assets. It’s because we’re all so short-term and basically a bit innumerate. We don’t get it that cheap assets with high yields is a much better state to live in than high priced assets and tiny yields, or in the case of bonds, negative.

Meb: A lot of the low yields around today, I think S&P was darn near plumbing the lowest dividend yield ever. I mean, obviously, there’s a gross difference with the buybacks, but it got darn near 1% here in the last few months. Well, Jeremy, this has been a blast as always. Let’s do this again. Stay safe and healthy.

Jeremy: Thank you. Bye-bye. Good to talk to you.

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 feedback at the mebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.