Rationally Assessing an Irrational Event
“The current situation is not supposed to happen, which makes it tricky for us to understand exactly when it will end.”
–Ben Inker, GMO Quarterly Newsletter (Q1 2013)
Investing guru and resident elder Jeremy Grantham’s latest quarterly newsletter is out, and the surprise — at least to me — is that it’s his junior colleague who has the best sound bites, in a follow-on piece titled, “A Funny Thing Happened on the Way to Equilibrium.”
The conundrum that GMO analyst Inker seeks to address: how elevated stock prices and equally lofty returns on capital can coexist, seemingly indefinitely (note: except for a brief period in 2008, at no time in the last two decades or so have stocks fallen to what has been considered historically cheap levels).
Surreal Environment? Or Flawed Model?
Inker’s other zinger (ok, non-zinger) is a would-be corollary to Herbert Stein’s famous observation (also known as Stein’s Law), which states that “if something cannot go on forever . . . it will stop.”
Inker’s formulation:
“If something that cannot go on forever has been going on for an inexplicable length of time, try to understand why it has been going on so long and whether your model might be the problem.”*
Surveying record-high stock and bond prices, record-low interest rates, and a still-sluggish economy stretching seemingly to the horizon . . . lots of other investor-types are scratching their heads and posing the exact same question.
P.S.: Grantham’s piece, “The Race of Our Lives,” features his handicapping the odds that modern society will avert disaster before it destroys itself and planet Earth generally.
He doesn’t explicitly put a number on it, but digesting his arguments, I will for him: slightly better than 50-50.
*If Mr. Inker wants a pithier line, here’s mine: “The fault, dear Brutus, is not in our stars, but in ourselves models.”
