It is often said that the most dangerous words in investment are that 'this time it's different', but could it be?
- The value philosophy – that everything reverts to the mean – presents one of the few reliable ways to earn super-normal returns
- Value investor Jeremy Grantham recently broke with tradition to say, “it can be very dangerous indeed to assume that things are never different".
- It is difficult to find hard evidence that this time really is different
The phrase resonates through stockmarket history as experts pontificated that old rules of valuation no longer apply and the current crisis/situation bears little similarity with what occurred in the past. The words were widely echoed during the 1990s tech boom, as they were during the depths of the bear market of 2008. Since the days when it was first formally identified by Graham & Dodd, the value philosophy has proved its worth and presented investors with one of the few reliable ways to earn super normal returns, since valuation levels do typically revert to the mean. Indeed such is our respect for its power, it plays a principal role in Square Mile's tactical asset allocation process.
Reasoning that things are different this time is typically an expensive mistake. So, I almost fell off my chair the other day when I read that no less an authority than Jeremy Grantham was postulating that valuations may be reaching a new, higher plateau and that "it can be very dangerous indeed to assume that things are never different".
Grantham, the G in GMO, has been a value investor for longer than I've been alive (and I stopped being a spring chicken some time ago). Grantham observes that over the last 25 years, the p/e ratio on the S&P 500 has averaged some 65% to 70% higher than in the prior 60 years:
Intuitively, we might have guessed that this has come about with the general fall in interest rates. Unfortunately, James Montier, also of GMO, has looked hard to find evidence of this and has come up lacking.
Grantham’s article argues that the principal reason for dearer valuations rests with higher profit margins, which in turn have been elevated by reduced borrowing costs and higher leverage ratios. Tellingly, he speculates that this time the effect may only fade away over a period measured in decades rather than one measured in years.