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10 Rules for Investing

Last update on: Jun 18 2020

Jeremy Grantham of GMO issued his quarterly letter for the fourth quarter of 2011, and as always I recommend investors spend some time with it. This letter is titled “The Longest Quarterly Letter Ever” (it’s 15 pages) and follows last quarter’s “The Shortest Quarterly Letter Ever.” This letter has three sections. The first is 10 rules for the individual investor, and it’s definitely worth your time. The second section is a philosophical essay on the deficiencies of capitalism, with an emphasis of Grantham’s view that it has negative consequences for the environment. The third section is investment observations and forecasts with some emphasis on the firm’s relatively accurate forecasts of 10 years ago. Overall, the entire letter is a good educational piece for all investors.

The 800-pound gorilla (the one that prefers bond holders to bamboo) is not in the room yet, but you can hear him thumping his chest up in the hills. He will come eventually, and before he does, you should remember that stocks are underrated inflation hedges. The underlying corporations have real assets, employ real people, and sometime even make real things, although a good idea embedded in a small thing (like an iPad) or a service is just as good. Equities have been tested over and over again in different places and in different decades and they have always been found to be very effective hedges. Serious resources – oil and copper in the ground and forestry and farmland – will almost certainly also be good and very probably much better than broad stocks in the short run. Gold may be good too. Who knows? But for stocks to work dependably as inflation hedges one has to have a several-year time horizon: in the short term, rising inflation can hurt stocks badly, for as mentioned last quarter, inflation is usually a powerful negative behavioral input. Investors hate jumps in inflation because they sharply raise the levels of uncertainty. Fairly quickly, though, earnings always catch up, and after multi-year surges in inflation (as in Brazil in the ’80s) we end up with the total market value in its normal range as a percentage of GDP while regular bonds if they exist, get destroyed.

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