“In early 1955 when I testified before the Fulbright Committee the stock market was then about 400, my central value was also around 400 and the valuation of other ‘experts’ using other methods all seemed to come to about that level. The action of the stock market since then would appear to demonstrate that these methods of valuations are ultra-conservative and much too low, although they did work out extremely well through the stock market fluctuations from 1871 to about 1954, which is an exceptionally long period of time for a test. Unfortunately in this kind of work, where you are trying to determine relationships based upon past behavior, the almost invariable experience is that by the time you have had a long enough period to give you sufficient confidence in your form of measurement just then new conditions supersede and the measurement is no longer dependable for the future.” [Emphasis added. By the way, the deliberate total return from the S&P 500 from the end of 1963 until today has been 5.75% real, exactly what we at GMO assume to be the long-term, normal return.] 

“My reason for thinking that we shall have these wide fluctuations – of which we had a taste in 1962, in May particularly – is that I don’t see any change in human nature vis-à-vis the stock market which is sufficient to establish more restraints in the public behavior than it showed over so many decades in the past.” 

“But let me point out ‘for the record’ that it is not impossible in theory that the market’s high level alone could sooner or later precipitate a collapse without the necessity for these technical weaknesses [described above, Ed.] to show themselves. The collapse might be triggered by some untoward economic or political development. But if things do happen that way it will be the first time in market history, I believe, that we would have the end of a bull market without the excesses and abuses of the sort I have mentioned.” [Emphasis added.] 

“The main need here is for the investor to select some rule which seems to be suitable for his point of view, one which will keep him out of mischief, and one, I insist, which will always maintain some interest in common stocks regardless of how high the market level goes. For if you had followed one of these older formulas which took you out of common stocks entirely at some level of the market, your disappointment would have been so great because of the ensuing advance as probably to ruin you from the standpoint of intelligent investing for the rest of your life.”

Eoin Treacy's view

Here is a link to the full report.

Anticipation is a big topic in the first day of The Chart Seminar not least because it’s a big part of life. Think about how you plan your holidays. When you first go on vacation you might book a last-minute deal to anywhere, next year you will do some additional research and plan ahead. While at your chosen location you might meet someone, who got a better deal by buying early. On the following year you plan ahead even further. By the time you are spending time on cruise ships you’ll notice they take reservations three years in advance. More data and experience allow us to plan ahead for what are in many cases predictable events. That planning changes the nature of market. 

What I find particularly interesting from reading Jeremy Grantham’s missives over the last few years is that he is increasingly of the opinion that the extremely low valuations observable in previous cycles, up until the 1970s, may no longer be possible. 

With 90 years of back history it is reasonable to believe that the fundamental and economic data is both public and widely available to anyone who wishes to do the regressions. If it is common knowledge that a certain set of circumstances results in low valuations which might be sustained for only a short period, it makes sense to buy early to ensure the opportunity is availed of. That decision to anticipate the event can result in the correction being shallower than might otherwise have been the case. 

In an uptrend, particularly a consistent advance where there are clearly recognizable consistency characteristics, once the majority of market participants understand the rhythm of the market, they have an incentive to anticipate it. That is exactly what happened with gold in the run-up to the 2011 peak. 

The consistency of the market over the preceding six years had been volatile 18-month ranges which were resolved by emphatic upward breaks in the September of odd numbered years. After three iterations of this rhythmic trend and a significant advance in the price, the predictability of this rhythmic market resulted in investors anticipating the breakout. That occurred in 2010 and the weight of money moving into the market resulted in the pace of the advance accelerating to the eventual peak in 2011. 

In quantum mechanics Heisenberg’s Uncertainty Principle describes a similar phenomenon. The more we know about the trajectory of a particle the less we know about its position, might be transferred to the financial markets as “The more we know about the rhythm of the market cycle the less likely it is to be sustained” 

Anticipation therefore explains how acclerations, both up and down, evolve.