In a recent white paper, GMO’s James Montier takes an interesting look at what he says are “The Seven Immutable Laws of Investing”.
The first rule, on which Montier spends the most time, invokes the late, great Benjamin Graham: “Always Insist on a Margin of Safety”. Montier writes: “Valuation is the closest thing to the law of gravity that we have in ﬁnance. It is the primary determinant of long-term returns. However, the objective of investment (in general) is not to buy at fair value, but to purchase with a margin of safety. This reﬂects that any estimate of fair value is just that: an estimate, not a precise ﬁgure, so the margin of safety provides a much-needed cushion against errors and misfortunes. When investors violate Law 1 by investing with no margin of safety, they risk the prospect of the permanent impairment of capital.” (his emphasis)
Montier looks at a couple different ways to value stocks and bonds. When neither stocks nor bonds offer a satisfactory margin of safety (which he says was the case when he wrote his paper, which was released in March), he says he’d raise cash. “This is obvious not for its thoroughly uninspiring near-zero yield, but because it acts as dry powder — a store of value to deploy when the opportunity set offered by Mr. Market once again becomes more appealing,” he writes. “And this is likely, as long as the emotional pendulum of investors oscillates between the depths of despair and irrational exuberance as it always has done. Of course, the timing of these swings remains as nebulous as ever.”
Montier also examines his other six laws, which include:
- This Time Is Never Different
- Be Patient and Wait for the Fat Pitch
- Be Contrarian
- Risk Is the Permanent Loss of Capital, Never a Number
- Be Leery of Leverage
- Never Invest in Something You Don’t Understand
Montier also talks about some other issues, including why the “Fed Model” doesn’t work, and why the fact that bonds are unattractive doesn’t necessarily mean stocks are attractive.
A copy of Montier’s paper can be obtained through GMO’s web site.