Jeremy Grantham, a Brit from Doncaster (and Sheffield Uni) who made it very big in America through his deep understanding of markets (co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO) in Boston), spoke a week or so ago about his sense of trepidation regarding the US equity market (see "Ray Dalio and GMO's Jeremy Grantham on How They're Seeing the World Right Now" https://www.youtube.com/watch?v=-qD4kqAarec).
He said he was surprised to find himself in the third great investment bubble of his career,
“basically in the US the market is showing signs of breaking down...the worst opening for the year for the S&P since I was one year old in 1939. The Nasdaq is down 27.5% from its high, Russell 2,000 about -23%. So, it’s getting to be interesting; Bitcoin is down…meme stocks in ragged diasarray.”
His knowledge of financial history, and especially of bubbles, leads him to declare that this is “the real McCoy; it seems to be playing out pretty close to 2000”.
The three great bubbles in the US in the last one hundred years (1929 in shares, 2000 in shares, 2006 in housing) have common characteristics that separate them from more ordinary bull markets apart from the extreme valuations relative to income received on the underlying assets.
“great bubbles…are characterised by nearly hysterical behaviour, really seriously weird over-optimism, which is very rare. Which are characterised by accelerated price moves on the up side; and by a weird deviation on the up side between the blue chips going up and the risky stocks going down. And that is rare as hens teeth. It happened brilliantly in ’29, it happened during the year 2000 again in spades with the S&P ex-growth continuing to go up through September 2000 and the growth stocks going down basically 50% and the internet stocks dropping maybe 60 – 70%.”
He observes the same today, “and we saw a very handsome deviation between the S&P rising last year and the Russell dropping quite handsomely. So there was a 20 – 25 percentage point spread on the up side. And that for me is a pretty good indicator.”
So why is it that the riskiest shares fall first. It’s mostly to do with the incentives for fund managers to stay invested in shares. They recognise the dangers market-wide but see some areas as less vulnerable to very large falls in a downturn. If they invest in those, yes, they will experience share price falls, but not as much as if they were hold say unprofitable tech shares. Therefore relative performance looks good – they’re down say 10% when other investors are down 20%
“And I’ll tell you what this describes. It describes Mr Prince’s “I’ve got to keep dancing, because the music’s still playing” – We understand that completely; the enormous commercial imperative of the industry to play up to and over the edge”.
[Chuck Prince, Citigroup CEO, told the FT in July 2007 that he recognised that the party would end at some point but there was so much liquidity it would not be disrupted by the turmoil in the US subprime mortgage market. He said “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”]
Grantham said that investors are not complete idiots so they say “’Well, I’ve got to keep dancing. But I don’t have to keep dancing with Pumatech (the most advanced stock in 1999). I’m going to transfer to Coca Cola. And I’ll keep dancing off the edge, but I’ll go off with Coca Cola.’ And it works. The Coca Cola’s are maybe handsomely overpriced, but in 1929 and 2000 they always go down a lot less as the bubble breaks. And that’s the phenomenon that causes this very rare indicator of impending doom, which we saw last year.”
The confirmation of the presence of this tendency in the markets today along with numerous other indicators, just like in 1929, 2000 and 2007, convinces Grantham that “this was not only the real McCoy bubble…[but] I believe the declines will be very substantial.”
So what form will the downward turn take?
“We have a market today which feels superficially like 2000. And I
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