The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.
Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in but this bubble will burst in due time, no matter how hard the Fed tries to support it, with consequent damaging effects on the economy and on portfolios. Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives…These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle…
75% of the time, major asset classes are reasonably priced relative to one another…The real trouble with asset allocation, though, is in the remaining times when asset prices move far away from fair value…in major bull markets that last for years…[and] these events can easily outlast the patience of most clients and, when price rises are very rapid, typically toward the end of a bull market, impatience is followed by anxiety and envy. As I like to say, there is nothing more supremely irritating than watching your neighbors get rich…
I am long retired from the job of portfolio management but I am happy to give my opinion here: it is highly probable that we are in a major bubble event in the U.S. market, of the type we typically have every several decades and last had in the late 1990s. It will very probably end badly, although nothing is certain…
…The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behavior, especially on the part of individuals. For the first 10 years of this bull market, which is the longest in history, we lacked such wild speculation but now we have it. In record amounts….
- The “Buffett indicator,” total stock market capitalization to GDP, broke through its all-time-high 2000 record.
- In 2020, there were 480 IPOs (including an incredible 248 SPACs2) – more new listings than the 406 IPOs in 2000.
- There are 150 non-micro-cap companies (that is, with market capitalization of over $250 million) that have more than tripled in the year, which is over 3 times as many as any year in the previous decade.
- The volume of small retail purchases, of less than 10 contracts, of call options on U.S. equities has increased 8-fold compared to 2019, and 2019 was already well above long-run average…
- Robert Shiller…recently made the point that his legendary CAPE asset-pricing indicator (which suggests stocks are nearly as overpriced as at the 2000 bubble peak) shows less impressive overvaluation when compared to bonds. Bonds, however, are even more spectacularly expensive by historical comparison than stocks. Oh my!
…[Given the above,] I am not at all surprised that since the summer the market has advanced at an accelerating rate and with increasing speculative excesses. It is precisely what you should expect from a late-stage bubble: an accelerating, nearly vertical stage of unknowable length – but typically short. Even if it is short, this stage at the end of a bubble is shockingly painful and full of career risk for bears.
…As prices move further away from trend, at accelerating speed and with growing speculative fervor, my confidence as a market historian increases that this is indeed the late stage of a bubble. A bubble that is beginning to look like a real humdinger.
The strangest feature of this bull market is how unlike [it is from] every previous great bubble…
- Previous bubbles have combined accommodative monetary conditions with economic conditions that are perceived at the time, rightly or wrongly, as near perfect, which perfection is extrapolated into the indefinite future. The state of economic excellence of any previous bubble of course did not last long, but if it could have lasted, then the market would justifiably have sold at a huge multiple of book.
- Today’s wounded economy, however, is totally different: only partly recovered, possibly facing a double-dip, probably facing a slowdown, and certainly facing a very high degree of uncertainty yet the market is much higher today than it was last fall when the economy looked fine and unemployment was at a historic low.
- Today the P/E ratio of the market is in the top few percent of the historical range and the economy is in the worst few percent. This is completely without precedent and may even be a better measure of speculative intensity than any SPAC.
- This time, more than in any previous bubble, investors are relying on accommodative monetary conditions and zero real rates extrapolated indefinitely. This has in theory a similar effect to assuming peak economic performance forever: it can be used to justify much lower yields on all assets and therefore correspondingly higher asset prices, but neither perfect economic conditions nor perfect financial conditions can last forever, and there’s the rub.
All bubbles end with near universal acceptance that the current one will not end yet because:
- in 1929 the economy had clicked into “a permanently high plateau”;
- Greenspan’s Fed in 2000 was predicting an enduring improvement in productivity and was pledging its loyalty (or moral hazard) to the stock market;
- Bernanke believed in 2006 that “U.S. house prices merely reflect a strong U.S. economy” as he perpetuated the moral hazard: if you win you’re on your own, but if you lose you can count on our support. Yellen, and now Powell, maintained this approach. All three of Powell’s predecessors claimed that the asset prices they helped inflate in turn aided the economy through the wealth effect – which effect we all admit is real – but all three avoided claiming credit for the ensuing market breaks that inevitably followed: the equity bust of 2000 and the housing bust of 2008, each replete with the accompanying anti-wealth effect that came when we least needed it, exaggerating the already guaranteed weakness in the economy. This game surely is the ultimate deal with the devil…
- interest rates will be kept around nil forever, in the ultimate statement of moral hazard…The mantra of late 2020 was that engineered low rates can prevent a decline in asset prices – forever – but of course, it was a fallacy in 2000 and it is a fallacy now. In the end, moral hazard did not stop the Tech bubble decline, with the NASDAQ falling 82% – yes, 82% – or, in 2008, did it stop U.S. housing prices declining all the way back to trend and below…All the promises were in the end worth nothing, except for one; the Fed did what it could to pick up the pieces and help the markets get into stride for the next round of enhanced prices and ensuing decline – and here we are again, waiting for the last dance and, eventually, for the music to stop.
EXHIBIT 1: BUBBLES – GREAT WHILE THEY LAST
Housing bubble as of 11/30/2011, Tech bubble as of 2/28/2003
Source: S&P 500 (Tech bubble); National Association of Realtors, U.S. Census Bureau (Housing bubble)
Nothing in investing perfectly repeats. Certainly not investment bubbles. Each form of irrational exuberance is different… Even now, I know that this market can soar upwards for a few more weeks or even months – it feels like we could be anywhere between July 1999 and February 2000. Which is to say it is entitled to break any day, having checked all the boxes, but could keep roaring upwards for a few months longer. My best guess as to the longest this bubble might survive is the late spring or early summer, coinciding with the broad rollout of the COVID vaccine…but remember that timing the bursting of bubbles has a long history of disappointment.
Even with hindsight, it is seldom easy to point to the pin that burst the bubble. The main reason for this lack of clarity is that the great bull markets did not break when they were presented with a major unexpected negative. Those events, like the portfolio insurance fiasco of 1987, tend to give sharp down legs and quick recoveries. They are in the larger scheme of things unique and technical and are not part of the ebb and flow of the great bubbles. The great bull markets typically turn down when the market conditions are very favorable, just subtly less favorable than they were yesterday – and that is why they are always missed.
Either way, the market is now checking off all the touchy-feely characteristics of a major bubble…
- the intensity and enthusiasm of bulls,
- the breadth of coverage of stocks and the market, and, above all,
- the rising hostility toward bears…In the last few months the hostile tone has been rapidly ratcheting up. The irony for bears though is that it’s exactly what we want to hear. It’s a classic precursor of the ultimate break; together with stocks rising, not for their fundamentals, but simply because they are rising…and
- the acceleration of the final leg, which in recent cases has been over 60% in the last 21 months to the peak, a rate well over twice the normal rate of bull market ascents. This time, the U.S. indices have advanced from +69% for the S&P 500 to +100% for the Russell 2000 in just 9 months – not bad – and there may still be more climbing to come but it has already met this necessary test of a late-stage bubble…
The combination of timing uncertainty and rapidly accelerating regret…means that the career and business risk of fighting the bubble is too great for large commercial enterprises…so, don’t wait for the Goldmans and Morgan Stanleys to become bearish: it can never happen. For them it is a horribly non-commercial bet….Their best policy is clear and simple: always be extremely bullish. It is good for business and intellectually undemanding. It is appealing to most investors who much prefer optimism to realistic appraisal…and when it all ends, you will, as a persistent bull, have overwhelming company. This is why you have always had bullish advice in a bubble and always will…
What to Do?
As often happens at bubbly peaks like 1929, 2000, and the Nifty Fifty of 1972 (a second-tier bubble in the company of champions), today’s market features extreme disparities in value by asset class, sector, and company:
- Those at the very cheap end include traditional value stocks all over the world, relative to growth stocks…[and they] have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020, with spreads between Growth and Value performance averaging between 20 and 30 percentage points for the single year!
- Similarly, Emerging Market equities are at 1 of their 3, more or less co-equal, relative lows against the U.S. of the last 50 years.
Not surprisingly, we believe it is in the overlap of these two ideas, Value and Emerging, that your relative bets should go, along with the greatest avoidance of U.S. Growth stocks that your career and business risk will allow.
Editor’s Note: The original article by Jeremy Grantham has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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