Investors are witnessing the “biggest U.S. fantasy trip of all time” in the stock market thanks to a clueless Federal Reserve, speedy stimulus and surprising success with Covid-19 vaccinations, according to Jeremy Grantham, financial historian and co-founder of the investment firm GMO.
It’s been just over a year since the last stock market crash, which resulted in a 35% drop from peak to trough, followed by the fastest rebound in history.
“The Covid crash is quite distinct from a classic long bull market ending,” he said. “As a sharp external effect, it was more like the 1987 technical crash caused by portfolio insurance: A short hit and a sharp recovery.” Of course, after Black Monday it took two years for the S&P 500 to return to where it was -- this year it took five months.
Right now, signs of a bubble are everywhere. Various measures of debt and margins are at peaks, trading volume is signaling bullish sentiment and volumes on call option volume and over-the-counter penny stocks are at records.
“The last 12 months have been a classic finale to an 11-year bull market,” Grantham said. “Checking all the necessary boxes of a speculative peak, the U.S. market was entitled historically to start unraveling any time after January this year.”
It’s particularly dangerous now because the bond, stock and real estate markets are all inflated together, Grantham added, noting that even commodity prices are surging.
“That trifecta-and-a-half has never happened before anywhere -- the closest before was Japan in 1989,” he said. “The consequences for the economy were dire and neither land nor stocks have yet returned to their 1989 peaks!”
Calling all major asset classes overpriced and citing James Grant’s calculation that interest rates at a 4,000 year-low, Grantham called the traditional 60/40 portfolio allocation “particularly dangerous.” Instead, he recommended seeking the intersection of value stocks and emerging-market equities, two sectors he called cheap and that he expects will return 10% to 20% a year. In comparison, he said the S&P 500 is likely to do poorly, while Bitcoin should be avoided completely as it adds nothing to GDP. For equities, he recommended that investors average into the stock market once it reaches “more reasonable levels, say 18x earnings.”
On the subject of liquidity, which bulls have argued is a reason why there’s more room to rally, Grantham said although the rate of increase in M2 is extremely high, its growth has declined in recent weeks at the fastest rate ever recorded, from about 18% year-over-year to 12%.
“The best analogy is the fun ping-pong ball supported in the air by a stream of water,” he said. “The water pressure is still very high and the ball is high, but the ball has dropped an inch or two.”
A historian of bubbles, Grantham said Bitcoin is the asset that most resembles the Nasdaq at the peak of the dot-com bubble. Back then, the Nasdaq’s halving was “a perfect warning shot for the broad market, six months in advance.”
He’s not alone in that sentiment. But for a broader market readthrough, Grantham pointed to declines in the leading growth stocks. Tesla Inc., for example, has lost a third of its value since the February peak. Even SPACs, which were all the rage earlier this year, have dropped ~25% since their record high. Grantham had no positive things to say on the retail frenzy, either.
“Meme investing -- the idea that something is worth investing in, or rather gambling on, simply because it is funny -- has become commonplace,” he said. “It’s a totally nihilistic parody of actual investing. This is it guys, the biggest U.S. fantasy trip of all time.”
Green Thumbs Up
Grantham, a recipient of the Commander of the Most Excellent Order of the British Empire in 2016 for his work on climate change, is known for emphasizing the need for green investing. He acknowledged elements of a bubble in ESG strategies but said they’re in line with other assets. His bigger point was that government support and corporate recognition make it a solid long-term bet.
“Lithium and copper, for example, may be at temporary highs,” he said. “But in the long term they are very scarce resources critical to decarbonizing, and their prices will go much higher.”
Grantham remained positive on electric vehicles, which have returned as much as 200% since the March 2020 bottom and more than doubled the gains in the S&P 500. “EVs may get ahead of themselves and suffer -- Amazon was down 92% by 2002 -- but some will go very much higher,” he said.
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