Deviations From Long-Term Growth Trends Back To Extremes

In 2022, we discussed the market’s deviations from long-term growth trends. That discussion centered on Jeremy Grantham’s commentary about market bubbles. To wit:

All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected all the way back to trend with much greater and longer pain than average.

Today in the U.S. we are in the fourth superbubble of the last hundred years.”

Are we currently in a market bubble? Maybe. Honestly, I have no idea. The problem is that market bubbles are only evident and acknowledged after they pop. This is because, during the inflation phase of the market bubble, investors rationalize why “this time is different.”

As we noted then, there are three components of market bubbles:

  1. Price
  2. Valuations
  3. Investor Psychology

When investors bid up asset prices that exceed underlying earnings growth rates, market bubbles were previously present. Since economic activity generates revenues and earnings, valuations can not indefinitely exceed the underlying fundamental realities.

Interestingly, the correction in 2022 started the reversion process of that deviation. However, investor speculation has since pushed that deviation near its previous peak.