Financial markets are in a “fully fledged epic bubble,” according to Jeremy Grantham, co-founder and chief investment officer of Boston-based Grantham, Mayo & van Otterloo (GMO).
“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.,” wrote Grantham in "Waiting For The Last Dance," a blog posted Tuesday to GMO's website, noting that bubbles are usually where fortunes are made and lost.
The current bubble has created opportunity for investors in the areas of value stocks and emerging markets, said Grantham.
“Value stocks 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!” said Grantham. “Similarly, Emerging market equities are at one of their three more or less coequal 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.”
During more normal periods of market performance, small outperformance can be achieved by “valuation-based” investors, but asset allocation is not a “very important” element for success, writes Grantham. In most bear markets, which are “short and brutal,’ investors are frozen into inaction, giving asset managers an opportunity to reposition their portfolio and retain their business.
Long bull markets, on the other hand, can pressure clients into action, said Grantham. “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.”
Regardless of monetary support from central bankers, Grantham believes that the current bubble will burst in due time.
“It will very probably end badly, although nothing is certain,” wrote Grantham. “I will also tell you my definition of success for a bear market call. It is simply that sooner or later there will come a time when an investor is pleased to have been out of the market. That is to say, he will have saved money by being out, and also have reduced risk or volatility on the round trip. This definition of success absolutely does not include precise timing. (Predicting when a bubble breaks is not about valuation. All prior bubble markets have been extremely overvalued, as is this one. Overvaluation is a necessary but not sufficient condition for their bursting.) Calling the week, month, or quarter of the top is all but impossible.”
In fact, Grantham said the bubble could break “any day” or the markets could keep roaring upwards for a few months longer, but guessed that it will not survive past the late spring or early summer when the Covid-19 vaccines are rolled out to a broader segment of the population. At that time, the “most pressing issue facing the world economy” will have been dealt with, but investors will finally realize that the economy is still in poor shape and that “valuations are absurd,” with prices far diverged from the underlying economic realities.
But Grantham acknowledges that it is difficult to idenitiify the “pin” that bursts the bubble, even in hindsight.