Investors are challenged because they cannot discern the effects of market behavior from the impact of manager decisions, and the world is too far removed from previous market downturns – in 2000, 2008 or 1989 in Japan – to have evidence of a manager’s ability to cope with volatility. As in many late-stage bubbles, bears will face “rising hostility” from emboldened market optimists.
Grantham noted that he called the market tops and lows correctly in 2008 and 2009, but was not as successful in calling the top of Japan’s Nikkei index in 1989, pulling out of the market almost three years too early, or the 2000 dot-com crash in the U.S., when GMO sold its discretionary U.S. positions in 1997, again, three years before the actual top.
“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,” wrote Grantham. “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.”
Grantham cited investor “mania” for high-flying electric vehicle stocks like Tesla and Nikola, and for bargain-hunting in stocks ike Hertz and Kodak. He notes that at it’s current market $600 million capitalization, Tesla is worth $1.25 million for every car it has sold, versus $9,000 per car for General Motors.
He also cites the “Buffeft indicator,” the ratio of the total stock market captiaization to GDP, which has blown thorugh its previous high set in 2000, and the surge of new IPOs in 2020 in the midst of a pandemic, driven in part by a boom in SPACs.
This bubble is different, according to Grantham, because in previous markets a bubble is accompanied by accommodative monetary policy and “near-perfect” economic conditions which are extrapolated indefinitely into the future. However, this bubble is occurring amidst a “wounded economy” harmed by the economic devastation caused by a global pandemic. Investors are extrapolating low and negative rates indefinitely into the future, which, to them, justifies lower yields and higher asset prices.
“Yet the market is much higher today than it was last fall when the economy looked fine and unemployment was at a historic low,” wrote Grantham. “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.”
Investment managers now face a crossroads, said Grantham. Bears will suffer during the “vertical” phase of a late-stage bubble, which is usually short. Bulls will suffer when the bubble bursts. And no one can know exactly when a market cataclysm will occur.
“Requiring that you get the timing right is overreach,” wrote Grantham. “If the hurdle for calling a bubble is set too high, so that you must call the top precisely, you will never try. And that condemns you to ride over the cliff every cycle, along with the great majority of investors and managers.”