GMO co-founder Jeremy Grantham believes that the bubble in bonds has burst after a 40-year bull market. Equities and housing are likely right behind it, though he admits he isn’t sure which one will be next.
Housing was “late to the party,” in Grantham’s view, but prices have soared 15% in the last year. Bidding wars among Americans afflicted with cabin fever have erupted and home prices broke through their 2006 peaks.
If “we manage to pull a trifecta” and all three markets were to crash in the next year or two, the negative wealth effect, closely correlated to the severity of recessions, could be enormous, said Grantham. Were markets to re-price stocks, bonds and housing back to “near normal,” somewhere between $20 trillion and $30 trillion in wealth could disappear.
Back in 2017, Grantham told Financial Advisor that ever since 1995 stock prices had levitated to price levels only seen once in the early 20th Century–in 1929. Then a confluence of factors converged at the turn of the millennium to propel price-to-earnings multiples to new heights—60% higher than they stood at for most of 1900-1995 period.
Valuations remained near these levels for all but a few brief periods since the late 1990s, which Grantham views as a “long-term aberration.”
Globalization was probably the biggest single factor driving this anomaly. An expanding global labor market gave corporations a huge one-time advantage that weakened labor in the developed world. “Five hundred million Chinese were joined unexcitedly by 200 million Eastern Europeans [who had been] pretending to work for their Communist” masters, he explains.
American workers saw sharp declines in their negotiating power. Wages in the U.S. rose only 10% after inflation in the last 50 years, Grantham notes. In contrast, real wages climbed more than 60% in both England and France, a little noticed fact.
This permitted American corporations to double their profit margins over a half century. Grantham expects the balance of power between capital and labor to drift partially back towards historical parity in the coming decade.
Sincere or not, both political parties in the U.S. suddenly have signaled increased sympathy for workers in lieu of corporations in recent years. This is evidenced by the growing political clout of asymmetric politicians with similar appeal like Sen. Bernie Sanders and former President Donald Trump.
Thirty years of easy monetary policy dating back to former Fed Chairman Alan Greenspan also played a huge role in the bond bubble, Grantham says. Many global bond markets hit a 2,000-year high in 2020, he adds, crediting newsletter publisher Jim Grant for that observation.
Around the developed world, interest rates are even lower than in the U.S. Equities abroad, however, have not reached the heights that they have in America, home to the vibrant tech sector.