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Are we in a stock market bubble? And if so, what should investors do? I speak today with Jeremy Grantham, who has been calling the ups and downs of market cycles for almost 50 years, after founding GMO Asset Management in 1977.
You have a solid thesis on what’s going on in the markets right now. So why not start by explaining to you what we are currently seeing in the stock markets.
Historically, it has always been difficult to know how far a bull market can go. And the value turned out to be a very low reading to rely on, as the value can go up and up. And I like to say that every value manager’s nightmare is Japan in 1989, when the price / earnings ratio jumped to 65 times. He had never passed 25 years before this cycle.
The tech bubble of 2000 was pretty amazing as it broke through the previous high of 21 times earnings in 1929 and soared to 35, which was pretty brutal if you played it, like us, from 21 to 35.
And we needed a decent enough bear market to look good after that. And luckily, we have one. But Japan continued to go all the way to 65. Just to warn you that these things can happen, if you bet on the store you have a better indicator than value.
There are obvious examples. And we should probably be talking about GameStop. But the list is surely quite long at this point. And maybe we should walk it.
GameStop is a good place to start. And it’s obviously a very low-value business that has been strangely taken over by aggressive individuals with recent, shall we say, little experience, and pushed through the roof. And in the process, grabbed some short sellers in an awkward position and forced them to hedge, which of course is always fun for the reader and painful for the hedge fund.
And so we have GameStop and the retail traders. We have Spacs. You certainly can’t avoid mentioning the Tesla share price in this context.
And maybe Bitcoin. And Hertz was famous from last year, where a bankrupt company suddenly multiplied by five or ten times with a guaranteed value of zero, like indeed …
As it indeed turned out to be. Tesla, as a company, has always done the impossible. And there is no doubt that it will continue. But if you are a financial analyst, you can push the numbers involved to justify the price today. And this is, of course, quite remarkable. And if you believe in market efficiency, you’ve got a little problem here.
Because if the company’s sales have gone up 20% to 25%? 100, the share price went up 700%. 100, or it was multiplied by eight. So which one was effective? Was it effective a year ago before Covid? Or is it effective today? But you can’t have both.
One of these two figures was therefore extremely ineffective.
I want to come back to the Fed and monetary policy. It seems that your opinion is very simple. The Fed’s monetary operations have done little for the economy and have gone a long way in inflating a potentially destabilizing bubble. Is it that simple, would we be better off without a Fed at all under these circumstances?
We would be better off with a Fed that had the simple instruction of trying to maintain a constant increase in money supply relative to GDP – period. And all its fanciful obligations are misplaced, badly designed. And I have a simple experience, which I love.
It shows that the debt-to-GDP ratio in the United States climbs back up after WWII, slowly increasing on the page imperceptibly until you reach Greenspan. There is simply no evidence that debt increases growth. There is a convention that this is the case.
When we’ve spoken in the past about Jeremy, you’ve been pretty confident the overthrow is coming soon this year.
Predicting the future is a beast. We know that. And we’re a bit limited as historians because of the history we have. And we’ve been blessed with some wonderful displays of crazy investor behavior. But among the serious bubbles, Japan is far in a class of its own.
The tale of old wives apparently the land under the Emperor’s palace was worth more than the entire state of California, we spent two days watching it, and it was true.
It wasn’t an old wives tale. It was an incredible commentary on the property values of downtown Tokyo. Either way, Japanese land is the biggest bubble in history. The Japanese stock market is the largest stock market bubble in history. Followed by 2000 and 2021, in my opinion.
So we had a small series of them. And they all have one thing in common. They are all characterized by price acceleration above the bull market average. And they’re all characterized by growing insanity and investing, as I say, getting to the front page, getting into the cocktail party, getting into the midday TV show. And we checked each of them.
Now, if that wants to break out and make a new branch of history, he can do it. Nothing is ever certain. This thing could go on for years and years and Bitcoin could become like a Rembrandt masterpiece worth exactly what someone wants to pay for.
But if history means repeating itself, as a general principle, I’ve always made a big deal out that every bubble is different. What you are looking for is just the spirit of exercise. It’s crazy? Is it accelerated? And when he goes into that mode, the mode we’ve been in for a few weeks, it still hasn’t lasted more than a few months.
Then let me play devil’s advocate. People who remain bullish make the following argument, which you have certainly heard a million times over, that bond yields are insanely low. And the difference between government bond yields and stock yields is actually historically normal. The Fed has the power to keep these bond yields low.
And so this relationship will continue and stock valuations will remain high.
These are two levels of response. The meta level is that you don’t think a bubble peak occurs with a background of pessimism. This is not the case. It happens when you have a perpetual bull story, something is a new high plateau in 1929. This Alan Greenspan’s 2000 deal, that the internet will drive away the dark clouds of ignorance forever and that we will have ever higher productivity, he argued. .
In my opinion, he had almost nothing good.
But every bull market has a permanent history, beautiful profit margins, unusually high in 1929, 2000. In each of them, Japan, will last forever, because the conditions that brought them there will last forever.
Many commentators and market investors argue that a spike in inflation or inflation expectations is the only thing that can pop this balloon. You don’t seem to be of that opinion. You seem to think that a spike in inflation might be enough, but you don’t need to break into this market.
That is well said. Thank you. This is completely my opinion.
But to save a second, use an asset class that is the most overvalued it has ever been, where 20% of sovereign bonds have negative real yields, and they guarantee to take part of your money out of 10 or 30. years. that you give them your money, that’s kind of weird. And it is absolutely unprecedented in history. Using that as a yardstick and saying that US stocks are no more overvalued than the most overvalued bond market in history is a weird way of determining value.
Why not use Bitcoin? Hey, compared to Bitcoin, the US looks really cheap. I would buy more if I were you. It is a ridiculous idea to use a very overvalued asset as a benchmark of any kind. Yes, we are in dire straits in the United States because we have an extraordinarily overvalued bond market that coincides with an extraordinarily overvalued stock market. It doesn’t make me feel better. It makes me feel worse.
It should make me feel worse. This means that a 60-40 portfolio is doomed to have a terrible return 10, 20 years from now.
It seems that we are now living in a market spanning decades that is nothing more or less than a succession of bubbles – 2000, 2008, now 2020. In this kind of context, it seems to me that active management becomes very difficult. And outperforming, say, the S&P 500 becomes a matter of precisely timing market highs and lows more than almost anything else.
Do you think that active management can still outperform in the long term? I know you no longer manage GMOs. But the core US GMO equity fund has been pretty much tied to the S&P since 1985. Is it as good as an equity fund can?
There is always a way to manage a portfolio. And that is to predict the future on a stock-by-stock basis and to do it slightly better than the market. The market is often quite good. Sometimes the deal is ridiculously wrong.
The actual present value of the long-term dividend stream would justify a very steady market progression since 1925, when we made the data. Only tumbling and sinking 1% here or there, the reality is that, as we know, it is going up and down. It turns out to be 17 times more volatile than the perceptive stream of dividends warrants.
So we designed a market to be more a measure of hysteria than a measure of value. Sometimes he’s completely overwhelmed by crowd psychology. Now, between these speculative events every 10 or 20 years, the market can be pretty close to fair value. It can do a pretty decent job.
The paradox is that the only moments that really matter in portfolio management are these deviations from fair value. Sometimes they are going down. My favorite letter of all time was called “Reinvesting when Terrified,” which we released on Lucky Day the day the market hit its lowest level in 2009. And we said, come together. The market is crushed. You can have double digit returns for a long time.
Gather your program. Send it to your committee. And start bringing yourself back to the market. And of course you feel crippled. Why not you? The conditions are very bad. And I pointed out then that the market does not start when it sees the light at the end of the tunnel.
The market actually turns when everything is really dark. But it’s a subtle shade that’s less black than it was the day before. And the same thing up here. The market doesn’t turn when something really bad happens, it turns into the second most bullish day in the past 20 years. But it’s a little less optimistic than yesterday.
And in the middle of the following week, a little less optimistic. And the following month, even less optimistic. And then you start to realize that the game has changed.
It really hit the spot.
Thank you. Bye Bye.