It is seldom easy to point to the pin that burst the bubble. The main reason for this lack of clarity is that the great bull markets did not break when they were presented with a major unexpected negative. Those events tend to give sharp down legs and quick recoveries. They are unique and technical but are not part of the ebb and flow of the great bubbles.
The great bull markets typically turn down when the market conditions are very favourable, just subtly less favourable than they were yesterday. And that is why they are always missed.
- Jeremy Grantham in Waiting for the Last Dance
Jeremy Grantham, revered investor, long-time advocate for action on climate change, and co-founder of GMO, has been issuing warnings that we are in a fully-fledged epic bubble.
At the start of the year, he said that he believed this even will be recorded as one of the great bubbles of financial history, and peppered his writing with phrases such as extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour.
In a conversation with Kunal Kapoor, the CEO of Morningstar, Jeremy Grantham reminds us how black and grey swans lurk offstage, and how “Covid-19 issues are not our routine-quarterly-earnings type of issues but much bigger deals in the long run.”
Here are a few excerpts from that conversation.
I welcome lower asset prices.
The higher the asset price, the lower the return. For example, let’s say you bought a forest or a farm in Australia. In the old days, it would yield 6%, today it yields 3% approximately. It is much harder to get rich reinvesting 3%. You double your money every 24 years instead of every 12 years. And in 48 years you are down to a quarter of what your wealth would have been.
Having high priced assets is great for retirees and old folks selling their assets. For everyone else it means that you compound your wealth more slowly. And you pay more for a house than what your parents paid.
You can’t get blood out of a stone. You can have a high-priced asset or a high-yielding asset, not both at the same time.
Don’t pull a Japan.
If you are going to have a bubbly market, it would be wise to have it in only one major asset class.
Japan had the biggest bubble in history in land and real estate. It simultaneously also had the biggest equity bubble of any advanced country. Now, 32 years later, neither are back to where it was in 1989, in nominal dollars. The higher you go, the greater the fall.
There is no traditional pin to burst the bubble.
There was an experiment of a ping pong ball on a jet of water. You turn the jet of water up and the ball would rise a bit. You turn the water down and it would fall but would not go all the way down until you turn it off completely.
That analogy is apt to the market.
The market reaches an all-time high when optimism is at an absolute peak. And the following day, is the second most optimistic day in history. But it is a shade less optimistic than it was yesterday, and the price begins to fall a little bit.
We have turned the pressure up and up. More money. More moral hazard. And here we are at the peak. It won’t take bad news or a thoroughly bad economy to bring this market down. It could be a perfectly good economy and a perfectly optimistic outlook, but less optimistic than it was a week ago and a month ago.
In conversation in January with Bloomberg, he said it would be surprising if we could have a bull market since 2009 that did not end up in animal spirits beginning to freak out a bit. An excerpt is reproduced below.
Normally it takes a perfect economy and friendly Fed behaviour, but this one has managed to do it with a somewhat wounded economy, on a global basis. And to compensate for that we have had even more speculator government (fiscal spending) combined with Fed friendliness.
The confidence has risen and rising until finally people are reaching for the greatest demonstration of confidence that can be displayed in their investment career. They are borrowing money to throw into the market. The common wisdom is that with fed on your side how can you lose. the belief is that all it takes is to have the Fed on your side and stocks will rise forever.
This bubble will burst in due time, no matter how hard the Fed tries to support it.
