Three Longs & Three Shorts

Waiting for the last dance

GMO is one of the most respected asset managers from the ‘value investing’ school. In this piece GMO boss, Jeremy Grantham, contends that that US equity markets today are in a bubble-like situation: “The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. 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… it is highly probable that we are in a major bubble event in the U.S. market, of the type we typically have every several decades and last had in the late 1990s. It will very probably end badly, although nothing is certain.”
Not only is it overvalued, Mr Grantham says that history shows that such overvaluations can continue to persist for several years thus making it: a) very difficult for investors to avoid getting sucked into the bull market and b) impossible to call the ‘top’ correctly: “The real problem is in major bull markets that last for years. Long, slow-burning bull markets can spend many years above fair value and even two, three, or four years far above. These events can easily outlast the patience of most clients. 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… Overvaluation is a necessary but not sufficient condition for their bursting.) Calling the week, month, or quarter of the top is all but impossible.”
So why is Mr Grantham convinced that equity markets, especially in America, are in a bubble? Firstly, he says that speculation abounds in America: “As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over $600 billion, amounts to over $1.25 million per car sold each year versus $9,000 per car for GM. What has 1929 got to equal that? Any of these tidbits could perhaps be dismissed as isolated cases (trust me: they are not), but big-picture metrics look even worse.”
Secondly, he points metrics like market cap: GDP and the number of IPOs: “The “Buffett indicator,” total stock market capitalization to GDP, broke through its all-time-high 2000 record. In 2020, there were 480 IPOs (including an incredible 248 SPACs2) – more new listings than the 406 IPOs in 2000. There are 150 non-micro-cap companies (that is, with market capitalization of over $250 million) that have more than tripled in the year, which is over 3 times as many as any year in the previous decade. The volume of small retail purchases, of less than 10 contracts, of call options on U.S. equities has increased 8-fold compared to 2019, and 2019 was already well above long-run average.”
Thirdly, Mr Grantham refers to high P/E multiple prevalent in the US market even as the US economy is struggling: “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…”
So what is the most likely trigger that will burst the bubble? Mr Grantham says, ironically, successful vaccination of the population from the ravages of Covide-19 could be the beginning of the end: “My best guess as to the longest this bubble might survive is the late spring or early summer, coinciding with the broad rollout of the COVID vaccine. At that moment, the most pressing issue facing the world economy will have been solved. Market participants will breathe a sigh of relief, look around, and immediately realize that the economy is still in poor shape, stimulus will shortly be cut back with the end of the COVID crisis, and valuations are absurd.”
BEFORE you panic and call your Marcellus contact person, please note that the final sentence of Mr Grantham’s piece says that he is bullish on Emerging Market equities: “Emerging Market equities are at 1 of their 3, more or less co-equal, 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…”