It isn’t often that investment gurus tear their own arguments and predictions apart, but that’s just what Jeremy Grantham does in his latest quarterly letter to GMO investors.
Comparing himself to a parrot, “I have been repeating for 10 quarters now my belief that we would not have a traditional bubble burst in the US equity market until we had reached at least 2,300 on the S&P, the threshold level of major bubbles in the past, and at least until we had reached the election,” he explained.
He adds that he had hoped to “recommend a major sidestep of the coming [market] deluge …, allowing us then, after a 50% decline, to leap back into cheap equity markets enthusiastically, more enthusiastically, that is, than we did last time in 2009.”
Grantham readily admits that he sees himself as “a bubble historian and one who is eager to see one form and break.” But no more.
“I have come to believe, however, very reluctantly, that we bubble historians have, together with much of the market, been a bit brainwashed by our exposure in the last 30 years to 4 of the perhaps 6 or 8 great investment bubbles in history,” he wrote.
“For bubble historians eager to see pins used on bubbles and spoiled by the prevalence of bubbles in the last 30 years, it is tempting to see them too often,” the co-founder and chief investment strategist of asset manager Grantham, Mayo, & van Otterloo explained.
As for today’s market? It’s “not a classic bubble, not even close. The market is unlikely to go ‘bang’ in the way those bubbles did,” he writes.
Instead, the market is probably going to revert to the mean in a “slow and incomplete” process.
Sound good? Think again, says Grantham, who is known for his generally pessimistic outlook.
“The consequences are dismal for investors: we are likely to limp into the setting sun with very low returns. For bubble historians, though, it is heartbreaking for there will be no histrionics, no chance of being a real hero. Not this time.”
Grantham’s new look at bubbles, of course, is based on statistical analysis.
The 2,300 level on the S&P 500, he points out, marks the two-standard-deviation (or two-sigma) point that has “effectively separated real bubbles from mere bull markets.”
Today, though, it’s most likely “a red herring.” That’s because the data means we are comparing today’s “much higher” pricing environment with “far lower” levels in the past.
As other investment gurus are discussing today, things are different, and that’s because of – wait for it – “a 35-year downward move in [interest] rates …, which, with persistent help from the Fed over the last 20 years and a shift in the global economy, has led to a general drop in the discount rate applied to almost all assets.
As many advisors and investors are well aware, assets return 2-2.5% less than they did in the 1955-1995 era, Grantham notes.
This tough reality raises a number of questions, he says, but it also implies that for the next 20 years it doesn’t matter that much “whether the market crashes in two years, falls steadily over seven years or whimpers sideways for 20 years.”
The key difference, according the Grantham, is what happens in the short term: “Are we going to have our pain from regression to the mean in an intense two-year burst, a steady seven-year decline, or a drawn-out 20-year whimper?”
Again, we “are not in a traditional bubble today,” he states, which gives market watchers – and value managers, in particular – some room to think about the many possibilities to come.
Grantham argues that what stand out are the current level of euphoria, or “wishful thinking,” and a lack of excellent fundamentals, which “are way below optimal.”