Renowned investor Jeremy Grantham, who correctly predicted the Japanese asset price bubble in 1989, the dot-com bubble in 2000 and the housing crisis in 2008, is “doubling down” on his latest market bubble call.
“This bubble will burst in due time, no matter how hard the Fed tries to support it, with consequent damaging effects on the economy and on portfolios,” writes Grantham in his latest market outlook, titled “Waiting for the Last Dance.”
It is an “epic bubble” fueled by “extreme overvaluation, explosive price increases, frenzied issuance and hysterically speculative investor behavior,” writes Grantham. But the fabled investor who co-founded Grantham, Mayo, & Van Otterloo (GMO) and is now dedicated to fighting climate change, says this current bubble is different from previous ones.
Those bubbles combined accommodative monetary policy with strong economic conditions; this bubble is occurring in a “wounded economy,” though one supported by easy Federal Reserve policy, with market prices much higher than they were pre-pandemic when the economy was stronger and the jobless rate fell to a historic low.
“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,” writes Grantham. “Investors are relying on accommodative monetary conditions and zero rates extrapolated indefinitely …. This game surely is the ultimate deal with the devil.”
In addition, says Grantham, the “final leg” of recent asset bubbles have topped 60% in the 21 months before they peaked, or twice the “normal rate of bull market ascents.” The S&P 500 currently has gained almost 70% in the past nine months — and the Nasdaq 100%.
These major indexes could still climb higher from here, says Grantham, but his “best guess is that the bubble will burst in late spring or early summer,” whenever there is a “broad rollout” of the COVID-19 vaccine. He recommends investing now in value and emerging market stocks, which have both been underperforming U.S. growth stocks for years.
At the root of Grantham’s argument is his disbelief in the argument made by many market strategists, that current stock prices are justified by near-zero interest rates based on the concept of a company’s future discounted cash flow.
The notion that low rates can prevent a drop in asset prices “was a fallacy in 2000 and it’s a fallacy now,” writes Grantham, recalling the 82% drop in the Nasdaq in 2000 and the $8 trillion decline in housing values in 2008. “Here we are again, waiting for the last dance and, eventually, for the music to stop.”
But Grantham has been waiting for quite a while for the market bubble to burst. He has been calling for a correction to the bubble since early 2018, when the S&P 500 was trading about one-third lower than it is today.
His outlook stands in sharp contrast to the view of U.S. equity strategists at Goldman Sachs led by David Kostin. Goldman is forecasting a 14% gain in the S&P 500 this year, following 2020’s 16% gain.
The call is based on expectations for widespread COVID vaccinations, U.S. GDP growth of 5.9%, continued low interest rates and an above-consensus earnings per share forecast of $175 in the S&P 500, which is 6% higher than pre-pandemic profits in 2019. The expect the forward P/E multiple of the S&P 500 index will expand from 21.5 to 22.1.
World Bank’s Caution
The World Bank on Tuesday issued a less rosy outlook for the U.S. and global economy due to stalled growth starting in the third growth quarter, a resurgence of coronavirus infections, challenges related to the distribution of COVID vaccines and global debt accumulation. The institution downgraded its forecast for is forecasting 4% global growth in 2021, which is under the 5% pre-pandemic trend, along with 3.3% GDP growth in the U.S.
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