“Today in the U.S. we are in the fourth superbubble of the last hundred years,” wrote GMO co-founder Jeremy Grantham, in a note to investors Thursday.
In the note, Grantham and his colleagues laid out what it means to be in a “superbubble,” why were are in one that’s rapidly losing air, and what asset manager GMO has been doing about it.
“One of the main reasons I deplore superbubbles — and resent the Fed and other financial authorities for allowing and facilitating them — is the underrecognized damage that bubbles cause as they deflate and mark down our wealth,” he explained.
In general, an equity bubble starts to deflate “from the riskiest end of the market first — as it has been doing since last February,” according to Grantham. “So, good luck! We’ll all need it.”
As of early Monday, the Nasdaq was down 13% year to date, the S&P 500 about 8% and the Dow Jones Industrial Average roughly 6%.
Grantham admits that “no one wants to hear the bear case” about bubbles, because it’s “the worst kind of party-pooping.” Bubbles and especially superbubbles “are often the most exhilarating financial experiences of a lifetime,” he notes.
And while he doubts “speculators in the current bubble will listen” to him, Grantham says, “giving this advice is my job and possibly the right thing to do.”
See the slideshow above for Grantham’s look at why we’re in a superbubble and what he and GMO see as the best way to respond.
And “for distracted readers,” he provides the following summary of “bubble rules.” Sigma is how GMO measures deviation from the mean.
- All 2-sigma equity bubbles in developed equity markets have burst — all the way back to trend. The U.S. reached the 2-sigma level in the summer of 2020.
- But some of them went to 3-sigma or more before they burst — producing longer and deeper pain. The U.S. reached 3-sigma in late 2021.
- Timing is uncertain and when you get to 3-sigma superbubbles, such as we have now, there are few examples. Yet they have all shown certain characteristics before they broke:
- A speculative investor frenzy that generated stories for distant decades, which we have had for well over a year;
- A penultimate blow-off phase where stock gains accelerate, as we had in 2020;
- And the ultimate narrowing phase — unique to these few superbubbles — where a decreasing number of very large blue chips go up as riskier and more speculative stocks underperform or even decline, as they did in 1929 and 2000 and as they have done since February 2021.