Yes, we are in a Bubble

By Morningstar |  13-01-21 | 
 

In Waiting for the Last Dance, Jeremy Grantham explains why he believes the market is in a bubble. Here is an extract from his long essay.

The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. I believe this event will be recorded as one of the great bubbles of financial history.

This bubble will burst in due time, no matter how hard the Fed tries to support it.

Predicting when a bubble breaks is not about valuation. All prior bubble markets have been extremely overvalued, as is this one. Overvaluation is a necessary but not sufficient condition for their bursting.

Since the summer, the market has advanced at an accelerating rate and with increasing speculative excesses. It is precisely what you should expect from a late-stage bubble: an accelerating, nearly vertical stage of unknowable length – but typically short. Even if it is short, this stage at the end of a bubble is shockingly painful.

I am doubling down, because as prices move further away from trend, at accelerating speed and with growing speculative fervor, of course, my confidence as a market historian increases that this is indeed the late stage of a bubble. A bubble that is beginning to look like a real humdinger.

  • The market is now checking off all the touchy-feely characteristics of a major bubble. The most impressive features are the intensity and enthusiasm of bulls, the breadth of coverage of stocks and the rising hostility toward bears. It’s a classic precursor of the ultimate break; together with stocks rising, not for their fundamentals, but simply because they are rising.
  • The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behaviour, especially on the part of individuals. For the first 10 years of this bull market, which is the longest in history, we lacked such wild speculation. But now we have it. In record amounts.
  • 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 SPACs) – 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.
  • Nobel laureate and long-time bear Robert Shiller – who correctly and bravely called the 2000 and 2007 bubbles – is hedging his bets this time, recently making the point that his legendary CAPE asset-pricing indicator (which suggests stocks are nearly as overpriced as at the 2000 bubble peak) shows less impressive overvaluation when compared to bonds. Bonds, however, are even more spectacularly expensive by historical comparison than stocks.
  • Another more measurable feature of a late-stage bull, from the South Sea bubble to the Tech bubble of 1999, has been an acceleration of the final leg, which in recent cases has been over 60% in the last 21 months to the peak, a rate well over twice the normal rate of bull market ascents. This time, the U.S. indices have advanced from +69% for the S&P 500 to +100% for the Russell 2000 in just 9 months. And there may still be more climbing to come. But it has already met this necessary test of a late-stage bubble.

Nothing in investing perfectly repeats. Certainly not investment bubbles.

Each form of irrational exuberance is different; we are just looking for what you might call spiritual similarities. Even now, I know that this market can soar upwards for a few more weeks or even months – it feels like we could be anywhere between July 1999 and February 2000.

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. “Buy the rumour, sell the news.” But remember that timing the bursting of bubbles has a long history of disappointment.

The great bull markets did not break when they were presented with a major unexpected negative. Those events, like the portfolio insurance fiasco of 1987, tend to give sharp down legs and quick recoveries. They are in the larger scheme of things unique and technical and 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.

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