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John Engle
Articles (605) 

Jeremy Grantham: We Are Facing an Epic Market Bubble

Value investors may find vindication at last if the bubble bursts

February 08, 2021 | About:

Over the past year, the stock market has managed to not merely weather the profound economic and social impacts of a global pandemic, it has seemingly shrugged them off entirely. As I have discussed previously, this disconnection between capital market behavior and the real economy has largely come about thanks to the unprecedented efforts of the Federal Reserve to prop up asset valuations at all costs.

Unfortunately, the cost of those interventions may prove even higher, according to Jeremy Grantham (Trades, Portfolio) of GMO Capital Management.

From bull to bubble

According to Grantham, the Fed's actions have helped preserve the current bull market, which began more than a decade ago in the aftermath of the Great Financial Crisis, far beyond its natural end. On Jan. 5, the noted value investor discussed the potential dangers that have emerged as a result of this seemingly unstoppable bull market:

"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. These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle. For positioning a portfolio to avoid the worst pain of a major bubble breaking is likely the most difficult part. Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in. But 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."

Grantham's warning is anything but hysterical. By virtually any empirical measure, the stock market looks overheated. For example, before the current bull market, the total market capitalization of U.S. stocks rarely exceeded total U.S. gross domestic product for any great length of time. The consistency of this metric has made it a favorite of Warren Buffett (Trades, Portfolio), a fact that earned it the moniker of the Buffett Indicator. Stocks surged past gross domestic product years ago, but unlike in bull markets of past decades, there has been no reversion to the mean.

Asset managers head to the exits

Grantham is hardly alone in noting the historic deviations playing out in financial markets. On Feb. 7, Asif Suria echoed Grantham's concerns in his latest edition of InsiderArbitrage:

"Whether you look at the Buffett indicator of total stock market capitalization divided by GDP which stands at an all time high of nearly 190% or that the U.S. stock market represents more than 60% of world equities (Japan represented about 45% of global equities during its dual stock and real estate bubbles in the late 1980s), it is hard not to draw the same conclusion as GMO Capital's Jeremy Grantham (Trades, Portfolio) that we are in an epic bubble."

According to Suria, who tracks insider buying and selling across a range of asset classes, executives at many of the world's biggest asset managers have been selling stock lately:

"Insider buying decreased last week with insiders purchasing $30.66 million of stock purchased compared to $30.78 million in the week prior. Selling increased significantly with insiders selling $2.19 billion of stock last week compared to $1.17 billion in the week prior."

No less than six senior figures at BlackRock Inc. (NYSE:BLK) have sold significantly in the last week, including CEO Larry Fink, who brought in $20 million from stock sales. When the insiders start selling, there may be reason for investors to pause.

Return to value

With the warning signs blaring, what can investors do? According to Grantham, there may be a fresh opportunity emerging in value-oriented companies:

"Those at the very cheap end include traditional value stocks all over the world, relative to growth stocks. Value stocks have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020, with spreads between Growth and Value performance averaging between 20 and 30 percentage points for the single year!"

Value stocks have been battered for years, with even the recent recession failing to lift their fortunes as many had long hoped it would. However, I do see value in Grantham's prognosis. While value stocks have failed to pay off over the past year, the conditions under which they should thrive have only been magnified. I recommend being prepared to seize such opportunities if and when they emerge.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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