Jeremy Grantham (Trades, Portfolio) is a legendary investor and the founder of GMO, an asset management firm with over $60 billion in assets under management. In a March interview with Rosenberg Research, he discussed his thoughts on “great bubbles” and changes in the macroeconomic environment.
I have summarized this discussion and added some of my own comments for context. Let’s dive in.
Learning from great bubbles
According to Grantham, the great bubbles (and crashes) included the Great Depression, which started in 1929, the tech bubble in the year 2000 and the 2008 housing bubble. He added the “2021 bubble” as another, which recently seems to have popped.
Another example is Japan, which had the “greatest bubble in history” at 60 times earnings for the stock market in the late 1980s. This was combined with the greatest real estate bubble at the same time. He said things got so ludicrous that the “land under the emperor's palace” was priced higher than the entire state of California.
Throughout all these bubbles, Grantham highlighted a common scenario: economic conditions which seem “nearly perfect” and investor confidence “in full screaming blossom.” People were buying stocks “because they were going up” and not because of fundamentals.
Further, he noted leverage has usually been higher than normal during these periods.
Once people realize that the bubble cannot inflate forever, you get a “rapid unraveling” of the most “speculative stocks.”
Market divergence and corrections
Then, Grantham said there usually occurs a “divergence,” where the blue-chip stocks continue to rise higher. This leads people to believe we “can't be in a bear market” as the S&P 500 is up. For instance, during the 2021 correction, speculative growth stocks and SPAC-based vehicles were the first to fall. But by 2022, the big tech giants also saw rapid declines.
An example of the early madness is Quantumscape Corp. (QS, Financial), which Grantham admitted to investing in several years earlier as a startup. However, in 2020, the stock skyrocketed from $10 to over $100 and had a valuation of $52 billion for a “research effort” that did not even have a product. This seems crazy now looking back, but at the time this increase in share price was driven by the hype surrounding electric vehicles and the battery manufacturers which followed.
Quantumscape's stock has since spiraled back down to around $7 per share as of August.
Market correction case studies
The guru noted a similar occurrence also happened during the dot-com bubble (and crash) of 2000. The companies that were valued based on “eyeballs” and had no revenue were the first to “peel off.” This was followed by companies such as Pets.com and finally blue-chip names such as Cisco (CSCO, Financial).
Another pattern Grahtham highlights is a “January bounce,” which is usually driven by “tax loss harvesting” as investors sell stocks that have fallen. However, they then become so cheap that they actually become good investments again.
We saw this phenomenon take place in the first quarter of 2023, with names such as Meta Platforms (META, Financial) increasing by 133%.
“Every one of these superbubbles has been followed by a recession,” Grantham added.
The presidential cycle
Grantham also discussed a unique phenomenon called “the presidential cycle.” This occurs when politicians in power aim to “stimulate the economy” in the “run-up to an election.”
GMO studied the patterns between re-election and the economy. The only correlating factor he discovered was “the state of the labor market in the six months run-up to an election.”
Therefore, in the seven-month window between October and April, the cycle (and usual stimulus injected) has created “7 times” the average return since 1932, according to Grantham.
He also calls the “window” before an election “the short seller's graveyard” as stocks tend to go up.
Forecast for the future
The investor said he believes we are now waiting for a “huge unraveling of confidence” and declining economics. However, the “intrusion” of the aforementioned presidential cycle could delay the worst of the economic impact. According to him, this has “never happened” in the history of great bubbles.
Will the housing market crash?
Grantham believes we have yet to see the full impact of higher interest rates on the housing market. For example, if someone took out a mortgage at 2.8% and the new rate is 5.5%, this is a dramatic shift that will result in higher mortgage servicing costs and lower profit margins. A valuation correction is also expected.
A general measure of the value of housing is analyzing its price as a multiple of household income. In this case, Grantham said, the U.S. figures are close to the housing bubble of 2007. In other parts of the world, such as the U.K., the gap is even greater.
He also pointed out that the housing market is on a longer cycle. The previous 2007 housing bubble took “six years” from peak to trough, but the stock market only took between one and two years.
The investor cautioned that economic stress builds up like “huge pressure” behind a dam and it can be challenging to work out which brick will go first. This could be in the financial sector, as we saw with Lehman Brothers or even Silicon Valley Bank.
Population shocks and the economy
At a macroeconomic level, Grantham believes there is a “population shock” pending as there is a decrease in babies born per parent. This is expected to mean a reduction in young workers over the next decade or two, which will impact gross domestic product.
Final thoughts
Grantham is an incredible investor who is truly a student of history. His insights from past bubbles help to put future bubbles and crashes into context.
As investors, it is useful to have a battle plan and create a big-picture view of the macroeconomic landscape to help keep perspective and control emotions during recessions. Following any past crash or recession, the economy has recovered, so that is an optimistic point to remember.
