Paul Volcker knew what he was doing, but since then, it’s been a horror show: Jeremy Grantham

Jeremy Grantham doesn’t expect the market to find a bottom until late next year, and advises against expecting a soft landing for the economy.

Paul Volcker, inflation, recession, super bubble, Federal Reserve policy, market, risk,
None of the great psychological bubbles have ever had anything other than an ordinary recession or a savage recession.

Bloomberg: Federal Reserve policy has been a “horror show” ever since former Chair Paul Volcker stepped down in 1987, resulting in a series of bubbles and crashes, according to Jeremy Grantham, the co-founder of investment firm GMO.

That’s why the stock market is now in what 84-year-old Grantham calls a “meat-grinder” phase, arising after a super bubble fueled by extraordinarily low interest rates in the decade following the global financial crisis. He doesn’t expect the market to find a bottom until late next year, and advises against expecting a soft landing for the economy: “None of the great psychological bubbles have ever had anything other than an ordinary recession or a savage recession.”

Grantham joined the What Goes Up podcast to discuss the current state of play in markets, as well as some of the long-term risks he’s been studying, like climate change, de-globalization, the return of the Cold War and shortages in natural resources and labor.

Here are some highlights of the conversation, which have been condensed and edited for clarity.

Q: You warned about a stock-market plunge this year. Lay out what you’re seeing.

A: I personally am a great respecter of January as an unusual month. And what January does is, it tends to be pretty kind to small-cap and value. Indeed, more than 100% of all the so-called small-cap effect has occurred in January for the last 100 years. So, it’s huge for small-cap and value, but also has this rather more complicated thing, and that is, it does very well for stocks that got utterly hammered the year before.

That’s pretty obvious — what happens is you lose 40%, 50%, 60%, 70% or so. You take your losses to reap the tax-loss effect. And then you have the money in your hand and you have a year-end bonus, Christmas bonus and so on. And you look out into the new year, you can see them as bargains. They’re down a lot — in this case, the growth stocks. And so you buy them. So, I was kind of fearful of that.

We look back at what happened in 2000. There are only a handful of great bubbles that look like this one. And the one that looks most like it is the great tech bubble of 2000. And during 2000, the blue-chips continued to go up, the dot-coms, and then they shot the junior growth stocks and then the medium growth stocks and finally the great Cisco’s of that era. And by the end of the year, the Nasdaq was down 40%. And a lot of the growth stocks were probably down about an average of 50% or 60%. It was a bloodbath. And that pretty much sums up what happened to highly speculative stocks last year, don’t you think?

And so, what happened in 2001? January 2001 was up 12% — led by the specs that had been wiped out the previous year. This seems so boring as to hardly be worth commenting on, but that is exactly what happened this year. And one of the proofs is if you take the order of horror last year and flip it, that is precisely the order of heroics this year.

Q: Will that parallel to the dot-com bubble go from peak to trough?

A: The bottom was in late 2002. Mostly the great bubbles, when they break, they take a long time. They typically take a couple of years, three years, and every now and then they get rid of it in a real hurry. But my guess was this was going to be a long one. The buy-in to the idea that stocks only go up and the amount of speculative craziness that was set in train by the Covid supplemental payments meant that individual participation was actually off the scale — bigger than 2000, bigger than the dot-com. And so, this looked like it would have a whole lot of buy-the-dip from day one. And it’s had a lot of buy-the-dip.

But 2000 had some wonderful rallies. Even in 1929, it rallied almost 45% off the lows of ‘29 until April of 1930. A hell of a rally — must have made people feel that the worst was over, and then it rolled over and went down well over 80% on the S&P and most of the speculative index went down 95%, give or take.

Anyway, let’s hope we don’t go there. But it just gives you an idea. Great bear markets can have wonderful rallies. Great bear markets can take their time. And we have a very, very recent one where quite a few players in today’s market experienced 2000, and it went on for three painful years. And the housing bust was a quick one but not that quick. It took over a year of pretty steady declines. So, my guess is this one will not bottom until deep into next year.

Q: So, three straight years of losses, do you think?

A: I do think. There is a fighting chance this year will not be down that much. And a very good chance that through April, it might easily be up.

Q: To bring us to the present — Powell surprised markets with his hawkishness. Talk to us about what Powell is doing. Is he being aggressive enough, not aggressive enough? And will it work?

A: They have hardly gotten anything right since Alan Greenspan first arrived. Paul Volcker knew what he was doing, but since then, it’s been a long, continuous horror show. They’ve engaged in policies that drive up the prices of assets — other things being even — and created spectacular overpriced bubbles. They then break because that’s what bubbles have to do. They simply break of their own extreme overpricing and we pay a very tough price.

And then the Fed races to the rescue. Oh dear, the wreckage of 2000. They came in and they prevented the S&P from going down more than 50%, which it would’ve done. With moral hazard, lots of aggressive language and reduction in rates, they managed to curtail that at 50%. They couldn’t stop a recession. They didn’t stop the Nasdaq going down 82%. They threw the kitchen sink at it.

And then what happened to Bernanke? He’s facing a housing bubble. He says, ‘Oh, US housing has never declined.’ It never had — it has never had a bubble before. It was famously diversified between California going up and Florida going down, et cetera, or vice versa. And then he said, ‘The US housing market merely reflects a strong US economy.’ The US housing market has a long historical record. You could measure it. It was a three-sigma event, which is the kind of event in a normal series that would occur every 100 years. And all his staff could see that. No one apparently plucked up the courage to tell him.

The housing market, it went up and then it came down in a beautiful round trip — symmetrical, perfect, the best one I ever saw. So, three years up, three years down, they sucked in extra people to owning houses — 3% or 4% of the public. It went from a normal 62% to 65% or 66% for the first time in history. And then painfully for the marginal buyers, that went all the way back to 61%, 62%. The housing market went all the way back to trend and actually over-corrected, which is typical for two or three years.

That’s a lot of pain. It was all their fault. And why would we believe that they know what they’re doing?

And then they stoked the fire again. And this time, it’s real estate. It went to a higher multiple of family income per house than the housing bubble in late last year, after the biggest year in history, 20% for last year. Biggest move, including the housing bubble. Forestry, farming, fine art, you name it, bonds of course, and the stock market way back up.

Why would they do this? It’s always the same. They always break and everyone says, ‘Oh, it’s fine this time’ — it never has been. Everyone says there won’t be a hard landing, it’ll be a soft landing. None of the great psychological bubbles have ever had anything other than an ordinary recession or a savage recession. There are normal ones and there are terrible ones. There are no soft landings in my little universe of super bubbles that you can see statistically as easy as pie. So, why don’t more people see them? Because it’s not good for business. The commercial understanding is, you’re always bullish and that maximizes your money.

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First published on: 12-03-2023 at 19:19 IST
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