Jeremy Grantham, Long-Term Investment Strategist, and Co-Founder GMO is of the view that the market is entering the superbubble’s final act. According to him, only a few market events in an investor’s career really matter, and among the most important of all are superbubbles.
And, how are Ordinary bubbles different from superbubbles? Here’s what they are – Ordinary bubbles are, to us, those that reach a 2 sigma deviation from the trend. Superbubbles reach 2.5 sigma or greater. The true U.S. superbubbles – 2.5+ sigma events – are 1929, 2000, and 2021. Here is what Jeremy Grantham writes in his piece, “Entering the superbubble’s final act.”
Bear market rally from June lows: One of those features is the bear market rally after the initial derating stage of the decline but before the economy has clearly begun to deteriorate, as it always has when superbubbles burst.
This in all three previous cases recovered over half the market’s initial losses, luring unwary investors back just in time for the market to turn down again, only more viciously, and the economy to weaken. This summer’s rally has so far perfectly fit the pattern.
Inflation and economy: The U.S. stock market remains very expensive and an increase in inflation like the one this year has always hurt multiples, although more slowly than normal this time. But now the fundamentals have also started to deteriorate enormously and surprisingly: between COVID in China, war in Europe, food and energy crises, record fiscal tightening, and more, the outlook is far grimmer than could have been foreseen in January. Longer term, a broad and permanent food and resource shortage is threatening, all made worse by accelerating climate damage.
My theory is that the breaking of these superbubbles takes multiple stages. First, the bubble forms; second, a setback occurs, as it just did in the first half of this year, when some wrinkle in the economic or political environment causes investors to realize that perfection will, after all, not last forever, and valuations take a half-step back. Then there is what we have just seen – the bear market rally. Fourth and finally, fundamentals deteriorate and the market declines to a low.
The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing, and stocks all critically overpriced and now rapidly losing momentum), commodity shock, and Fed hawkishness. Each cycle is different and unique – but every historical parallel suggests that the worst is yet to come. If history repeats, the play will once again be a Tragedy. We must hope this time for a minor one – 2000 was minor, 1972 major, and 1929, of course, horrific.