“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 behaviour, 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.”
So published one of the grand old men of investing and asset allocation last week, Jeremy Grantham.
He’s been warning about this bubble for a while now but his January opus, Waiting for the Last Dance, sums up his case very nicely indeed, along with the perils of being an investment manager.
He was writing specifically about the American market but there are implications for Australia and, as we saw in 2008, market contagion remains a problem.
The Tesla share price, Bitcoin and Nasdaq’s valuation (I use the word loosely) are all nonsense somewhat removed from the ASX and most Australians’ superannuation funds, yet their eventual popping will still shake us.
Mr Grantham is famous for identifying the past three big bubbles and forecasting their demise.
As he freely admits though, his timing was well out on two of the three: “I came fairly close to calling one bull market peak in 2008 and nailed a bear market low in early 2009 when I wrote ‘Reinvesting When Terrified.’ That’s far more luck than I could hope for even over a 50-year career.
“Far more typically, I was three years too early in the Japan bubble. We at GMO got entirely out of Japan in 1987, when it was over 40 per cent of the EAFE benchmark and selling at over 40x earnings, against a previous all-time high of 25x. It seemed prudent to exit at the time, but for three years we underperformed painfully as the Japanese market went to 65x earnings on its way to becoming over 60 per cent of the benchmark! But we also stayed completely out for three years after the top and ultimately made good money on the round trip.
“Similarly, in late 1997, as the S&P 500 passed its previous 1929 peak of 21x earnings, we rapidly sold down our discretionary US equity positions then watched in horror as the market went to 35x on rising earnings. We lost half our asset allocation book of business but in the ensuing decline we much more than made up our losses.”
(On a vastly smaller scale, I know Mr Grantham’s pain. I was sceptical of the Dot Bomb bubble – it was a time when the Sydney Morning Herald business section had more coverage of Dot Com businesses than the rest of the market combined – and was challenged to put my money where my mouth was. I did with an option bet against the Nasdaq. Unfortunately that was in early 1999. Oh well.
I won’t run here Mr Grantham’s case for the present US bubble being a big one – you can click on the link above for his whole article – but it is worth quoting why so much money continues flow towards the precipice: “I expect once again for my bubble call to meet my modest definition of success: At some future date, whenever that may be, it will have paid for you to have ducked from midsummer of 2020.
“But few professional or individual investors will have been able to have ducked. The combination of timing uncertainty and rapidly accelerating regret on the part of clients means that the career and business risk of fighting the bubble is too great for large commercial enterprises. They can never put their full weight behind bearish advice even if the P/E goes to 65x as it did in Japan.”
That is in keeping with Anthony Peters’ Second Law: “Nobody has ever been fired for being long of a falling market, but being short of a rising one is a career-threatening mistake.”
Mr Peters also is bearish about present market excess and is especially leery of the near-incomprehensible levels of government debt underwriting it.
The Grantham article came across my desk within days of one of Mr Peters’ missives which, in part, explained the different mindsets of equity and bond investors.
To greatly condense, bonds do best when interest rates are falling and interest rates fall in weakening economies – recessions are Christmas for bond dogs.
“The best we bond people can hope for is that our securities return to the 100 cents in the dollar at which they were issued,” he wrote.
“We find it hard to follow the thinking of equity geeks, who make a living out of what we perceive to be packing scientific language around big and largely random second guesses.”
Bond people live and breathe macro-economics, but dealing with monthly statistics is hard enough “without believing that we can forecast where the economy will be two, three or more years forward”.
“Yet our equity cousins get paid well to make blithe assumptions as to what a company will be earning two or three years down the road and what in consequence the share price is going to be.”
His best lines though were a succinct exposition of what led to the GFC.
“Although I made my retirement pot in investment banking I was trained in good old commercial banking. The difference? When looking at a deal, a commercial banker tries to assess how much he might lose. An investment banker, on the other hand, wonders how much he can make.
“The gradual dismemberment of the Glass-Steagall Act which in the aftermath of the Crash of ’29 enforced the separation of commercial and investment banking activities led to the mixing of the two cultures, the toxic result of which we were to experience in 2007-2008.
“Giving investment bankers the power vested in a commercial bank’s balance sheets was as destructive as encouraging commercial lenders to solely focus on the upside potential of any transaction.”
The bulls’ argument for “this time it’s different” is the collapse of interest rates (monetary policy stimulus) causing a repricing of all assets – free or nearly free money is doing what governments and central banks want it to do: Causing asset inflation.
“Stimulus is proof that things aren’t good,” Mr Peters counters. “More stimulus is proof that they’re not getting better.
“Anticipating even more stimulus, as global equity markets quite demonstrably are, is also anticipating that it’s not going to be getting much better well into the future.”
Yet trillions of stimulus dollars are keeping the game rolling. Mr Grantham reminds readers of the quote attributed to John Maynard Keynes: “The market can stay irrational longer than the investor can stay solvent.”
Mr Grantham poses the question of what an investor should do.
Mr Peters has one answer: “If this is a world where Elon Musk, master of marketing and self-promotion sans pareil, can become the richest man of all times, I’d rather like to get off. Anyone for tulip bulbs?”
Mr Grantham instead relies on asset allocation being a game of relativities, that the current bubble is throwing up extreme disparities in value by asset class, sector and company.
Value stocks are very cheap relative to “growth” stocks and emerging markets are at around their relative lowest against the US in half a century.
“We believe it is in the overlap of these two ideas, Value and Emerging, that your relative bets should go, along with the greatest avoidance of US Growth stocks that your career and business risk will allow.”
Australia is fortunate to have stocks offering relative value and that our economy broadly remains a cousin of emerging markets despite the federal government’s efforts.
As for the temptation to chase the bubble stocks, a final lesson from Mr Grantham.
“These events can easily outlast the patience of most clients. And when price rises are very rapid, typically toward the end of a bull market, impatience is followed by anxiety and envy. As I like to say, there is nothing more supremely irritating than watching your neighbours get rich.”