Why Jeremy Grantham Says We Are In A ‘Superbubble’

The current market is a "superbubble" and investors must prepare for an epic finale, according to Jeremy Grantham of GMO.

"Only a few market events in an investor’s career really matter, and among the most important of all are superbubbles. These superbubbles are events unlike any others: while there are only a few in history for investors to study, they have clear features in common,” wrote Grantham, co-founder of Boston asset manager GMO, in a research note on Wednesday.

“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," he wrote.

"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."

Having established through various parameters including geopolitics, population and resources, Grantham said people should prepare for an “epic finale”.

According to him, previous superbubbles saw a much worse subsequent economic outlook if they combined multiple asset classes–such as housing and stocks in Japan in 1989 or globally in 2006, or if they combined an inflation surge and rate shock with a stock bubble as seen in the U.S. in 1973.

The current superbubble features the most dangerous mix of these factors in modern times, as all three major asset classes–housing, stocks, and bonds–were critically historically overvalued at the end of last year, he wrote.

“Now we are seeing an inflation surge and rate shock as in the early 1970s as well. And to make matters worse, we have a commodity and energy surge (as painfully seen in 1972 and in 2007) and these commodity shocks have always cast a long growth-suppressing shadow.”

Given all these negative factors, it is not surprising that consumer and business confidence measures are testing historic lows, said the seasoned investor.

In terms of the tech sector, “the leading edge of the U.S. (and global) economy, hiring is slowing, layoffs are rising, and CEOs are increasingly bracing for recession”, Grantham said.

According to Grantham, there has been a recent bear market rally in line with three historical precedents—”the bear market rallies that marked the middle phase of deflating superbubbles”.

If the bear market had already ended, the parallels with the other U.S. superbubbles would be completely broken, he said.

“Each cycle is different, and each government response is unpredictable. But these few epic events seem to act according to their very own rules…”

If history repeats itself, “the play will once again be a Tragedy”, Grantham wrote.