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StockBeat: On Late-Stage Bubbles, and How to Survive Them

Stock Markets Jan 07, 2021 05:50AM ET
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© Reuters.

By Geoffrey Smith

Investing.com -- Fund managers’ letters to investors can be tedious affairs, but sometimes there comes one so brilliant that all you can do is to reproduce it as exactly as possible.

The latest from GMO founder Jeremy Grantham is one such example. You can find the full version here, but for those who don’t have the time to read it, the main points are as follows

The long bull market since 2009 has matured into a "fully-fledged epic bubble", and is generating almost all of the most reliable signs that this bubble is in its late stage.

These signs include behavior, especially by small investors, that Grantham characterizes as “crazy”. He notes that 150 micro caps have tripled over the last year, “which is over three times as many as any year in the previous decade.” Additionally, he notes, “the volume of small retail purchases, of less than 10 contracts, of call options on U.S. equities has increased 8-fold compared to 2019, and 2019 was already well above long-run average.”

There have been increasingly frequent signs of mania with regard to single stocks: he highlights Hertz (OTC:HTZGQ), Kodak (NYSE:KODK), Nikola (NASDAQ:NKLA) “and, especially, Tesla (NASDAQ:TSLA),” whose valuation now equates to $1.25 million per car sold each year, compared to $9,000 for General Motors (NYSE:GM).

“What has 1929 got to equal that?” Grantham asks.

The other tell-tale sign of a late-stage bubble all the way back to the 18th century, is the acceleration of gains. In recent times, he notes, that has been around 60% in the final 21 months before the peak. In the current rally, the major indices have done all of that and more in just nine months.

Sadly, there is just no way of timing the top. Bubbles typically don’t burst in response to single negative events. A veteran of over four decades, Grantham freely admits getting out of the Japanese stock bubble almost three years too early in the 1980s.

“The great bull markets typically turn down when the market conditions are very favorable, just subtly less favorable than they were yesterday,” he argues. “And that is why they are always missed.”

However, he points to one telling, if anecdotal factor, common to bubbles, namely the “intensity and enthusiasm of bulls” and the “rising hostility toward bears.” He cites 1999, when his clients acted “as if we were deliberately and maliciously depriving them of gains”.

The above factors make it impossible for most sell-side analysts to go against the consensus. Here, we just have to quote Grantham at length.

“Don't wait for the Goldmans and Morgan Stanleys to become bearish: it can never happen. For them it is a horribly non-commercial bet. Perhaps it is for anyone. Profitable and risk-reducing for the clients, yes, but commercially impractical for advisors. Their best policy is clear and simple: always be extremely bullish. It is good for business and intellectually undemanding. It is appealing to most investors who much prefer optimism to realistic appraisal, as witnessed so vividly with COVID. And when it all ends, you will as a persistent bull have overwhelming company. This is why you have always had bullish advice in a bubble and always will.”

So what is to be done? If you can’t time the end of the bubble, then at least concentrate exposure where things are relatively cheap, Grantham argues. Value stocks have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020. Likewise, emerging market stocks are at one of their three “more or less co-equal relative lows” against U.S. equities over the last 50 years.

“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 U.S. growth stocks that your career and business risk will allow.”

StockBeat: On Late-Stage Bubbles, and How to Survive Them
 

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Comments (19)
Benoit Avril
Benoit Avril Jan 12, 2021 1:57PM ET
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The thing is there are a lot of contradicting ideas in the market wisdom. The market can't be predicted, yet, it repeats itself. I think there are few factors that make things quite different. First, it's a bubble that is fueled by people who said they will continue to fuel it for a very long while, and the last financial crisis has been dealed with the solutions that led to the first crisis. So even if somebody thinks "it's very high", he will also think, "anyway if it falls, in 10 years, I will get it back". As long as that money doesn't flow through the economy, there is no inflation in sight. Major central banks explicitly told us, it will be hard for savers in the future, so rates are never going to get higher, and investors won't cash in. Even if the money flowed to the economy, production costs drop so much for any good that inflation disappear. There will be no end to the continuous optimisation of process, Technology will always be more and more efficient.
Benoit Avril
Benoit Avril Jan 12, 2021 1:57PM ET
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Also, the way money flowed to the economy is by making some people in previous third world countries slightly less poor. A huge middle class emerged in China, and a new one has born in India.
RobinThe Hood
RobinThe Hood Jan 07, 2021 2:29PM ET
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It usually isn't wise to bet against Grantham.
Rob Ropes
Rob Ropes Jan 07, 2021 8:51AM ET
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Thank you for your reference to Jeremy Grantham's letter. I read it, it has the ring of truth. I need to listen to a manager with 50 years experience.  A wise man learns from another's experiences and mistakes so the he doesn't need to repeat them.  I'm not looking for a very expensive education in investing.
Zach Lohman
Zach Lohman Jan 07, 2021 8:49AM ET
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The with some of the fund manager commentary is that it often advocates for so called less risky stocks. Defense means cash, gold, mortgages, hedges and francs. Less risky stocks will crash with the rest. I have reserves but I learned a long time ago there’s no such thing as kind of less risky equity.
Zach Lohman
Zach Lohman Jan 07, 2021 8:49AM ET
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The problem
Notvery Goodathis
Peteymcletey Jan 07, 2021 8:49AM ET
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But the point is timing it. what if value stocks go up 100% before they drop 50%? cash looks like trash right now. assets are good though - so buy a new car etc.
Zach Lohman
Zach Lohman Jan 07, 2021 8:49AM ET
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Notvery Goodathis You’re right. I have reserves but mostly have equity since it can always keep rising. I was only pointing out that equity is risky by nature so if you want defense it must be in another asset class.
Izzy Hayat
Izzy Hayat Jan 07, 2021 8:03AM ET
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other than Tesla and some speculation stocks... show me where this mass over valuation is happening... or this financial strain is at right now... what i'm seeing is this massive bottleneck and pressure to the upside... this "reccession" didnt occur by financial pressure like businesses were too levereged or they were doing something wrong... this was government intervention turning off the taps when there was absolutely nothing wrong with financial system, in fact it was quite the contrary
Izzy Hayat
Izzy Hayat Jan 07, 2021 8:03AM ET
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lol look no further than the amount of dislikes I have as an indication that we're not in a bubble haha
Benoit Avril
Benoit Avril Jan 07, 2021 8:03AM ET
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kind of agreej but look at the average PER of the S&P.
Abdul Sattar
Abdul Sattar Jan 07, 2021 7:59AM ET
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may bons
Jerome NY
Jeff_Musk Jan 07, 2021 7:45AM ET
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Below comments shows bubble is at it’s top
Оля Раваева
Оля Раваева Jan 07, 2021 7:45AM ET
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Bubble it is, but where you dont see bubbles? All values are bubbled
Оля Раваева
Оля Раваева Jan 07, 2021 7:39AM ET
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"Value" and "Emerging"? Ha ha. They will drop much lower the US "Growh" in case of ugly scenario
charles kang
charles kang Jan 07, 2021 7:11AM ET
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this PONSI stock mkt now manipulate by the govt via the fed loose monetary policies and with more stimulus ongoing.
Victor Tan Cheong Wee
Victor Tan Cheong Wee Jan 07, 2021 6:53AM ET
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But if Wall st is down, can emerging market be up?? Anyone can share?? Or he means to say only growth stock will get hit hard,
Nicholas Pantaleo
Nicholas Pantaleo Jan 07, 2021 6:53AM ET
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I think hes more saying because they are low already they have less they can drop compared to the growth stocks who can plummett from historic highs. Value and emerging markets wont be hit as hard and offer good upside dur to being down. Essentially rebalance to underperforming instead of chase overperformers is what it boils down to.
 
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