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Of course, it is not strange that the argument cheap money only masks a weak economy has gained no traction. The low-interest rate environment put in place by the Federal Reserve, European Central Bank and Bank of Japan and money pouring out of China has driven cash into real estate, commodities and speculative whimsies such as bitcoin and other cryptocurrencies. A Market Watch article last week only added to the enthusiasm by informing us that well-respected investor Jeremy Grantham, who is credited with calling the 2000 and 2008 downturns warned investors on Wednesday to be prepared for the possibility of a near-term “melt-up.”
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Returning to the MarketWatch story, Grantham states, “I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market,” The well-respected investor did this in a 13-page note where he emphasized this reflected his very personal view. Grantham, a value investor, co-founder and chief investment strategist of Boston-based asset manager GMO compared the present market setup with the run-up to past bubbles, including the 2000 tech boom and the precursor to the 1929 crash.
Grantham emphasizes that bubble calls shouldn’t necessarily rely on price alone. Instead, he puts emphasis on price acceleration, which captures “the importance of a true psychological event of momentum increasing to a frenzy.” Grantham refers to an academic paper published last year that concluded that the strongest indicator of a bubble in the U.S. and almost all global markets was price acceleration. Grantham points out that “just recently, say the last six months, we have been showing a modest acceleration, the base camp, perhaps, for a final possible assault on the peak. He wrote. “A range of nine to 18 months from today and a price rise to around 3,400 to 3,700 on the S&P 500 would show the same 60% gain over 21 months as the least of the other classic bubble events.”
Other bubble factors cited by Grantham include increasing concentration on certain stock market “winners,” the outperformance of quality and low-beta stocks in a rapidly rising market, “extreme overvaluation” and the role of the Federal Reserve. This all seems more of a reminder of well-entrenched market sayings such as the "trend is your friend" and "don't stand in front of a freight train" based on charts, wave patterns and his gut feelings that we have disconnected from true market value and when we do these trends seem to take on a life of their own. Of course, that does not mean Grantham is not right and even as icons such as Macys and Sears announce closing more stores the markets may ignore such things.
Below is a summary of what Grantham sees might happen.
- ■ “A melt-up or end-phase of a bubble within the next six months to two years is likely, i.e., over 50%.
- ■”If there is a melt-up, then the odds of a subsequent bubble break or meltdown are very, very high, i.e., over 90%.
- ■ “If there is a market decline following a melt-up, it is quite likely to be a decline of some 50%.
- ■ “If such a decline takes place, I believe the market is very likely (over 2:1) to bounce back up way over the pre-1998 level of 15x, but likely a bit below the average trend of the last 20 years, as the trend slowly works its way back toward the old normal on my ‘Not with a Bang but a Whimper’ flight path.”