Is Jeremy Grantham’s Warning of a “Super Bubble” Real?

Jeremy Grantham, the British investor/fund manager, had predicted the last three bubbles. He is back at it again. After successfully predicting the 1989 Japanese bubble, the 2000 dot-com bubble, and the 2007 housing bubble, Jeremy has made another bold prediction. US markets are in a bubble that is so big, that it will destroy more than $45 trillion of assets. He’s been warning of this for almost a year, and he now claims we’re close to the final burst that will cause the next market crash.

A normal market bubble is an event in which assets are priced at 2 sigma deviation from the historical trend. A super-bubble is when assets are priced at 3 sigma the standard deviation from the historical trend.

As you may observe, prices are way off historical values. And this is not just in terms of nominal prices, but also in terms of P/E and valuation premiums. 

If we were to recap the stock-related contents this would probably be it:

Then also look at the CAPE ratio, or cyclically adjusted P/E Ratio for the S&P 500:

The average value for this ratio is roughly 16, whereas this ratio is now sitting at 30. So, in terms of the super-bubble definition, it is currently 3 times the standard deviation away from the historical average in stocks. And even if this ratio got to 25, which would imply a -15% in stock prices, this would still be one of the highest values recorded in history. It would still have a long way before reaching the average of 16.

Another useful indicator is also the total allocation to stocks in comparison to other assets

As stocks go higher, people buy more. When stocks are high, people tend to put more money in stocks which is the prevailing sentiment in the market. This is also not a great thing, mainly because this over-allocation represents a sign of too much optimism in the markets.

Caution is the watchword. There are two options in a downward cycle – sell quickly or hold for the longer term. To sell quick may suggest you will recover when a buying opportunity arises much later. To hold means you have the means to take a longer-term view. Either way, it is to reduce gyrations and preserving portfolio value in a 8-10 year cycle. The selection of which option is based largely on risk aversion or otherwise. To each his own!

Reference:

Jeremy Grantham is warning of a “super bubble” in US markets, Thomas Herold, https://medium.com, Jun 14, 2022