81-year-old Jeremy Grantham is growing increasingly confident that the post-COVID rally in US equities counts as a bubble, and he thinks it’s being fueled by the retail crowd.
“My confidence is rising quite rapidly that this is the fourth ‘Real McCoy’ bubble of my investment career”, Grantham told CNBC’s Wilfred Frost on Wednesday afternoon.
Asked if he “applauds” newly-christened day traders who have scored quick gains in the rebound from the March lows, Grantham said “I certainly applaud them if they cash out and put in their piggy bank”.
“But typically when this happens, you know as well as I do how it ends”, he went on to say, before characterizing recent price action as “crazy stuff”.
“I’m [not] talking about the last three or four months, but the last few weeks”, Grantham added, elaborating. “We’ve now reached a level where you buy bankrupt companies and issue stock in bankrupt companies”.
He was referring to the Hertz saga, which took another turn for the absurd on Wednesday, when the SEC essentially had to intervene to dissuade the company from issuing $500 million in new shares to capitalize off the speculative mania in insolvency stocks.
The proceeds from that sale (which was mercifully suspended) would have doubtlessly gone to pay off investors higher up in the capital structure.
Read more on the ‘insolvency stock’ mania: ‘One Helluva Ride!’ Dip-Buying Perfection And The ‘Bizarre’ Case Of The Robinhood Rally
“The great bubbles can go on for a long time and inflict a lot of pain”, Grantham told Frost.
You don’t have to reference Hertz (or similarly ridiculous rallies in the shares of companies which are teetering on the brink of insolvency) to assert that equities are a bubble. Risk assets are powering higher against the worst economic backdrop since the Great Depression, which means charts like the following are ubiquitous.
Grantham’s remarks to CNBC served as a recap of cautious comments from GMO’s quarterly letter, published earlier this month.
“My simple life at GMO of focusing most of my efforts on climate change related investing was rudely interrupted by the coronavirus”, Grantham wrote, two weeks back, calling the virus “a bottomless pit of complexity, contradictory data, and guesswork”.
Those somewhat frustrated sentiments echo similarly befuddled musings from a veritable who’s who of the financial pantheon. Paul Tudor Jones is eating “humble pie“, Stan Druckenmiller only managed a 3% gain during a 40% rally, Warren Buffett threw in the towel after incurring a mind-boggling $50 billion paper loss during the first quarter, and Howard Marks doesn’t know what’s going on at all.
“I have been completely amazed”, Grantham said, marveling at the scope of what recently became the most spectacular bear market rally on record.
“The speed and now the extent and the lack of major interruptions along the way, it is a rally without precedent”. You get the idea. Grantham is incredulous.
Frankly, this discussion is getting a bit tedious. I understand the need for every legend to weigh in on the glaring disconnect between equities and the economy, but there are only so many ways to make the same point.
The bottom line is that although the future for corporate profits is plagued by unprecedented uncertainty, after more than a decade of conditioning, you can forgive the tendency for risk assets to respond to the promise (and delivery) of massive monetary stimulus. All that’s ever mattered since Lehman is liquidity — why should a virus change that?
But it’s not just central banks. It’s also government spending, which is being openly enabled by monetary policy.
This time around, extreme monetary largesse is paired with a coordinated fiscal push of historic proportions, complete with direct, cash handouts to households. The table is a summary of these efforts.
(BofA)
We are witnessing the biggest double-barreled adrenaline shot ever administered to markets and the global economy.
Given that, it’s not wholly surprising that assets are reacting the way they are.
Or maybe it is. Maybe we should all expect more of ourselves in terms of “voting with our feet” to impose a little discipline on a market where rationality is in short supply.
In any event, you can read more from Grantham below.
Via GMO
THE VIRUS, THE ECONOMY, AND THE MARKET
By Jeremy Grantham, on June 4
My simple life at GMO of focusing most of my efforts on climate change related investing was rudely interrupted by the coronavirus. The virus is a bottomless pit of complexity, contradictory data, and guesswork.
The interactions of the virus with the economy and new economic measures are the same: complex and without precedent.
And the interactions with the market psychology of these medical, financial, economic, and political actions, well, as any self-respecting gangster would say, “Fuhgeddaboudit.” So, starting in late January — yes, I was way ahead of the U.S. and the U.K. administrations, both spectacularly slow to get the point — I have been spending twice my usual total research time on all these new interactions, which for anyone interested in data analysis have presented an amazing challenge. The good news is the days flash by. The bad news is that new data arrives faster than humans can keep up with.
For now, let’s get this on the table.
There are no certainties here. At GMO we dealt with three major events prior to this crisis, and rightly or wrongly, we felt “nearly certain” that sooner or later we would be right. We exited Japan 100% in 1987 at 45x and watched it go to 65x (for a second, bigger than the U.S.) before a downward readjustment of 30 years and counting. In early 1998 we fought the Tech bubble from 21x (equal to the previous record high in 1929) to 35x before a 50% decline, losing many clients and then regaining even more on the round trip. In 2007 we led our clients relatively painlessly through the housing bust. In all three we felt we were nearly certain to be right. Japan, the Tech bubbles, and 1929, which sadly I missed, were not new types of events. They were merely extreme cases akin to South Sea Bubble investor euphoria and madness. The 2008 event also was easier if you focused on the U.S. housing euphoria, which was a 3-sigma, 100-year event or, simply, unique. We calculated that a return trip to the old price trend and a typical overrun in those extreme house prices would remove $10 trillion of perceived wealth from U.S. consumers and guarantee the worst recession for decades.
All these events echoed historical precedents. And from these precedents we drew confidence.
But this event is unlike all those. It is totally new and there can be no near certainties, merely strong possibilities. This is why Ben Inker, our Head of Asset Allocation, is nervous and this is why you are nervous, or should be.
Everyone can see and feel that this is different and can sense the bizarre nature of the market response: we are in the top 10% of historical price earnings ratio for the S&P on prior earnings and simultaneously are in the worst 10% of economic situations, arguably even the worst 1%!
And worse, we had U.S. and global problems looming before the virus: an increasingly disturbed climate causing global floods, droughts, and farming problems; slowing population growth, in the developed world, soon to be negative; and steadily slowing productivity gains, especially in the developed world, and therefore a slowing GDP trend. In the U.S., our 3%+ a year trend is down to, at best, 1.5% in my opinion. It is closer to a 1% maximum in Europe. We had, as mentioned, top 10% historical P/Es in the U.S. and much the highest debt level ever in the U.S. for both corporations and peacetime government. So, after a 10-year economic recovery, this would have been a perfectly normal time historically for a setback.
And then the virus hit.
Simultaneously, it is causing supply and demand shocks unlike anything before. Ever. It is generating a much faster economic contraction than that of the Great Depression. And unlike 1989 Japan, 2000 Tech (U.S.), and 2008 (U.S. and Europe), it is truly global. The drop in GDP and rise in unemployment in four weeks have equaled what took one to four years to reach in the Great Depression and were never reached in the other events. Rogoff & Reinhart, Harvard Professors who wrote the definitive analysis of the 2008 bust, agree that this event is indeed completely different and suggest it will take at least 5 years to regain 2019 levels of activity. But this is a guess. We really don’t know how long it will take. Nearly certain is that a V-shaped recovery looks like a lost hope. The best possible outcome would be that there will be, almost miraculously, billions of doses of effective vaccine by year-end. But most viruses have never had a useful vaccine and most useful vaccines have taken well over five years to develop and when developed have been only partially successful. Yes, this time there will be an enormous effort with unprecedented spending. But still, a leading vaccine expert says quick success would be like “drawing successfully to several inside straights in a row.” And even if all works out well with a vaccine there will remain deep economic wounds.
Bankruptcies have already started (Hertz on May 22nd) and by year-end thousands of them will arrive into a peak of already existing corporate debt. It will need spectacular management, which it may get. But it may not. Throwing money — paper and electronic impulses — at the problem can help psychology and, particularly, the stock market, where extra stimulus money can end up but does not necessarily put people back to work; there will be up to 20% unemployment for at least a moment.
Sound and massive infrastructure spending would address the problem better, including greening both the grid and energy production. At least the size and speed of the initial financial help, which fortunately we learned to do in the housing financial bust, has saved us from the certainty of Great Depression II. But this is only round one. And many global administrations are, shall we say, not consistently sensible.
Unanticipatable outcomes seem to be guaranteed. We will all have had an enforced several months of introspection. This could turn out to be a fulcrum, or tipping point, for new social and business trends: deficiencies in capitalism; inequality; climate change and our environment: limited resources in a finite world; our current high consumption economy; growth at any price.
Attitudes to several of these factors were already beginning to shift before the virus. Resistance to the downsides of the status quo was already stirring. Now, all may be up for grabs.
In short, we have never lived in a period where the future was so uncertain. Yet the market is 10% below its previous high in January when, superficially at least, everything seemed fine in economics and finance. And if not “fine,” well, good enough. The future paths include many that could change corporate profitability, growth, and many aspects of capitalism, society, and the global political scene. Some perhaps for the better, but some not. The key here is uncertainty, which in some ways seems the highest in my experience. So, in terms of risk and return — particularly of the worst possible outcomes compared to the best — the current market seems lost in one-sided optimism when prudence and patience seem much more appropriate.
Summary
The few-line summary of my argument is this: the current P/E on the U.S. market is in the top 10% of its history. The U.S. economy in contrast is in its worst 10%, perhaps even the worst 1%. In addition, everything is uncertain, perhaps to a unique degree. The market’s P/E level typically reflects current conditions (please see Appendix). Markets have historically loved fat margins, low inflation, stability and, by inference, low levels of uncertainty. This is apparently one of the most impressive mismatches in history. That being said, this is a new type of crisis and much will be different. There are no certainties but there are probably still some better and safer themes. Caution and patience are likely to be two of them.
I read a long interview with him this past weekend and he went into detail on why Ben Graham style value investing in developed markets is dead & won’t be returning. When I was done I asked myself why anyone would invest money with his firm in equities in those markets. It’s a big percentage of the 50 billion they manage.
On the other hand his firm expects Emerging Market Value stocks to do very well over the next 7 years if you can stomach the volitlity.
This article might be tedious for the highly informed. But for a relative beginner to high finance it provides some different perspectives.
The full text of Grantham’s comments was very helpful for historical perspective. The one thing that seems different today and tips towards helpful for investors is that all the major economic influence centers seem to be in agreement that the market needs to stay strong. They may not be able to accomplish that, but they will try their damnedest.
So what are people’s asset allocations, stocks to bonds? Are you de-risking?
In answer to above, personally I’m trying to hold portfolio beta around 0.6 with single stock longs vs a partial hedge of index shorts, and significant cash. Some yield holdings but not using much bonds for that, because, where is there enough bond yield worth buying?
I see this kind of sinplistically.
If the virus is controlled, the economy recovers. With too much debt, lots of rebuilding, deglobalization, higher tax rates, etc but it’s still a “normalish” economy plus the Fed and MMT whether explicit or de facto.
So this is really a bet on drugs and epidemiology.
The epidemiology is getting figured out. We know enough about transmission, IFR, mutation rate, etc to make estimates. Like we know the IFR isn’t 10% like it seemed for a couple weeks in Wuhan, we know the virus is not mutating quickly, we know it is spread mostly by extended in person exposure, etc.
So this is really a bet on drug development.
And that’s a type of bet I’m comfortable making.
@jyl I like the way you think. However, I would make three points in addition.
1) Optimistically, really effective drugs are between one to two years out.
2) Vaccines are a crap shoot, but might be available in the US by mid-2021. However, you will also need to be especially well connected or quite rich to get a dose in that time frame.
3) The epidemiology is getting figured out, but my observation is that Americans will be unable to make use of that information if it costs them any significant degree of pleasure.
Hence, for the next couple of years, I am moving my holdings to countries that have demonstrated the ability to handle a moderate amount of discipline and have demonstrated the ability to suppress the pandemic. Obviously, that does not describe the US. That is a defensive move until we hit the next low. I expect a ‘W’ recovery in the US, and we are just starting our way down for the second time.
I am not particularly optimistic. But what is not discussed is effective treatment rather than a vaccine. HIV has no vaccine. But it is not the problem it was because there are now pretty effective treatments. Someday maybe there will be a vaccine for it. In the meantime there are effective treatments for the disease. The focus on the vaccine is important. But in the near term, effective drug treatments are more likely to help our problem. If we had effective treatments, we could be confident of leading a somewhat normal existence. That is more realistic- a vaccine is likely to be a much longer slog. That said, GMO makes a good point. The risk adjusted return right now is unknowable really, but does not appear that great to me.
What an anomaly that those who are well respected with a history of investment success are being “schooled” by Robinhood’s retail investors. They don’t really understand what is happening. The other thing that one can say is that there is a generational gap. Old (losing), young (winning). The final chapter has not been written and perhaps there is a brutal turn ahead, but for now it is an anomaly.
For the broad market indexes, I don’t see much (any?) fundamental undervaluation. I can see “external” forces driving asset price inflation regardless – all the Fed/MMT stuff well covered here. But when I do old school modeling and valuation, nope, not compelling.
On an individual stock level, I see lots of fundamentally undervalued names. Do this: pull a list of all US stocks, screen for % from YTD high and low. You’ll see lots still down big pct from highs, most of those are cyclical names, and many of those had been underperforming into the year as you’d expect for cyclical names in the later stages of a cycle. Eliminate the ones whose businesses are plausibly not going to be the same post-virus – mall based retail, office REIT, etc. Still a pretty big list. Narrow down to the ones whose businesses should recover post-virus to pre-virus levels. That’s still a long list, so narrow down further to those where you’re very confident of recovery. There’s more than a small number of targets to work on.
The thing is that this requires a bunch of work. I think the days of simply buying SPY or a basket of FAMNGs is over for a while. Although that’s been the wrong call since late March …
No vaccine for HIV because HIV is a very unique virus. Summary here: https://www.healthline.com/health/hiv-aids/vaccine-how-close-are-we#obstacles
For SARS-CoV-2, none of that applies. The immune system does respond to the virus and defeats it in most cases, there are recovered patient whose antibodies can be copied, the developmental vaccines are showing efficacy in animal models, etc. This looks like a more “conventional” vaccine problem, if you will. With two dozen vaccine development programs, limitless funding and urgency, and overwhelming political imperative to approve something . . . the odds of success are high.
“Success” doesn’t mean in six months everyone gets a vaccine that gives 100% permanent protection. More like in six months some people can start getting a vaccine that is 50% effective in preventing infection and 70% effective in preventing serious symptoms but has to be readministered every year – numbers are guesses but something like that.
Not a magic bullet but a real help – R is around 1.1-1.2 in the US states with recent surges in cases, if vaccines and general not being stupid (wear mask, etc) take that down to 0.8, the pandemic will be suppressed fairly quickly.
Add similar outcomes in treatment drug development. Convalescent sera seems to have a significant benefit in early/mild disease, so it’s reasonable to think that targeted antibodies have a good chance of delivering similar or more benefit. Immunosuppression via dexamathasone seems to have a significant benefit in severe disease, so it’s reasonable to think that targeted immunosuppressives have a good chance of being equally or more effective.
None will be magic bullets but as doctors learn what drugs to use at each stage of the disease, the consequences of getting Covid will be much less. We’re already seeing the IFR markedly lower than it seemed to be in Wuhan and Italy.
None of this is certain, it’s all still a bet, but I feel a lot more comfortable assessing this sort of thing now than, say, in March.