Is the fall of the Nasdaq and Bitcoin the end of a “superbubble”?

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Most investment managers tend to give their clients upbeat messages that highlight opportunities to make money in the markets. Jeremy Grantham, the 83-year-old co-founder of GMO, a Boston-based investment firm, does the opposite. “The long, long bull market since 2009 has finally matured into an epic bubble in its own right,” he warned, in early 2021. This event will be recorded as one of the great bubbles in financial history, so was the South Seas bubble, 1929 and 2000.” Grantham conceded that it is difficult to predict when a speculative bubble will burst. But, after citing some of the market action over the past twelve months, including Tesla’s huge ramp-up, he advised clients to be cautious, adding: “at some future date, regardless the date, it will have paid for you ducked from midsummer 2020.”

After Grantham issued the warning, the S.&P. 500 jumped another twenty-seven percent in 2021, and the Nasdaq index rose twenty-one percent. At the start of 2022, a hypothetical investor who took Grantham’s advice to sell in the summer of 2020 would have missed out on an S. & P. ​​500 rise of more than fifty percent and huge profits. So was Grantham wrong in issuing his terrible warning? Or was he just early? Between its January high and the close of trading last Friday, the S. & P. ​​500 fell about 8.3% and the Nasdaq about 13%. Over the same period, the VIX index, which tracks expected volatility and serves as a fear index on Wall Street, has climbed about 73%. The value of Bitcoin, which boosters call an alternative currency but trades more like an inverse fear index, has plunged about twenty-five percent this month.

If Grantham’s warnings are well-founded, the stock market correction could mark the start of something much bigger and much more damaging. In his latest market commentary, which GMO posted on its website on Jan. 20, Grantham wrote that the stock market bubble he identified last January had turned into a “superbubble,” which also encompassed bonds. , real estate and, increasingly, commodities. “What is new this time, and only comparable to Japan in the 1980s, is the extraordinary danger of adding multiple bubbles together, as we see today with three and a half major asset classes bubbling simultaneously to the first time in history,” Grantham said. . “When pessimism returns to markets, we face the biggest potential drop in perceived wealth in US history.” For stock valuations to return to historical trends, the S. & P. ​​500 would need to fall all the way to 2,500, he argued, implying another drop of more than 40%.

To what extent can we trust Grantham’s analysis? He is known for the timely news he released on Japanese stocks in the late 1980s, US tech stocks in the late 1990s, and the housing bubble in 2007. Over the past decade, however, he also issued a long series of warnings that turned out to be wrong or very premature. Since at least 2011, he has been warning of a possible collapse of the S. & P. ​​500, which was then around 1300. (Friday, it closed at 4,397.94.) the market was “ripe for a major downside” in 2016, a year in which the Dow Jones Industrial Average rose 13.4% despite a rocky start. On Wall Street, statements of this nature earned Grantham a reputation as a “permanent bear” whose warnings could be safely ignored — or, at least, temporarily ignored while you line your pockets. Right now, however, Grantham’s whining isn’t so easy to dismiss, as what has served as the markets’ greatest support over the past two years – the extraordinarily loose policy of the Federal Reserve, due to the pandemic – seems about to be deleted.

Extreme valuations alone are often insufficient to burst a stock market bubble. During the Japanese housing bubble of the 1980s, prices became so high that it was widely reported that the land surrounding the Imperial Palace was worth more than all the land in California. In the late 1990s, the Nasdaq tripled in value in eighteen months. In both cases, many people warned that the price increases were not sustainable, but it was only after central banks raised interest rates that the air started to come out. Between 1989 and 1990, the Bank of Japan raised its key rate from 2.5% to 6%. Over the next year, land prices peaked and the Nikkei index fell more than thirty-five percent. The Nasdaq bubble followed the same pattern. Between 1999 and 2000, the Fed, under the leadership of Alan Greenspan, raised the federal funds rate from 4.75% to 5.75%, citing, among other things, the danger of inflation. In March 2000, the Nasdaq collapsed. A year later, it had dropped more than sixty percent.

Past is not necessarily prologue, of course. But what is causing the current deep tremors on Wall Street is the realization that the Fed is preparing, once again, to raise interest rates to fight rising prices. A few weeks ago, Jerome Powell, the chairman of the Fed, described inflation, which reached 7% in December, as a “serious threat”. On January 25 and 26, Powell and his colleagues will hold their first policy meeting of the year. At their second rally in 2022, scheduled for March, they may start raising rates. They have already begun the tap-tightening process they have used to pour more than four trillion dollars into financial markets since the start of the pandemic – a policy known as quantitative easing. Morgan Stanley chief market strategist Mike Wilson recently warned that stocks could fall further, but not as far as Grantham predicted.

Of course, most Wall Street and CNBC analysts remain publicly optimistic. They point out that even if the Fed raises rates three or four times in 2022, it will still be very low by historical standards, and low interest rates are generally good for stocks. Moreover, despite the huge gains the stock market has enjoyed over the past few years, it is not as valued relative to corporate earnings as it was during the height of the dotcom bubble. In 2000, the price-to-earnings ratio of Nasdaq 100 companies reached one hundred and seventy-five; today it is only about thirty-six. And there’s something else the bulls are focusing on: Many of the “pandemic stocks” that investors have been upping the ante on in 2020 have already fallen sharply. The zoom is down more than seventy percent from its peak. The peloton is down more than eighty percent.

Other measures, however, give credence to Grantham’s caution. The cyclically-adjusted price-to-earnings ratio on S.&P. 500 stocks, a measure that Yale economist Robert Shiller developed to calculate the average of short-term changes in corporate earnings, indicates that the market is more valued than it was in October 1929. And major market reversals, almost by definition, are not limited to the most absurdly overvalued stocks. Once a historic selloff has started, it often envelops most of the market. In his final commentary, Grantham described the recent falls in some speculators’ and cryptocurrency favorites as “the final ‘market shrinking’ phase of a great bubble.”

He also recalled his first experience of speculative frenzy, in the late 1960s, when he made easy money in speculative stocks, only to lose it all just as quickly. Remembering what happened “makes me easily sympathize with the idea that bearish advice in bubbles always comes from old foggers who ‘just don’t get it’, because I got this old foggy advice at the time and that I just didn’t. Listen.” Grantham wrote. He added: “I doubt the current bubble speculators will listen to me now.” He might well be right. With the Dow Jones up about five hundred percent since the end of the last extended bear market in March 2009, the buy-down mentality is still deeply entrenched. But stocks don’t go up forever, and the Fed’s U-turn means the game has changed. This might be a good time to listen to a voice of caution.

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