04 Jan The Tell: Stock-market investors should ‘brace for a possible near-term melt-up’: Jeremy Grantham
Jeremy Grantham, who is credited with calling the 2000 and 2008 downturns, warned investors Wednesday to be prepared for the possibility of a near-term “melt-up” that would likely set the stage for a burst bubble and a stock-market meltdown.
In a 13-page note that he emphasized reflected “a very personal view,” the value investor and 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.
“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,” Grantham said.
He terms the current market run-up the “possible/probable bubble of 2018-19.”
In the note, 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.” Read the note here.
Grantham favorably cited an academic paper published last year that concluded that the strongest indicator of a bubble in U.S. and almost all global markets was price acceleration.
As for the S&P 500 SPX, +0.64% Grantham says 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.
“Exhibit 4 (shown below) represents our quick effort at showing what level of acceleration it might take to make 2018 (and possibly 2019) look like a classic bubble,” 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.
Here’s Grantham’s summary of his guesses:
- ■ “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.”
So what should investors do? Grantham reiterated his call to own “as much emerging market equity risk as your career or business risk can tolerate” and some EAFE, an acronym for Europe, Australasia and Far East. The MSCI EAFE index tracks developed-market equities outside the U.S.
Investors who are more willing to speculate should consider a small hedge of some high-momentum stocks, primarily in the U.S. and possibly including “a few of the obvious candidates” in China.
“In previous great bubbles we have ended with sensational gains, both in speed and extent, from a decreasing number of favorites. This is the best possible hedge against the underperformance you will suffer if invested in a sensible relative-value portfolio in the event of a melt-up,” Grantham wrote.
At the same time, in the event of an accelerating rally in line with previous blow-off phases, investors should be ready to reduce equity exposure, “ideally by a lot if you can stand it, when either the psychological signs become extreme, or when, after further considerable gain, the market convincingly stumbles,” he said.
He cautions, however, that investors who can’t handle the stress and are unable to develop and execute an exit strategy should “sit tight and ignore all this advice, except for the overweighting of emerging [markets].”