Jeremy Grantham warns ‘tragedy’ looms as shares ‘super bubble’ could burst

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A “superbubble” appears dangerously close to its “final act” after the recent rally in US stocks lured some investors back into the market just ahead of a potential “tragedy”, according to Jeremy Grantham, the legendary co-founder of the London-based investment firm. Boston. GMO.

Grantham, who has repeatedly warned investors about a market bubble, told a newspaper on Wednesday that “superbubbles are events like no other” and share some common characteristics.

“One of those characteristics is the bear market rallying after the initial downgrade stage of the downturn, but before the economy clearly begins to deteriorate, as always happens when superbubbles burst,” Grantham said. “This, in all three previous cases, has recovered more than half of the market’s initial losses, luring unwary investors back just in time for the market to fall again, only more viciously, and the economy to weaken. This summer’s rally so far fits the pattern perfectly.”

The US stock market tumbled in the first half of 2022 as investors expected soaring inflation to lead to a hawkish US Federal Reserve. The S&P 500 closed at a low this year of 3,666.77 on June 16, before rallying over the summer along with other stock benchmarks amid investor optimism for signs that the highest inflation in decades was abating.

Fed Chairman Jerome Powell recently ended that rally with his Aug. 26 speech at the Jackson Hole, Wyo., economic symposium, erasing this month’s gains as he reiterated that the central bank would continue to tighten monetary policy for to tame rising inflation. He warned that the Fed will fight inflation until the job is done, even as it may bring pain to households and businesses.

“The US stock market remains very expensive, and a spike in inflation like this year’s always hits multiples, albeit slower than normal this time,” Grantham said. “But now the fundamentals have also begun to deteriorate terribly and surprisingly: Between COVID in China, war in Europe, food and energy crises, record fiscal tightening and more, the outlook is much gloomier than it would have been could have been predicted in January.”

Grantham had warned in a January paper that the US was nearing the end of a “superbubble” spanning stocks, bonds, real estate and commodities after massive stimulus during the COVID-19 pandemic.

I see: ‘Good luck! We’ll all need it: US market nears end of ‘superbubble’, says Jeremy Grantham

In his note on Wednesday, Grantham said “the current superbubble is characterized by an unprecedentedly dangerous mix of asset overvaluation (with bonds, housing and stocks all critically overvalued and now rapidly losing momentum), commodity shocks and Fed aggressiveness.” .

Superbubble bursting has multiple stages, according to Grantham.

First the bubble forms, and then a “recession” in valuations – like the one seen in the first half of 2022 – occurs as investors realize that “perfection” will not last, he said. “Then there’s what we’ve just seen – the bear market rally,” before eventually “fundamentals deteriorate” and the market falls to lows.

“Bear market rallies in superbubbles are easier and faster than any other rallies,” he said. “Investors assume that this stock sold for $100 6 months ago, so now at $50, or $60, or $70, it must be cheap.”

At the intraday peak on Aug. 16, the S&P 500 had recouped 58% of its losses since the June low, according to Grantham. This was “strangely similar to these other historical superbubbles.”

For example, “from the low of November 1929 to the high of April 1930, the market rallied 46% — a recovery of 55% of the loss from the peak,” he said.

He also highlighted the “speed and scale” of other bear-market rallies.

“In 1973, the summer rally after the initial decline recovered 59% of the S&P 500’s total loss from the high,” he wrote. More recently, in 2000, Grantham wrote that “the Nasdaq (which was the main event of the tech bubble) recovered 60% of its initial losses in just 2 months.”

U.S. stocks closed lower on Wednesday, with the three major benchmarks falling for a fourth straight day on the final day of August. The Dow Jones Industrial Average DJIA,
-0.88%
fell 0.9%, while the S&P 500 SPX,
-0.78%
and the tech-heavy Nasdaq Composite COMP fell 0.8%,
-0.56%
slipped 0.6%.

Reading: The stock market’s summer rally ended in August. Here’s what history says about September.

“Economic data inevitably lags at important turning points in the economy,” Grantham said. “To make matters worse, in changing events like 2000 and 2007, data series like corporate earnings and employment can then be massively revised downward.”

“It’s during this lag that the bear market rally usually occurs,” he said. And now the current superbubble seems to have “stopped between the third and last act,” according to Grantham.

“Get ready for an epic finale,” he said. “If history repeats itself, the play will once again be a Tragedy. We have to hope this time for a small one.”

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