Jeremy Grantham, a British investor, co-founder and chief investment strategist of Grantham, Mayo and van Otterloo (GMO) is renowned for his prediction of multiple bubbles. Considered as one of the 50 Most Influential Investors according to Bloomberg Markets, Grantham is alerting us of that we are in a bubble and no matter how hard the Fed tries to support it, this bubble will burst in due time.

According to the article published by GMO, titled, “Waiting for the Last Dance” the arguments that we are in a bubble are summarised below:

The first is that valuations are dangerously dependent on the persistence of historically low bond yields and in a report by Bloomberg, USD 18 trillion are at negative rates while the stimuli in 2020 are unprecedented since WWII.

The “risk premium”, which is the investment return equities are expected to yield in excess of the risk-free rate of return (commonly, the Treasury bonds), equity markets appear inexpensive. However, this could change instantaneously with a rise in bond rate as it is conversely correlated with equity prices.

These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle. For positioning a portfolio to avoid the worst pain of a major bubble breaking is likely the most difficult part. Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in. — Jeremy Grantham

So will bond rates rise sharply from there?

US rates have already risen since November 19, 2020 (+26% on the US 10 year) and there is a general consensus that this risk has increased in the US since the elections in Georgia gave Democrats control of the Senate. This facilitates the implementation of an economic stimulus programme, that can be inflationary.

Another interesting indicator is the ratio of the US market’s market capitalisation to GDP, also known as “The Wilshire 5000 Index / GDP”, made popular by Warren Buffett. The indicator shows the current stock market is much more expensive than it was even at the peak of the internet bubble in 2000.

Subjectively, the risk that market behaviour has reached an irrational stage in which there is no longer room for fundamental valuations because investors simply calculate that they can sell at a higher price to more “fool”.

“But this bubble will burst in due time, no matter how hard the Fed tries to support it, with consequent damaging effects on the economy and on portfolios. Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives.” — Jeremy Grantham

Illustrating this, Bank of America’s Global Fund Manager Survey shows that the level of risk that professionals are willing to take is at its highest for 20 years while the amounts of individuals investing in “call options” is at an all-time high. It hums the eternal music that professionals go out while individuals invest at the top.

Jeremy Grantham reminds us that “Predicting when a bubble breaks is not about valuation. All prior bubble markets have been extremely overvalued, as is this one. Overvaluation is a necessary but no sufficient condition for their bursting. Calling the week, month, or quarter of the top is all but impossible.”

In addition, he emits, with a little irony, the hypothesis according to which a bubble is formed and often bursts well after having passed the “summit of reason” accelerated by the failure of large institutions to alert their clients: “… the career and business risk of fighting the bubble is too great for large commercial enterprises. They can never put their full weight behind bearish advice… So, don’t wait for the Goldman’s and Morgan Stanley’s to become bearish: it can never happen. For them, it is a horribly non-commercial bet… Their best policy is clear and simple: always be extremely bullish. It is good for business and intellectually undemanding. It is appealing to most investors who much prefer optimism to realistic appraisal… This is why you have always had bullish advice in a bubble and always will.”

Contributed by Gwendal Garrigue, https://www.arwen-finance.com/