By Geoffrey Smith
Investing.com – The fund managers' letters to investors can be long, but sometimes one is so brilliant you can only reproduce it as closely as possible.
The latest from GMO founder Jeremy Grantham is one such example. The full version can be found here, but for those who don't have the time to read it, the key points are as follows
The long bull market since 2009 has turned into a "full-fledged epic bubble" and produces almost all of the most reliable signs that this bubble is in a late stage.
These signs include the behavior of Grantham, particularly retail investors, who are labeled "insane". He notes that 150 microcaps have tripled in the last year, "that's more than three times as many as every year in the last decade." He also notes that "the volume of small retail purchases of fewer than 10 contracts for call options on US stocks has increased eight-fold compared to 2019 and was already well above the long-term average in 2019."
In terms of individual stocks, there have been increasing signs of mania: it highlights Hertz, Kodak, Nikola, and especially Tesla (NASDAQ :), which are now valued at $ 1.25 million per car sold per year, compared to $ 9,000 – dollars for General Motors (NYSE :).
"What does 1929 have to offer?" Ask Grantham.
The other tell-tale sign of a late-stage bubble well into the 18th century is the acceleration in profits. Most recently it was around 60% in the 21 months before the peak. In the current rally, the major indices have achieved all of that and more in just nine months.
Unfortunately there is no way to pinpoint the tip. Bubbles usually don't burst in response to single negative events. A veteran of over four decades, Grantham freely admits that he got out of the Japanese stock bubble almost three years early in the 1980s.
"The big bull markets usually refuse when market conditions are very favorable, only slightly less than yesterday," he argues. "And that's why they are always missed."
However, he points to one, albeit anecdotal, factor that bubbles have in common, namely "the intensity and excitement of the bulls" and the "increasing hostility towards bears". He cites 1999 when his customers "pretended we were deliberately and maliciously withheld from them profits".
The above factors make it impossible for most sell-side analysts to break the consensus. Here we just have to quote Grantham at length.
“Don't wait for the Goldmans and Morgan Stanleys to get bearish. It can never happen. For them it's a terribly noncommercial bet. Maybe it's for everyone. Profitable and risk-reducing for customers, yes, but economically impractical for consultants. Your best policy is clear and simple: always be extremely bullish. It's good for business and intellectually undemanding. It appeals to most investors who prefer optimism to realistic assessment, as COVID clearly shows. And when it all ends, as a stubborn cop, you will have an overwhelming company. This is why you have always been given bullish advice in a bubble and always will. "
So what is to be done? If you can't time the end of the bubble, at least focus exposure where things are relatively cheap, argues Grantham. Value stocks had their worst relative decade to date, ending in December 2019, followed by their worst year in 2020. Similarly, emerging market stocks are at one of their three “more or less equivalent relative lows” versus prior year US stocks over the past 50 years.
"We believe that it is in the intersection of these two ideas, value and emerging, that your relative bets go, along with the greatest US growth stock avoidance that your career and business risk allows for."