Jeremy Grantham Warns Fed Can’t Keep ‘Epic Bubble’ From Bursting

Legendary investor Jeremy Grantham believes the stock market bubble he has warned about will burst despite efforts by the Federal Reserve to keep it inflated — and it will probably go down as one of the greatest in financial history.

“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,” Grantham, co-founder of investment firm GMO, said in a paper Tuesday. “Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives.”

Grantham, who is long retired from portfolio management but has continued to share his views on markets, said it is “highly probable” that the U.S. is in a major bubble event typically seen every several decades. He compared it to the South Sea bubble and events of 1929 and 2000.

“Speaking as an old student and historian of markets, it is intellectually exciting and terrifying at the same time,” Grantham said. “These great bubbles are where fortunes are made and lost – and where investors truly prove their mettle.” 

[II Deep Dive: GMO Has a Plan to Profit From a Growth Stock Bubble]

As Grantham sees it, the “strangest feature” of today’s bull market is its persistence despite “a wounded economy” faced with high uncertainty amid the Covid-19 pandemic. 

“The market is much higher today than it was last fall when the economy looked fine and unemployment was at a historic low,” he said. “More than in any previous bubble, investors are relying on accommodative monetary conditions and zero real rates extrapolated indefinitely.”

That has the similar effect of assuming endless peak economic performance, he said, though perfect economic and financial conditions don’t last forever.

All bubbles end with nearly everyone believing they won’t, including in 2000 when Alan Greenspan’s Fed was predicting an “enduring improvement in productivity and was pledging its loyalty (or moral hazard) to the stock market,” according to Grantham.

“The mantra of late 2020 was that engineered low rates can prevent a decline in asset prices. Forever!” he wrote in his paper. “But of course, it was a fallacy in 2000 and it is a fallacy now.”

In his view, a successful bear-market call is not precisely predicting when good times will end.

“It is simply that sooner or later there will come a time when an investor is pleased to have been out of the market,” he said, as the investor “will have saved money by being out, and also have reduced risk or volatility on the round trip.”

For example, “GMO got entirely out of Japan in 1987” on concern the market was extremely overvalued, according to the paper. Although Grantham deemed it a prudent exit at the time, he said the firm was three years too early calling the Japan bubble and painfully underperformed as the Japanese market kept inflating to more than 60 percent of the benchmark EAFE index.

“But we also stayed completely out for three years after the top and ultimately made good money on the round trip,” said Grantham. 

By contrast, the GMO co-founder said he came “fairly close” to calling the peak bull market in 2008, and “nailed” the bear market low in early 2009. “That’s far more luck than I could hope for even over a 50-year career,” he said. Grantham also profited from the bursting of the 2000 bubble, though not before watching “in horror” as the market continued to soar after GMO had “rapidly sold down” its discretionary U.S. equity positions in early 1997, according to his paper. The firm lost half its asset allocation book of business, he said, but “more than made up our losses” in the ensuing decline.

“Believe me, I know these are old stories,” said Grantham. “But they are directly relevant.”

Throughout history, the most dependable sign of markets being in the late stages of a great bubble is “really crazy investor behavior, especially on the part of individuals,” he said. While the first decade of this longest ever bull market lacked such “wild speculation,” the mania has now shown up in record fashion, with Tesla standing out in the “fully-fledged epic bubble,” according to the paper.