Here’s the Executive Summary of Jeremy Grantham’s analysis of present trading trends at GMO:
All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected all the way back to trend with much greater and longer pain than average.Today in the U.S. we are in the fourth superbubble of the last hundred years.Previous equity superbubbles had a series of distinct features that individually are rare and collectively are unique to these events. In each case, these shared characteristics have already occurred in this cycle. The checklist for a superbubble running through its phases is now complete and the wild rumpus can begin at any time.
He goes on to explain that we are presently seeing four bubbles concurrently:
- Real estate
It’s an unprecedented situation and, when something is unprecedented, there is no way to know what will happen with any confidence. Here are his “Rules of the Bubble”:
- All 2-sigma equity bubbles in developed equity markets have burst – all the way back to trend. The U.S. reached the 2-sigma level in the summer of 2020.
- But some of them went to 3-sigma or more before they burst – producing longer and deeper pain. The U.S. reached 3-sigma in late 2021.
- Timing is uncertain and when you get to 3-sigma superbubbles, such as we have now, there are few examples. Yet they have all shown certain characteristics before they broke.
- A speculative investor frenzy that generated stories for distant decades, which we have had for well over a year;
- A penultimate blow-off phase where stock gains accelerate, as we had in 2020;
- And the ultimate narrowing phase – unique to these few superbubbles – where a decreasing number of very large blue chips go up as riskier and more speculative stocks underperform or even decline, as they did in 1929 and 2000 and as they have done since February 2021.
If a, b, and c are accounted for, light the blue touchpaper and retire to a safe distance, praying for a paradigm shift.
Nervous yet? If I didn’t live in the world, the “rumpus” might be fun to watch. As it is I do not look forward to it, even the less with inflation as high (or higher) than it is now.
Hat tip: Cullen Roche