While Wall Street strategists contemplate a healthy rotation from pricey stocks to cheap stocks, Jeremy Grantham is weighing a far more worrisome market shift: from overpriced stocks to an outright bubble.
The bubble term is thrown around a lot these days – directed not just at corners of the U.S. equity market, but also at Canadian real estate, the New Zealand economy and global art.
But Mr. Grantham, the co-founder and chief investment strategist at Boston-based GMO, which has $117-billion (U.S.) in assets under management, isn't using the term lightly.
He has studied previous asset bubbles, using data going back to 1925, and he saw troubles in the late 1990s and again prior to the 2008 financial crisis – so his track record is impressive.
At the same time, he is by no means a perma-bear: He published confidence-boosting bullish notes close to the bear market's bottom in early 2009.
Mr. Grantham has been growing concerned about the current state of the stock market for some time, but his warnings have included an interesting twist: Stocks are expensive, but they are likely to get even more expensive before the good times end.
Is it worth riding the index to the top?
Mr. Grantham offers an intriguing mix of bullish dare with bearish fear. He is certain that the bull market will end badly, just as it did in 2000 and 2007.
Yet, he believes that monetary policies from the U.S. Federal Reserve will likely drive stocks higher before the bubble finally implodes.
Indeed, he figures that if the S&P 500 moves deep into bubble territory, it will inflate above 2,250. That implies a gain of about 20 per cent from its current level – "a last hurrah," he calls it – even though he figures the index is already overvalued by 65 per cent.
A number of long-term value investors, who prefer cheap stocks mired in pessimistic sentiment, have already expressed concern about the market.
But Mr. Grantham argued that momentum investors outnumber value investors – "always [did] and probably always will" – and momentum investors typically don't worry about chasing stocks higher.
His guess is that stocks will struggle for direction until October, and then move higher to the next U.S. presidential election in 2016, as outright investment euphoria kicks in and any value investor who avoided the rally looks like an "old fuddy-duddy."
"And then around the election or soon after, the market bubble will burst, as bubbles always do," Mr. Grantham said, "and [the S&P 500] will revert to its trend value, around half of its peak or worse, depending on what new ammunition the Fed can dig up."
If he's right, there's something in his predictions for just about everyone.
David Berman