Asset allocation
A bubble is a category 4 hurricane
In almost 200 posts since I started this blog, I have written nothing about the outlook for the stock market or the economy. It has all been about the investment process. The reason is quite simple. Making predictions about the stock market or the economy is a fools’ game. But there is one exception.
In this post I will comment on Jeremy Grantham’s bubble calls. But first let me offer a few thoughts about bubbles and what I have learned about them.
Bubbles and investing
The best investment process is one that doesn’t depend on predictions or one’s outlook for the market. I make no effort to assess whether a bull or bear market is in the offing.
The one exception I make about this revolves around bubbles. In 50 plus years of investing my default asset allocation has been 100% stocks, but, and this is a big but, I have tried to avoid being invested in stocks in the late stages of bubbles.
In my view, bull and bear markets are like summer storms. There can be a lot of thunder and lightning but they tend not to be life threatening. True stock bubbles are different. Several times a century a stock market bubble occurs which can be likened to a category 4 hurricane. It can pose a fundamental threat to one’s financial assets.
As a result, I definitely want to know if there is a generalized stock market bubble so I can take appropriate action.
There have only been four real stock bubbles in the last 100 years, 1929, the late 1960’s, the Japanese bubble of the late 1980’s and the Dot Com bubble that burst in 2000.
Very few investors today lived through the late 1960’s bubble. By 1968 the Go Go market was in full swing. IBM was trading at 39 times earnings, Xerox at 50 times and Avon Products at 56 times. It was a true bubble. The bubble was not in one corner of the market such as tech companies. Blue chip stocks became the ‘one decision’ Nifty Fifty’ stocks. It didn’t matter what you paid. You could buy them and put them away for fabulous gains. Warren Buffett terminated his partnership, paid out his investors and went to cash. That’s the only time in his many decades of investing that he has taken such radical action.
My experience
From 1975 to 1985 I was 100% in equities. Things had gone well. I decided to step aside from the stock market. I put all our financial assets in 90-day treasuries that, at the time, were paying something like 11% interest. Yes, that’s right. I went back into the stock market in late 1990. I missed the rout of 1987 and the 1989 bear market. But, with hindsight, there had been no bubble, only bull and bears markets while I was in 90-day treasuries. With hindsight, I should have stayed in stocks.
In late 1998 I sold all our stocks except one, a heavy equipment dealer, and put the proceeds into two-year gov’t bonds paying just over 4%. I went back into stocks in late 2002. This proved to be a good decision. I missed the worst of the bust. Since the fall of 2002 I have been 100% in stocks.
In my view there have been no generalized stock bubbles since 2002. There have been localized bubbles such at Meme stocks, SPACs and bubbles in some individual stocks such as Nvidia, but no generalized bubble.
Once I am satisfied we are in a true generalized stock market bubble, I will sell all my stocks and go to short term bonds.
It will be apparent to readers that it is important for my investing process to identify and decide if we are in a true generalized stock bubble. Hence my intense interest in the subject.
Pundits and bubbles
In the last fifteen years, barely a week has gone by without some high-profile pundit declaring we are in a bubble. Dire predictions grab viewers’ and readers’ attention. Pundits tend to be quite articulate and have a practiced spiel. The pundits have various motivations. Some are simply promoting their investment firms. The fact they have a large audience does not prove their expertise.
Investors have to make their own judgement call about bubbles and take the appropriate action.
Jeremy Grantham
Jeremy Grantham is a very high-profile pundit. For at least the last five years he has been consistently declaring that the U.S. stock market is in a classic bubble.
Google and Wikipedia tell us that “Robert Jeremy Goltho Grantham CBE is a British investor and co-founder and chief investment strategist of GMO LLC, a Boston-based asset management firm. GMO had more than US$118 billion in assets under management as of March 2015.”
For example, in a note dated January 3, 2018, Jeremy Grantham wrote: “…as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market.”
A year ago, I had the nerve to confront and contradict Grantham’s most recent bubble call that had been published in an August 31, 2022 report titled: ENTERING THE SUPERBUBBLE’S FINAL ACT. There is no point repeating what I wrote in that post.
Of course the S&P 500 is up some 15.94% since Grantham’s report. Was I right and was Grantham wrong?
Here’s where it gets tricky. If I declare I was right, there is every chance the investing gods will strike me down as Grantham’s bubble bursts in a spectacular panic. All I can say is that I respectfully disagree with him and am acting accordingly.
I continue to read what Jeremy Grantham writes and listen to interviews. I do this because I make a habit of reading what I disagree with and spend little time reading what supports my views.
Jeremy Grantham still at it
Theron Mohamed in Markets Insider on Apr 24, 2023 reports: “The S&P 500 could plunge by up to 50% as the “everything bubble” collapses, Jeremy Grantham told economist David Rosenberg during a recent Rosenberg Research webcast.
And more recently, on September 15, 2023, Theron Mohamed reports: “There’s a historic bubble in stocks that’s about to burst — and the US economy will most likely suffer a recession, Jeremy Grantham has warned.”
“A dozen giant American stocks have had a hell of a run on the back of AI, and that has certainly created the impression that it’s game over,” he said, speaking at an investor event held by Livewire Markets in Sydney this week.
So, Jeremy Grantham is still on about it.
Conclusion
Ironically, it’s not difficult to identify a bubble when you see it. The problem with true bubbles is that you can get swept up in the euphoria and believe that ‘this time is different’, that all the rules of the game have changed because it’s a new era. I don’t see that at present. In 1998 it was easy to identify a true bubble.
Let me be clear. It’s entirely possible we will experience a bear market in the near future. I will endure the thunder and lightning it throws off with equanimity. I just don’t think it will be the bust and panic that follows a bubble from which the stock market can take years to recover its feet.
Also, ironically, I happen to think that the next really big stock market move will be a true bubble. We haven’t had one for over 20 years. But it may not happen for some time. Or it may start next year. Who knows?
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I have written extensively about bubbles. They are dealt with in the Motherlode in Chapter 29. Bubbles, crises, panics and crashes
That Chapter continues with these Sections:
29.01 What to do about bubbles?
29.02 The subject of bubbles has been studied
29.03 Globalization and bubbles
29.04 Bubbles have always been with us
29.06 Warning signs of a bubble
29.10 CAPE as an indicator of bubbles
29.11 Use of charts as a warning of bubbles
29.12 New era talk – this time is different
29.13 Barbers giving stock market advice
29.14 Corporate predatory behavior
29.16 No bell goes off to warn the investor of an impending crash
29.17 Picking the time to go to cash
29.19 Selling by others during a panic
29.21 No return to the dark ages
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You can reach me by email at rodney@investingmotherlode.com
I’m also on Twitter @rodneylksmith
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