One of the world’s most famous fund managers is warning that a “super bubble” that’s been building for more than a decade may be in the process of bursting.
Jeremy Grantham is the co-founder of GMO, which claims to have predicted the Japanese crash of 1989, the dotcom bust of 2000 and the global financial crisis of 2008.
He is now warning of another similar crash in asset prices, with speculative tech stocks first in the firing line.
And he warns the downturn is “likely” already happening, with Wall Street’s tech-heavy Nasdaq down 12 per cent from its peak in November and the broader S&P 500 index down almost 7 per cent from its record closing high in early January.
“I would say that is the beginning of the burst, when the specs that typically go up quite a lot more than the market goes down as the market goes up,” he tells The Business.
“So the S&P [500 index] went up 25 per cent last year, and a lot of the most speculative stocks of 2020 were already going down.
Mr Grantham says that process of a super bubble bursting appears to be well underway, with many of the most speculative stocks already losing at least half their value from the peak.
“At the end, the speculative stocks start to peel off and, even on the upside for the broader market, they start to go down,” he observes.
“That started early last year — the super-duper specs, the worst of them all, started to decline.
Mr Grantham says the current US market is looking “eerily similar” to the dotcom boom and bust but, as in 2000, he warns it is not only the speculative stocks that are heavily overvalued and will fall.
“I think it would be unlikely that the market would not come down by 50 per cent from its peak — the broad market, the S&P — and it would be unusual if the specs did not do worse than that.”
ASX ‘doesn’t look horrific’
The good news for Australian investors is that, even though Mr Grantham thinks real estate and bonds are overvalued across most of the developed world, he believes the local stock market is nowhere near as overpriced as Wall Street.
“I am not an expert on Australian equities. It doesn’t look cheap, but it doesn’t look horrific,” he says.
“When it comes to the stock market, rather like 2000 and the tech bubble, this is more an American affair than anything else.
“In the US, however, we have an extreme overpricing, extreme crazy behavior, and I think we’re in a rather dangerous equity bubble.
“So there’s a decent chance that Australia, the UK, Japan, there’s some fairly reasonably priced countries, if they come down in sympathy, they’ll come down a lot less and probably rally earlier.”
Where to stash cash?
His preference is to look for beaten-down stock values in some of the developing markets.
“Emerging markets, [and] some of the cheaper developed countries, would be very much a better idea than a massive holding of US equities,” he says.
“If you have to own US stocks, you should [own] high-quality stocks that are in good financial shape because this can always spiral into something of a financial crisis. They often do.”
Like when you go shopping, Mr Grantham says investors should be on the lookout for bargains, not paying top dollar.
“Make sure you don’t buy expensive markets, expensive stocks,” he warns.
“Emphasis value, cheapness for what you get. Hunt around for the cheaper countries, hunt around for the cheapest stocks within those countries.
“Carry some cash reserves. There’ll be, perhaps, some very nice buying opportunities.
One area where he urges particular caution is cryptocurrencies.
“Bitcoin, in particular, it does nothing for anybody and is superseded by a whole generation of smarter and more effective cryptocurrencies, many of which in turn, do not make money in the traditional way and a few do,” he argues.
“So I’m sure the idea embedded in cryptocurrency will be around for, perhaps, forever.
“But I’m equally certain that most of the value today as a store of value is a hoax.
“That is not a store of value. Everyone can agree that the volatility is massive. It goes up and down with the high-risk stocks.”
‘Golden age’ for corporate profits ending
Longer term, Mr Grantham warns that stock values will be weighed down by two factors that have been boosting them for decades.
One is higher inflation.
He argues that the levels of inflation seen in the US since the middle of last year should already have triggered a major sell-off in stocks on expectations that record-low interest rates would need to rise.
“The market is saying about inflation that it totally ignores it,” he says.
“It completely believes the fact that it’s temporary, ephemeral, etc … and it doesn’t appear to be.
“And if that seeps into the market in the usual way, it will mercilessly depress the price-earnings ratios.”
He says this could mean his forecast 50 per cent US share price crash could play out over an extended period, rather than be a short, sharp sell-off.
“This could turn out to be quite a struggle, where slowly but surely the market has to readjust to higher and higher rates and higher inflation,” he says.
The other factor he feels could weigh on share prices is a possible drop in the current record share of economic output going to company profits.
“Profit margins average 30-35 per cent higher than they had been in the previous 50-60 years,” he observes.
“Everything seemed to work out — corporations got a lot of political power, the taxes on capital all dropped, tax on dividends, tax on interest rates, tax on capital gains all came down.
“Most of the regulatory bodies were somewhat captured by corporations.
“The concentration in each industry has increased, and the FANGs (Facebook, Amazon, Netflix, Google) that are remarkable companies are, in their own way, instant monopolies.
“So the monopolistic feature of our economy today, and somewhat around the world, has increased.
“This is very good for profits. It’s not so good for growth, and governments are beginning to twitch a bit.”