Following a decade underperformance, things may be about to get even worse for 'value' investors. That at least is the view of value doyen Jeremy Grantham.
Mr Grantham is the highly respected 79-year-old co-founder and chief investment strategist of Boston-based investment company GMO. He is also a keen student of bubbles and has an excellent track record at calling major market tops and bottoms. He believes there is now a more than 50 per cent chance that the long-running bull market in the US is entering the “melt-up” or “blow-off” phase, which characterises classic stock market bubbles. A much-hyped period of synchronised global growth and US tax hikes sets the right backdrop for the emergence of a market based on “excellent fundamentals, euphorically extrapolated”, which is his definition of a “great bubble”.
Such melt-ups are characterised, in Mr Grantham’s view, by an acceleration in stock market gains and it is this period of money-making that value investors risk missing out on. He cites an extensive 2017 study of global 'bubble' markets titled “Bubbles for Fama” as also providing evidence of late-stage acceleration.
While “no two bubbles, even the classics, are the same”, based on history, if a melt-up was to occur in the US today, Mr Grantham would expect it to develop over the next nine to 18 months and take the S&P 500 to between 3400 and 3700 (compared with 2786 at the time of writing) to meet his criteria for a “classic bubble event”. Unfortunately, Mr Grantham puts the chances of a major fall following such a run at over 90 per cent, and in such an event he would see a decline of some 50 per cent as “quite likely”.
The issue for value investors is not only that they may miss out on the melt-up by selling on valuation grounds given this is already “one of the highest priced markets in US history”. Mr Grantham points out that value investors are also likely to miss out by avoiding the stocks that are most likely to benefit from any melt-up. He points out that, typically, when a bull market melts-up the action tends to become more and more concentrated among a few, highly-valued, big-name stocks.
While Mr Grantham believes there are not enough signs of euphoria present to suggest a bubble already exists, including what he terms as “touchy feely” signs – other notable market watchers view Mr Grantham himself as a contrarian “touchy-feely” indicator. It is worth noting that several commentators have portrayed Mr Grantham’s views in this light since he suggested “this time seems very, very different” at the start of May last year, when he argued the equilibrium level for equity valuations in the US had risen and that the market could continue to go higher. So far he’s been right on the latter point, and in regard to his melt-up conjecture, there has recently been an acceleration in the S&P 500’s gains.
For a flavour of the counter case, 13d Research’s insightful 'What I Learned This Week' publication, has this month listed numerous examples of signs of complacency and euphoria – a free extract from this subscription-only letter is published on the Medium blogging platform. As well as citing the melt-up argument advanced by “perma-bear” Mr Grantham as potentially a useful sign of “capitulation”, the trend-spotting specialist cites other contrarian indicators including: fund managers holding the lowest level of cash on record; individual investors holding the least cash since 2000; stocks as a percentage of financial assets at their second-highest level on record; record levels of purchases on margin (borrowed money); and dangerously bullish readings from Intelligent Investors – a 64-year old survey of investment advisers' views. So against Mr Grantham’s melt-up “warning”, 13d offers the stark warning that, “markets are Machiavellian and behave in a way to confound the greatest number of market participants”.