Popular investor Jeremy Grantham says the stock market is in the midst of a “super bubble”. This means that prices are more out of control than a normal bubble, and this indicates that stocks are not finished falling.
A garden bubble occurs when the market, or the stock price index, rises rapidly, ignoring the significant risks that eventually lead to a fall in prices. In those normal cases, the indicators rise to two standard deviations above the recent average prices.
In a super bubble, the number rises to 2.5 or higher. This is where the market has been in 2021, with stocks jumping from the lows they hit early in the pandemic.
Grantham, co-founder of Grantham, Mayo, and Van Outerloo, which manages about $70 billion in assets, are often seen as skeptical about the market. It could be said that he is a Perma Bear, or a perpetual pessimist, although he has taken an optimistic view of the market at times.
Nevertheless, it makes a compelling case that where stocks are today – and how they got there – fits right in with the phases that superbubbles go through.
The first stage is when the bubble is forming and the arrows are rising. The second stage is when there is a meaningful decrease in response to some bleak political or economic event. A bear market rally arises as people assume they can see a day when stocks return to their highs as economic challenges recede. This sets the stage for the final decline.
All this is very similar to the events of the past few years. for the first time
Standard & Poor’s 500
More than doubling from its low in March 2020 to early January this year. Low interest rates and fiscal stimulus boosted economic activity, corporate earnings and stock valuations.
The setback came in the first half of this year. The index fell more than 20% to its lowest level in mid-June as investors factored in the economic shock that could result from the Federal Reserve’s efforts to fight inflation. Consumer prices were already rising, but the picture worsened when Russia invaded Ukraine, driving up commodity prices.
The bear market rally seems to have come in since the markets bottomed out in June. The S&P 500 rose a percentage point in its mid-teens, recovering just over half of its loss, before calming down in late August.
Compare that to the treacherous markets of the last century. Recovering from the 1929 low, early in the Great Depression, the market recovered just over half of its loss before heading lower again. The same is true for the rally from the 1973 low. In 2000, the Nasdaq Composite recovered 60% of its bear market loss from the technology bubble.
“The present event, so far, appears eerily similar to these other historical super-bubbles,” Grantham wrote.
The question now is what will drive the market down from here. Grantham mentions the twin shocks of inflation and high interest rates that aim to eliminate it. And while the market is already down from its summer peak, it is also pulling back across key technical levels, indicating that more declines may be on the way.
There are a few factors on the ground critical to assessing what comes next. Investors need to watch how quickly the rate of inflation is going down because this is critical when the Fed is slow to raise interest rates. Expectations of lower economic demand have dampened earnings expectations, but earnings expectations could worsen.
More declines appear likely for stocks, but how ugly they are is not clear.
Write to Jacob Sonenshine at firstname.lastname@example.org
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