How And When The Bubble Finally Bursts: Jeremy Grantham's Take

Tyler Durden's picture

There has been much discussion in the past year(s) whether the Fed has inflated (the final) bubble. Sadly, most of it has been misguided. To get some "guided" analysis of what is easily the most important market topic of the day, we go to GMO's Jeremy Grantham and his latest quarterly letter covering just this: "Looking for Bubbles."

First the background:

What is a bubble? Seventeen years ago in 1997, when GMO was already fighting what was to become the biggest equity bubble in U.S. history, we realized that we needed to define bubbles. By mid-1997 the price earnings ratio on the S&P 500 was drawing level to the peaks of 1929 and 1965 – around 21 times earnings – and we had the difficult task of trying to persuade institutional investors that times were pretty dangerous. We wanted to prove that most bubbles had ended badly. In 1997, the data we had seemed to show that all bubbles, major bubbles anyway, had ended very badly: all 28 major bubbles we identified had eventually retreated all the way back to the original trend that had existed prior to each bubble, a very tough standard indeed.

Then, the bullish case, or in other words, what is the maximum the S&P can stretch further, before it all comes crashing down:

So now, to get to the nub, what about today? Well, statistically, Exhibit 3 reveals that we are far off the pace still on both of the two most reliable indicators of value: Tobin’s Q (price to replacement cost) and Shiller P/E (current price to the last 10 years of inflation-adjusted earnings). Both were only about a 1.4-sigma event at the end of March. (This is admittedly because the hurdle has been increased by the recent remarkable Greenspan bubbles of 2000 and a generally overpriced last 16 years.) To get to 2-sigma in our current congenitally overstimulated world would take a move in the S&P 500 to 2,250. And you can guess the next question we should look at: how likely is such a level this time? And this in turn brings me once again to take a look at the driving force behind the recent clutch of bubbles: the Greenspan Put, perhaps better described these days as the “Greenspan-Bernanke-Yellen Put,” because they have all three rowed the same boat so happily and enthusiastically for so many years.



... purist value managers may try to block out the siren call because they don’t wish to be tempted, and some may hear it and do nothing because the gains are never certain and the lack of prudence is painfully obvious in the end. Yet long-term value managers are outnumbered by momentum managers – always were and probably always will be – and momentum managers have no such qualms. Why this time, then, would they not play the game with even more enthusiasm, at least enough to drive the market to its 2-sigma level of 2,250 and perhaps a fair bit beyond? And although nothing is certain in the market, this is exactly what I  believe will happen.

But what if we are already well past the point of no return? Enter Hussman:

Out there in the wilds of the internet along with our free quarterly letter, which always feels like a long painful delivery, there is an equally free letter from John Hussman, who turns out to have the same work ethic as Alexey Stakhanov, that hero of the Soviet Union known for his massive and routine production over quota. Hussman, can you believe, produces a long and well-researched quarterly letter each week! Deplorable. Surely (he says enviously), he must be a workaholic and obviously unlike some of us less industrious types can have no life at all. But I will say this: he grinds some good data. He therefore makes a good representative of the analytical group, all value diehards who believe the market’s demise is imminent. And the data is comprehensive enough that I admit it worries me. Clearly he and the others may be right. Exhibit 7 reproduces – with his kind permission – his version of all of the value measures he deems important. They indicate an overpricing for the U.S. markets that ranges from 75% overpriced to 125% at the end of March. All of the measures have a history of being predictive – much more so than, say, Yellen’s reprehensible choice of current price as a multiple of next year’s estimated earnings. (Either she’s painfully ill-informed or, most implausibly, not too smart, in which case sooner or later we’re scr*w*d, or she knows this measure is a third-rate prediction of true value and is cynically using it to tout the market, in which case we’re doubly scr*w*d! But at least that latter reason would be an ideal proof of her buying into her predecessors’ Put, in case we had any doubt.)



But back to value and Hussman. Not surprisingly, GMO very much agrees with the spirit of this data, but our preferred measure for our 7-Year Forecast has the market slightly less overvalued at 65%. (Although, interestingly, at 2,250 – our 2-sigma target – it would be about 100% overpriced.) Our estimate allows for a very modest improvement in trend line profitability and an even more modest allowance for a slightly higher P/E as a response to probable lower equilibrium interest rates. Still our estimate of overpricing is pretty close to his.


Exhibit 8 shows an equally disturbing Hussman exhibit in which he has collated very bad things that happen to markets. His exhibit suggests that whenever this large collection of troublesome predictions line up like they have recently there has been a very serious and fairly immediate market decline. While I have no quarrel with the eventual outcome and recognize that possibly the bear market’s time may have come, particularly in light of recent market declines (April 13, 2014), I still think it’s less likely than my suggestion of a substantial and quite lengthy last hurrah.


Which brings us to the punchline: Grantham's "Best Guesses for the Next Two Years":

With the repeated caveat that prudent investors should invest exclusively or nearly exclusively on a multi-year value forecast, my guesses are:


1) That this year should continue to be difficult with the February 1 to October 1 period being just as likely to be down as up, perhaps a little more so.


2) But after October 1, the market is likely to be strong, especially through April and by then or in the following 18 months up to the next election (or, horrible possibility, even longer) will have rallied past 2,250, perhaps by a decent margin.


3) And then around the election or soon after, the market bubble will burst, as bubbles always do, and will revert to its trend value, around half of its peak or worse, depending on what new ammunition the Fed can dig up.


Conclusion and Summary


The bull market may come to an end any time, indeed as I write it may already have happened. It could be derailed by disappointing global growth, profits sagging as deficits are cut, a Russian miscalculation, or, perhaps most dangerous and likely, an extreme Chinese slowdown. But I believe it probably (i.e., over 50%) will not end for at least a year or two and probably not before it reaches a level in excess of 2,250 on the S&P 500. Prudent long-term value investors will of course treat all of the above as attempted entertainment (although I believe all statistically accurate) and be prepared once again to prove their discipline and man-hoods (people-hoods) by taking it on the chin.


I am not saying that this time is different (attention Edward Chancellor). I am sure it will end badly. But given this regime of the Federal Reserve and given the levels of excess at other market peaks, I think it would be different to end this bull market just yet

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SilverIsKing's picture

Everyone has an opinion like everyone has an asshole. Everyone also has a forecast. Big fucking deal. My forecast calls for more manipulation of every market, more war, less freedom, and more Dancing With The Stars.

Check back with me in a year and we can compare notes.

butchtrucks's picture

Agreed.  I'm going with Chauncy Gardiner:

President "Bobby": Mr. Gardner, do you agree with Ben, or do you think that we can stimulate growth through temporary incentives?

[Long pause]

Chance the Gardener: As long as the roots are not severed, all is well. And all will be well in the garden.

President "Bobby": In the garden.

Chance the Gardener: Yes. In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.

President "Bobby": Spring and summer.

Chance the Gardener: Yes.

President "Bobby": Then fall and winter.

Chance the Gardener: Yes.

Benjamin Rand: I think what our insightful young friend is saying is that we welcome the inevitable seasons of nature, but we're upset by the seasons of our economy.

Chance the Gardener: Yes! There will be growth in the spring!

Benjamin Rand: Hmm!

Chance the Gardener: Hmm!

President "Bobby": Hm. Well, Mr. Gardner, I must admit that is one of the most refreshing and optimistic statements I've heard in a very, very long time.

Slave's picture

I'm thinking we have one more bubble after this one before the SHTF. They'll still have enough money for more bailouts, welfare, and stimulus after this one. Probably gonna have hyperinflation too, they've already got big time diminishing returns for all this shit. Look out for more war on the other side, riots at home, civil disobedience, gun control, social engineering, etc. Just be sure to BTFD on the other side, and top off your preps with the profits.

I could be totally wrong, but think about it, if this fucker crashes tomorrow do you really think TPTB are going to let it all just die? Gonna just be 2008/2009 policy all over again.

chumbawamba's picture

Sell in May and go away.

Nothing is new under the Sun.

I am Chumbawamba.

Stuck on Zero's picture

Chauncey would have made a better Fed Chief than anyone in recent history.  We can just dream of Being There.


Ghostdog's picture

Benjamin Rand

"What is the message from Obama, Mr Gardener?"

Chance the Gardener

"Now get this honky..." "You tell Raphael that I aint taking no jive from no Western Union messenger." "You tell that ass-hole if he got something to tell me to get his ass down here himself, then he said that I was to get my white ass out of their quick or he"d cut it"

thomasco's picture

I agree.  Five years ago, this would not have been a message that said so much with so few words.  Now, the dishonesty of the government and banks is so obvious that few words recall it all to make the point.  We may never regain confidence in our markets.  That is the result and the end game may come within the year the writer suggests.

Robot Traders Mom's picture

Grantham is a sharp dude, but a lot of other sharp people think we'll see a collapse this year, others say not until the end of the decade.

The issue is that nobody knows exactly when the ponzi breaks. If it happened tomorrow, that shouldn't surprise anyone and likewise, if it didn't happen for five years, that shouldn't be surprising either. Be thankful that regardless, we've had a great opportunity to buy metals at dirt cheap prices for this long.

CrashisOptimistic's picture

It's amazing how many people don't understand.  There doesn't have to be collapse.  There can be, instead, perpetual death.

Russia doesn't want any military confrontation.  Why should they?  They are destroying their enemies every day with $109 Brent.  They drain that money from their enemies daily, and their enemies willingly bleed it for them.  

They will die.  Quietly.  Without bombast or gunfire.  They will send their young people to wash Russian toilets.  They will send their women to be Russian nannies.

The Saudis have done this to the Philippines and Bangladesh for a long time.  Russia will do the same.  A Russian citizen doesn't have to work.  He had the good judgment to be born on top of liquid that the enemy must have and they can quietly and gently have that enemy cut his own throat.

We also will soon hear about dual pricing.  One price to countries who make no effort to develop alternate energy sources.  A much higher price for those that fund that sort of thing.  Then the same dual pricing will go into effect for consumers who agree to disarm their military.  They get the lower price.  Countries that still fund a military?  They have to pay more.

James_Cole's picture

Grantham is a sharp dude, but a lot of other sharp people think we'll see a collapse this year, others say not until the end of the decade.

But Grantham is the sharpest. 
Mr. Magoo's picture

It will happen when they (Globalists /Central bankers) decide it will happen. They are all in it together to suck us dry

davidalan1's picture

I actually was naive enought to believe y2k was the end...lots of toilet paper stocked...

my poor wife...


now 15 years seems slo-mo

when will it fall apart/// so many ancillary factors...

I hate 4 dollar gasoline

thanks for your time

CPL's picture

There is no 'market' anymore.  It's three machines playing pong with real money.

Kirk2NCC1701's picture

Not so sure about the "real money" part. 

When money is conjured out of thin air or a keyboard, how "real" is it -- when it's rejected or no longer backed by enough force applied to the whole world?

Bindar Dundat's picture

The end has been happening since y2k.  We are the frogs in the water that heats up over time and we don't feel it until we simply don't feel anything anymore.

Bemused Observer's picture

Hey, at this point, no one can say they didn't see what was coming. All they can say is that they didn't time their exit right.

surf0766's picture

He has no clue.

optimator's picture


 The Market is easy to predict.  I predict that Fridays market is as likely to be down as up, perhaps a little more so.



TammanyBrawl's picture

Grantham is a smart guy, but it seems to me they are looking at the US like it's in a vacuum. Whistling past the graveyard regarding the worsening global macro conditions which could topple the house of cards toot sweet.

Yen Cross's picture

    This guy has been hanging around Dennis Gartman & Joe Lavorgna for way too long!

cougar_w's picture

it may never fall apart. the S&P might go up and up forever and if it looks like that is important, then that's how it will happen.

They could just lie, you know. The regulators and the exchanges, just make shit up every day. It went up it went down, but it was just a simulation.

Corporations, they could report any earnings they want, just make shit up. they only fear the SEC but if the SEC says "make shit up" then they will.

If someone leaks the news "they're just making this shit up" will the media report it? of course not. if they do, will anyone understand what that means? of course not.

If it gets to the point where nothing matters except appearances, then we'll get appearances and we'll like it.

What happens then is, it no longer matters. It just doesn't matter. Reality will have bitten, will have eaten, will have devoured all things. People will be broke and not know why. The market will be up 100 consecutive weeks and nobody will know why. They'll be digging in dumpsters for food and won't care at all.

It may never fall apart. That fact will have become utterly meaningless to the lives of actual human beings.

CrashisOptimistic's picture

And THAT . . . THAT . . . is why only oil matters.

Pareto's picture

+1 your right.  it really does come down to recognizing that if they can lie and cheat and get away with it - market manipulations, data, etc., then nothing really matters - at all.  There is no market anymore.  Its all lies and bullshit and HFT's running stops.  Hussman could be right about probability, but, this assumes a free and unfettered market.  I think the only way the market crashes is if the FED loses control of the Bond market and lets the 10 yr get away from them and i dont see that happening anytime soon - even if there is a dump, the FED will just mop it up.  Its going to be something that reaches to the core of a passified population.  Don't know what that might be, don't know when - but - its that kind of a thing that will crush any opportunity for the FED or anybody else to get out.

Jam Akin's picture

All of this "analysis" is most impressive but if it in the end represents a bunch of "smart" folks trying to remain "serious" and thus relevant in the face of rampant criminal manipulation, the clock is likely ticking much faster than any of them are willing to admit.

Dutch's picture

I recently studied the history of the stock market in the late '60s/early '70s. Money missing, capital shortfalls, firms going under, huge turmoil. All because the market kept going down. These days, TPTB, with an eye on history and the ability to forever pull that trigger on the last trade that sets the price for all, suggests that you are on to something here, Cougar.

And that is why money always shows up to BTFD, whether funded by our overseers, or by others who have figured it out already. Gonna be interesting to see when and how it goes wrong, if ever.

buzzsaw99's picture

Why does he assume it will be the stock market that crashes?

AUD's picture

Typical money market shyster. Too stupid to work out that in a bubble economy, there is no 'trend'. That won't stop him taking money from chumps who think they will get rich quick.

Its_the_economy_stupid's picture

and the seven skinny cows ate the seven fat cows, but verily, they remained skinny

IndianaJohn's picture

The hell you say!

Cattle don't do that.

valley chick's picture

Going with 2015 crash and burn for $100 Alex.

AdvancingTime's picture

You got my thumbs up, and I'm going with "irony for $200 Alex" It seems the crash or end is always one year away. It is ironic in that those who think things are getting better use the same line. It is hard to know when it is coming but the landing will be very "hard" and that is something you can count on.

The value of "something" is not an issue to take lightly. Value is not a constant and can be derived from several factors such as supply and demand or utility value, things can spoil or become obsolete making where you invest very important. Value is not as constant as many people think or always destined to rise. 

Having possession of an item is often more important than whether it is paid for in full, In the case of gold unless it is in your possession you should not be so sure that you will ever get it. Tell me the value of a promise on paper or implied, remember if you own gold that is represented by a certificate, you own a piece of paper. More on this valuable subject below.

I Write Code's picture


Every day,
in every way
I'm getting
a little bit higher.

conspicio's picture

This is all very impressive and well thought out bullshit. Mad props to the author, yo.

But back in the land of fairies and unicorns, past performance HAS NO FUCKING BEARING ON FUTURE PERFORMANCE at this point. Do I need to say that louder as you read that in your head? Shall I repeat it?

A market manipulated (BUT IT ISN"T MANIPULATED, I SWEAR) has absolutely nothing (ARE YOU FUCKING DEAF?) to do with future performance.

But hey, keep churning out bullshit for the masses, because one must convince oneself before convincing others.

Some Huxley for good measure:

Within the next generation I believe that the world's leaders will discover that infant conditioning and narco-hypnosis are more efficient, as instruments of government, than clubs and prisons, and that the lust for power can be just as completely satisfied by suggesting people into loving their servitude as by flogging them and kicking them into obedience.

FreeNewEnergy's picture

So, BTFD, duh.

Just in case, BTFATH.

Or, just die, lonely and afraid that you're missing out on some of the greatest gains in financial history. Your friends are all driving big, new SUVs, leased with mock currency from duplicitous bankers, living high on the hog in ostentatious 5400-square-foot abominations, dining on grouse livers and imported caviar, drinking splendid French wines from long-stemmed glasses, all the while looking down their petrified noses at you, saving rainwater and oat bran meal.

Plainly, there is a dissonance which cannot be sustained, lest the discordance stimulate an uprising of forces beyond any standard of control.

Pain - for one, more or all parties - is ensured.

aFalseProfit's picture

Poetic... digging it :-)   End of times snarkiness

FreeNewEnergy's picture

And if I see one more story or article claiming that recent price or chart action indicates that gold or silver is going higher, I might just slit my wrists.

AdvancingTime's picture

This market could turn and head south very fast. We may soon be forced to face our economic Armageddon. The forces that have driven stock markets ever-higher and upward may be beginning to wane. Many markets became distorted years ago when QE and super low interest rates hit the economy in an effort to lessen many of the missteps of recent years.

The policy of QE it now appears has been more helpful in holding up the underlying value of assets and derivatives than helping to repair a wounded economy. Unfortunately the economy has not fared as well as these asset prices and in many ways these policies have harmed Main Street. More on this subject in the article below.

Kirk2NCC1701's picture

I believe you've said this before, some weeks ago, I think. But I tend to agree with you.

Obama can leave the mess to Billary/Shrub3, the way Shrub2 left it on him.

czarangelus's picture

The problem with this announcement, however well learned and rational, is that as a system becomes more brittle it becomes more vulnerable to disruptions of smaller and smaller kinds. Something as simple and unpredictable as earthquake on the New Madrid fault could set us back 10 years, because we've negleted our infrastructure and fundamentals for so long.

Market Rage's picture

If you look at RUT and NDX, it may already be over.  If you get a gap higher tomorrow off the payrolls it's worth taking a shot.  That's my plan.  Everyone has been lulled into expecting SPX 1900, but the intraday futures action this week has been different.

arnoldsimage's picture

another date setter. haven't we had enough soothsayers.

CHX's picture

Suits me fine. And keep the metals depressed as much as possible please, for as long as possible. I want 850 gold and 14 silver. PLEASE

AdvancingTime's picture

In the past Jeremy Grantham has also pointed out that timimg a market is an impossible task. What I'm seeing develop is an "almost surreal" feeling of indifference towards reality. Companies have already ushered saving from interest paid on debt into the earning column and a major reason inflation remains low is they are sitting on a hoard of cash this has lowered the velocity of money.

We must remember the artificially low FED controlled interest rates are a massive one-off or onetime tailwind that is mainly behind us.  When rates stop going lower or reverse the positive effect will ebb and become a major headwind. With massive government debt in many countries and the economy still weak this headwind has the potential to become devastating. The collision of MMT, social unrest over inequality, and other destabilizing factors have the potential to create the perfect storm. More on this subject in the article below.