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Coping With Crazy

Adam M. Grossman

FOR MORE THAN a year, veteran investment manager Jeremy Grantham has been arguing that the U.S. stock market is in a bubble. And not just an ordinary bubble, but “an epic bubble… one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”

And yet, despite Grantham’s concerns, the market has only continued to march higher. In a recent interview, Grantham reiterated his concerns in even stronger terms. He cited these worrying signs:

  1. Valuations are at extreme levels. Among the valuation indicators that Grantham tracks, eight out of 10 point to a market that is even more overvalued than it was at the peak of the tech bubble in 2000.
  2. Not only are share prices increasing, but also they’re increasing at an accelerating pace. Prices are rising at two to three times their normal rates, says Grantham.
  3. “Crazy behavior” is widespread. As an example, Grantham points to the boom in special purpose acquisition companies, or SPACs. These investments, Grantham says, are simply a “license to rip investors off.”

By his own admission, Grantham is a contrarian—so contrarian that Harvard Business School once featured his firm in a case study. And yet his three-part indictment has a lot of validity. I’m not quite as worried as Grantham, but as I commented last week, aspects of today’s market do remind me of The Emperor’s New Clothes.

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But here’s the problem with bubbles: Unfortunately, there just isn’t a whole lot that can be done about them. In terms of futility, it’s maybe not as bad as complaining about the weather, but it’s close. Consider the challenges:

  • Even if you had an ironclad guarantee that Grantham is right—that the U.S. market will face a reckoning—it’s impossible to know when that day will come. The frothiest part of the market has weakened in recent weeks, with Snowflake, Tesla, Teladoc, Zoom and Peloton all down more than 30%. Maybe this is the sign that the music has stopped. It might be—or it might just be a temporary setback. That’s the tough thing about the market: Sentiment can turn quickly.
  • Just as it did in the mid-1990s, the market could continue to go higher before it goes lower. As a result, the future low might be no lower than where the market stands today.
  • Assuming the market does drop at some point, you won’t know in advance how steep the drop will be.
  • The shape and duration of every downturn are different. When the market does drop, it will be impossible to know—again, in advance—how long it will stay down.
  • Just as we saw last year, external forces, including government action, can intervene in the market at any time. When the Federal Reserve stepped in with its bazooka on March 23 last year, everything changed overnight. These kinds of things happen all the time. Sometimes they’re positive, sometimes negative, but always unpredictable.

Given these challenges, what action can or should you take? Here’s the prescription I recommend:

  1. If you’ve been experimenting with some of the market’s highflyers, including bitcoin, consider yourself fortunate, take your gains and move to higher ground. What if the gains are short term and would trigger a big tax? I can’t predict where any stock will end up, but I encourage investors not to lose sight of this reality: A short-term gain is always preferable to any loss.
  2. If you’re in your working years and have a long runway before retirement, you shouldn’t fret at all. In fact, you should hope and pray that Grantham is right. A market downturn will enable you to add to your investments at lower prices. Counterintuitive as it sounds, young people should welcome a downturn.
  3. If you’re losing sleep about the market, that’s usually a sign you should revisit your portfolio’s asset allocation. Ideally, your allocation should be structured so you’re insulated at all times from a potential multi-year market downturn. The operating framework I recommend is to assume that the market could drop 50% at any time, and that it might take five or seven years after that to recover.
  4. Be sure to rebalance your portfolio diligently, if not religiously. This, of course, includes rebalancing between stocks and bonds. But don’t forget to rebalance within asset classes. Jeremy Grantham’s view is that you should move substantially all of your stocks out of the U.S. and into emerging markets. That’s too extreme for me, but the general premise is useful: If an asset class has run up in value, you should happily take some of those gains and move them into an asset class that’s been lagging.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. In his series of free e-books, he advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman and check out his earlier articles.

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betsy L
betsy L
7 months ago

I keep 2 years in cash, the rest in stocks. All the stocks I own are headquartered in the US. I figure they know what foreign markets to make money in, I have no idea. I’m 66. I retired at 48, and this has worked well for me. Any thoughts?

Steve O
Steve O
7 months ago
Reply to  betsy L

Betsy, Tell us more retired at 48 for 18 years you are obviously the genius on life choices and actions. I agree USA companies own the world.
I am retired 5 years , 67 (35 S 50 B 15 C) and 20 years cash.
November 2020 moved to (20 S 55 B 25 C). I will relax and will buy the big dip.
I switched from stocks to bonds in late 1999, 2007 and now.
My wife the midlife GYN heard many visits start with the most troubling medical problem in 1998, 2003 and 2009 was “My husband lost all the money in index funds”.
Since retirement portfolio spend 1 – 2% and increased 1 million. We enjoyed traveling 9 months each year, so now no need for more $.
The scamdemic has crushed many HUMAN plans and opportunities for happiness.

betsy L
betsy L
7 months ago
Reply to  Steve O

If your traveling 9 mo you’ve got way more than me. I’ve got 3.5M, I take out 150K per year. 50K is dividends. I have 2 houses, MN and FL, no debt. I’m an LPGA Pro, work part time for fun. The hardest thing for me is to spend money. I’m conservative on the spending side, aggressive on the investment side. I owned athletic clubs and a got a good offer an sold.

betsy L
betsy L
7 months ago
Reply to  Steve O

20 years of cash for me is 25 million dollars. I wish

Raj Sundaram
Raj Sundaram
7 months ago

Instead of “more than a year”, I would actually say for more than 3 years. Jeremy has been calling US market overpriced since 2017 and called it a bubble around Jan 2018 itself. It definitely looks like a bubble from all the stuff happening in recent days but as you’ve mentioned not sure what exactly to do.Tilting from growth to value and from US to international seems a sensible thing to do but it’s been “sensible” like this for the last 3 years. I’m more and more convinced that it’s best to figure out a portfolio allocation, stick to it and rebalance occasionally (to not lose momentum factor). I used to believe that knowing more about investing and keeping up to date on some of the insights from folks like Jeremy Grantham, Howard Marks might give an edge on investing, but I now feel it’s a waste of time for a paltry excess return, if any at all. I recently re-read Bogle’s little book on common sense investing and I now totally agree with him.

Langston Holland
Langston Holland
7 months ago

Great article – a must read – thanks. Shiller’s famous Irrational Exuberance turned me off a bit because it’s so emotional when it didn’t need to be, but his CAPE won me years ago and it’s wonderful to see the author put it in such simple terms. It’s also fascinating to see him say the opposite of what I thought he would say.

It seems to me that nothing can be as important as how much something costs when you’re looking to sell it down the road, but there is the other side of the coin and it seems to have a bit more weight.

John Yeigh
John Yeigh
7 months ago

Regarding USforeign asset allocations, I’m sticking with Buffett over Grantham – “Never bet against America”

johny
johny
7 months ago
Reply to  John Yeigh

I have some foreign, but it isn’t because I’m betting against America

Langston Holland
Langston Holland
7 months ago

You will never hear a more fundamental truth about intelligent investing than #3, of which #4 is part of. I have strongly held opinions on things to come just as Mr. Grantham does, but nothing either of us have to say can hold a candle to this article. IMO. 🙂

A related article from my favorite Morningstar guy is interesting as well.

For years following the 60’s riots, the TV networks would sign out with “It’s 11 O’Clock, do you know where your children are?” I think this can be applied to our portfolio allocations today. Or any other day.

Ormode
Ormode
7 months ago

If the market dropped 50%, I’d have to buy. But the type of stocks I buy only drop 20-25% when that happens.

I know what I want to pay for the companies I’d like to own, so I’ll just hang out for a while. The markets may continue to surprise, but there’s no guarantee all the surprises will be on the upside.

Roboticus Aquarius
Roboticus Aquarius
7 months ago

Valuations are a tricky dribble. I’ve been hearing to expect lower future returns for 20 years, but my portfolio returns have done well enough.

Regarding valuation specifics, corporate structure is different, on average, than it used to be. Less labor and fewer capital goods purchases are generally required. GAAP for revenue and expense recognition has shifted. Tax rates are lower. Interest rates are near all time lows. Taken together, these things would suggest that the CAPE P/E ratio should be higher than it was, say, 40 years ago.

And then there is Grantham. I’m not sure he’s made a generally bullish call anytime in the past 15 years (he has promoted some company stocks). I believe he’s a very smart man, but he’s not playing the same game I’m playing. From my perspective he looks like a broken clock, the once that’s correct twice per day.

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