ACCORDING TO GMO investment strategist Jeremy Grantham, we’re in the midst of a rare “superbubble,” which he defines as a three-sigma event. Three sigma is a statistical term in probability, referring to an event which should occur less than 0.3% of the time or about once every 333 years.
Calling a bubble, let alone a superbubble, can be hazardous both to one’s reputation and one’s wallet. Even if Grantham’s call is correct, using that information to make money—or avoid losses—is easier said than done. Anyone who tried shorting the Nasdaq in the late 1990s can attest to that. Trying to time the market by selling out of stocks is a fool’s errand.
Grantham contends that this is the mother of all bubbles—a bubble in stocks, bonds, real estate and commodities. I’m not sure I agree with him about commodities. Still, it seems bonds, real estate and stocks—particularly U.S. growth stocks—are priced for perfection.
What follows is a condensed story of how we got here. To be clear, this is my view, not Grantham’s.
Day 1: In the beginning—circa 2008—the Fed said, “Let there be zero interest rates.” It came to pass and the Fed saw that it was good.
Day 2: The Fed embarked on quantitative easing (QE) and forward guidance, promising to keep rates low for as far as the eye could see. The potent triad of zero short-term rates, QE and forward guidance gave birth to the first bubble—the bubble in bonds. As Treasury yields cratered, income-seeking investors were pushed further out on the risk spectrum—first investment-grade corporate bonds, then junk bonds and ultimately into stocks.
Day 3: As credit spreads narrowed, the yield on U.S. junk bonds reached a nadir of 4%. Outside the U.S., government bond yields turned negative. Yield-starved investors held their noses and bought stocks. As share prices began their long ascent, the wealth effect was reborn. The Fed looked upon what was happening and saw that it was good.
Day 4: With the price of money near zero, investors succumbed to the original sin—the misallocation of capital. Companies with no profits raised record amounts of cash through public stock offerings. SPACs—special purpose acquisition companies with no profits and no business plan—were warmly embraced by investors. Corporate officers resorted to financial engineering, borrowing hordes of cash to buy back stock rather than invest in their business. The Fed looked the other way.
Day 5: Easy money, in the form of low interest rates, made its way to Main Street. Thirty-year mortgage rates fell to once unthinkable levels. This fueled another bubble in housing prices, the second in under two decades. The S&P/Case-Shiller U.S. National Home Price Index recently reached a level 50% higher than in 2006, the peak of the last housing bubble. Household net worth soared. The Fed saw that it was good.
Day 6: A pandemic appeared out of nowhere. In a frantic attempt to save lives, the economy was shuttered. The stock market cratered and an economic depression loomed. Emboldened by its recent successes, the Fed leapt into action with the aplomb of a superhero. In conjunction with aggressive fiscal measures, money supply ballooned. Plunging share prices were stopped in their track, marking the shortest bear market in history. The Fed, once again, had saved the day.
Day 7: Seeing all the good it had created, the Fed rested on the seventh day. The serpent of inflation, meanwhile, began to scheme.