With more than $100 billion under management, Jeremy Grantham, co-founder of GMO (Grantham, Mayo, & van Otterloo), a well-known US investment agency, recently released a report entitled "Wild Escape (LET THE WILD RUMPUS BEGIN)".

The report warns investors in US stocks that the decade-long bull market bubble in the US stock market is about to burst and that the S & P 500, one of the three major indices in the US, could fall by as much as 45 per cent. But he is bullish on emerging market stocks and low-valued companies in developed countries such as Japan. At the same time, he warned investors that holding cash might be a better option, or allocating certain precious metals such as gold and silver.

Graham is no ordinary analyst. As the head of the US head asset manager, he has accurately predicted the bursting of the US stock market bubble many times in the past, including the bursting of the dotcom bubble in 2000, the top of the bull market in 2008 and the bottom of the bear market in 2009. Considering the influence of GMO in international capital markets and Graham's accurate forecasts in the past, the reporter translated the main logic and conclusions of the report.

Overview

Today's US stock market is in the midst of its fourth super bubble in the past 100 years. Every time a super bubble appears, it has some common characteristics. At present, these features have appeared.

The penultimate stage of these superbubbles is that asset prices rise at a rate of two to three times the average rate of the entire bull market. In this super bubble, the accelerated rally in the US stock market began in early 2020 and ended in February 2021. During this period, the Nasdaq index has risen 58 per cent since the end of 2019 (an astonishing 105 per cent if calculated from the low after the COVID-19 outbreak).

The last stage of the super bubble was the underperformance of speculative stocks, but blue chips continued to rise. It happened before the stock market bubbles in 1929 and 2000, and the same thing is happening now. A reasonable explanation for this is that experienced professionals know that market prices are too high. But for commercial reasons, they must continue to dance on the dance floor on the edge of the cliff and pretend nothing has happened. If they eventually have to jump off a cliff, they would rather hold safer stocks.

This is why speculative stocks fall first at the end of the super bubble, and then the decline slowly spreads to blue chips. The most important and difficult thing to define in the late bubble is the sensitive characteristics of the behavior of crazy investors. But over the past two and a half years, there is no doubt that we have seen crazy investor behavior-- even more than in 2000-- especially in meme stocks and new energy vehicle-related stocks, cryptocurrencies and NFT.

The super bubble has been completed at all stages, and the crazy stampede could begin at any time.

This time the super bubble, similar to Japan in the 1980s, is a dangerous stack of bubbles, including stock market and real estate. When pessimism returns to the market, America will lose its greatest wealth in history.

Definitions of bubbles and superbubbles:

We have been defining investment bubbles through statistical measurements of extreme values-the deviation from the trend is 2 standard deviations. For a random, normally distributed sequence, such as flipping a coin, two standard deviation events should occur for every 44 trials. This definition seems a bit arbitrary, but it is reasonable.

But in real life, because of people's irrational behavior, the possibility of abnormal events will be higher.

We studied data on all asset classes in financial history and found that there were more than 300 cases of two standard deviations. In developed stock markets, the end result of every 2 standard deviation stock bubble over the past 100 years is a crash, with share prices falling back to their pre-bubble trend.

But in extreme cases, bubbles do not stay at just 2 standard deviations. So I define "super bubble" as three standard deviation events. Let's take the coin flip as an example. This happens every 100 times, but it may happen two to three times more frequently in real life.

There have been three super bubbles in the United States in the past 100 years: stocks in 1929 and 2000, and real estate in 2006. In addition, the same was true of the Japanese stock and real estate markets in the late 1980s.

We humans are really crazy!

We estimate that the trend value of the S & P 500 is about 2500 points, while the S & P 500 is currently 4700 points, which means that the S & P 500 could fall by 45%.

The harm of multiple asset bubbles existing at the same time

The history of Japan 40 years ago clearly shows one thing: while stock bubbles are dangerous, real estate bubbles are more dangerous. If both happen at the same time, it could be a disaster. The bursting of Japan's stock and property bubbles 40 years ago is still affecting the country. Until now, neither the Japanese stock market nor the real estate market has returned to their 1989 peak.

Now, for the first time in US history, multiple types of asset bubbles are happening at the same time.

First, the US housing bubble is unprecedented. Today, the ratio of median home prices to median household income in the United States is at an all-time high. Us house prices rose by more than 20 per cent in 2021, even more than in 2006.

Second, the behavior of investors in American stocks is more fanatical and extreme. They believe that the stock market will rise forever, so they have been buying. This is the typical mindset of bubble participants. Interestingly, although house prices are also rising in other developed countries, the performance of the stock market lags behind that of the United States.

Third, bond prices in the United States are also significantly higher than in other major countries in the world, and bond interest rates are at an all-time low.

Fourth, commodity prices, including oil and important metals, are also above trend.

Finally, the global food price index released by the United Nations is close to an all-time high.

High commodity prices will push up inflation and hurt real incomes. Looking back at 2008, rising commodity prices and the bursting of asset price bubbles will eventually cause heavy economic losses.

We should know that when these bubbles gather at the same time, the impact will be several times that of a single bubble. In 2007, the direct loss caused by the bursting of the US housing bubble was $10 trillion, or half a year's GDP in the United States. But at that time, the bond market only had a bubble in the price of junk bonds, while the bubble in the stock market was small. When the housing bubble burst, the stock and bond markets were also hit hard.

Even though multiple asset price bubbles have begun to occur at the same time, the Fed has not really taken it seriously.

How did this happen: will the Fed never learn?

Looking back, it is not normal that there have been several big asset bubbles in the United States in the past 25 years. I don't think it's a matter of luck, it's a matter of dove Fed chairmen since Volcker. Not only do they tolerate these bubbles, they can even say laissez-faire.

For example, Greenspan served as chairman of the Federal Reserve from 1987 to 2006. I have always questioned his ability, whether he is in office or now. In the late 1990s, the U. S. stock market experienced the biggest stock bubble to date, and he was the biggest driver behind it. After the bubble burst, the US economy paid a heavy price.

His successor, Ben Bernanke, deserves to learn from this. He should have been aware of the US housing bubble in advance, but he did not. In the face of the apparent super bubble in US real estate, Mr Bernanke insisted that "the US housing market only reflects the strong fundamentals of the US economy" and that "the US housing market has never collapsed". The message he was trying to convey was unsaid, but it was clear: "House prices will never fall, because without a bubble, there can never be a bubble." "

From a purely statistical point of view, he may be right: there was no bubble in the US housing market in the past. Because the rise and fall of the property market in different places is not completely uniform, on the whole, the statistics are very normal. But after Greenspan and Bernanke's relay loosened, eventually, the country's real estate market began to rise uniformly.

If the two chairmen don't find a problem, what about the Fed's statistics-savvy economists? Didn't they find the problem?

I think there are two explanations, either because there is something wrong with their academic standards, or because of their dissenting workplace risks: don't give information that your boss doesn't want to hear. Therefore, they finally chose to be silent.

As a result, this unprecedented, apparently "non-existent" real estate bubble eventually burst and fell back to the trend that existed before the bubble.

The bursting of the US real estate super bubble finally caused serious economic damage to the US and the global economy.

As a result, the Fed became an accomplice to the super bubble for the second time. This time, the pain was exacerbated by the bursting of the housing bubble, the associated mortgage chaos and the subsequent fall in the US stock market, which was overvalued rather than a bubble. In the end, the real estate crisis led to a depression in the entire economy, and major financial institutions received unprecedented bailouts.

In the wake of the crisis, although Bernanke and Paulson did a good job lobbying for congressional bailouts, overall, the Fed acted as the helmsman of a large economy. rashly let the economy travel at high speed in dangerous waters and ignore the risks of icebergs. After the ship hit the rocks, the captain should have been punished or even tried. On the contrary, after the ship sank, the captain was rewarded for helping women and children board lifeboats.

While Greenspan was in office, he continued to deregulate financial institutions. It is these financial institutions that have spawned the real estate super bubble. Compared with the stock market bubble in 2000, this real estate bubble is bigger and has more serious consequences.

The Fed is supposed to learn from the super bubbles of the past few decades and stop them from happening in advance. Unfortunately, the Fed did not do this. We are content with more lifeboats rather than avoiding icebergs. We forgive and forget incompetence and cannot even punish them for total dereliction of duty. (Iceland, population 300000, 26 bankers sent to prison; United States, population 300 million, number of bankers in prison, zero)

Bubbles, growth and inequality

The long-term negative effect of asset bubbles is rising inequality: if you want to participate in rising asset prices, you need to own some assets, while the average person, who accounts for 1/4 of the population, has nothing. By contrast, the top 1 per cent have more than 1/3 of the country's assets.

We have found that the level of inequality in the United States has deteriorated rapidly since 1997 and is now the most unequal of all rich countries. What is even more shocking is that the whole country has the lowest level of economic liquidity, even worse than the UK. A few decades ago, Britain was the object of our ridicule because of its social and economic rigidity.

The direct consequence of rising inequality is a reduction in public consumption. In terms of marginal effects, rich people will not spend much more when they become richer, but for ordinary people, they will not spend all their increased income.

After the housing bubble burst in 2008, the government and the Federal Reserve launched record rescue measures. The same is true after the outbreak of COVID-19 's epidemic crisis. But all of this will have consequences. This time it was the most dangerous surge in asset prices in financial history. At some point in the future, when pessimism breaks out, a fall in asset prices will be inevitable.

If the prices of all these assets fall by 1/3, the total loss of wealth will reach $35 trillion in the United States alone. If this negative wealth and income effect, coupled with inflationary pressures caused by shortages of energy, food and other commodities, we will face serious economic problems.

The last moment of the super bubble

The penultimate phase of the superbubble is characterized by "blow-off", in which share prices accelerate to two to three times the early bull market average. The previous super bubbles in history are no different.

As for frenzied speculation, a lot of unusual things have happened since 2020:

1. Crazy meme stocks, including GME and AMC. These are two companies with ordinary fundamentals, but driven by sentiment among stock forum users, they have rebounded from their post-COVID-19 low to a high in 2021, up 120-fold and 38-fold, respectively. At one point, GME accounted for 20 per cent of the entire Russell 2000 index.

2. The cryptographic currency, the dog coin, has risen nearly 300-fold to a market capitalization of $90 billion, just because Elon Musk has been joking.

3. The share price of Hertz soared after it announced that it would buy Tesla, Inc..

Most of these events are now a thing of the past, and people have become increasingly numb to this pleasure over the past six months. GME, AMC, dogcoin and more than 1/3 Nasdaq stocks are now down more than 50 per cent from their highs, and bitcoin is down 50 per cent. One of my favorite companies that make lithium batteries, Quantumscape, once surpassed General Motors Co in market capitalization. But now its share price has fallen 83%.

Photo: the US stock market has performed in various categories over the past year. The best performers are the top 10 stocks in the S & P 500 by market capitalization. This was followed by the S & P 2000, the small-cap index, and the Goldman Sachs Group non-profit technology stocks index, the worst performer.

The death of a vampire

At the moment, we are in a bull market vampire phase: you throw everything you have to it, you stimulate it with the COVID-19 epidemic, you suppress it with the end of quantitative easing and the promise of higher interest rates, you poison it with unexpected inflation, but it doesn't work, the index is still rising.

In the past, these tricks have always been able to drive down the price-to-earnings ratio, but they may not be able to do so this time. Just like in the second half of 2007, real estate mortgage problems were exposed and financial institutions exploded one after another, but the bull market is still stumbling forward, and the market thinks the rise is eternal. But in the end, there was no accident.

Conclusion: what should you do as an investor?

GMO's advice is to avoid US stocks as much as possible, but we are bullish on value stocks in emerging markets and several developed countries, especially Japan. Personally, I also like some flexible cash, some inflation-resistant goods, and a little gold and silver. For cryptocurrency, I think this is the contemporary "emperor's new clothes".

I feel more and more like a boy watching the naked emperor pass by. So many important people and institutions are admiring the incredible coat of cryptocurrency, which is so complex and superior in technology that ordinary people simply cannot understand it and must wear it to trust. I won't. In this case, I learned to avoid rather than trust.