Whether the US stock market has entered the bubble stage after all? How bad is the bubble? When will the bubble burst?

Faced with this series of big questions worthy of the name, Wall Street legendary investor Grantham, who accurately predicted the 1989 Japanese bubble, 1999 dotcom bubble and 2008 housing bubble, gave his answer on Boston's asset management giant GMO.

The GMO founder and chief investment strategist released a lengthy "executive summary" to the company's executives, giving guidelines for future asset allocation, entitled "waiting for the Last Dance-the difficulty of Asset allocation and the late stage of the Super Bubble"The following is the full text:

The long bull market since 2009 has finally reached its final stage and developed into an epic bubble.

Extreme valuations, explosive share prices, frenzied new share offerings and historic investor fanaticism have convinced me that this event will go down in history as one of the most significant bubbles in financial history, alongside the South China Sea bubble, 1929 and 2000.

These huge bubbles are not only the birthplace of wealth, but also the place of destruction of wealth, of course, is where investors have repeatedly proved their character. Avoiding the damage caused by the bursting of a major bubble may be one of the hardest jobs in portfolio allocation. Whether it is the pursuit of enterprise of experts, or the inherent human defects of ordinary people, it will be difficult for people to refuse the charm of the bubble.

However, bubbles always burst, and so is the current bubble, and no matter how hard the Fed supports it, it is unlikely to change the end result, nor is it enough to withstand the damage to the economy and portfolio.

For most investors today, this is likely to be the most important event in their entire investment career. As a lifelong student and market history researcher, I feel both excited and scared at the moment.

After all, what we are facing now is probably an once-in-a-lifetime experience.

"there is an irrefutable truth in the market that the future return of assets with relatively high prices is always lower than those with relatively low prices. The former can give you the satisfaction of the present, while the latter can give you a steady return in the future, but you can't have both. In fact, the price we pay for rising at the moment is that expected returns are falling in the decade after the peak. "

-Grantham, November 12, 2020

Most of the time, or, more accurately, 3/4 of the time, the relative prices of various major assets are reasonable. The reasonable response of asset allocators is to choose those assets whose valuation indicators show that the price is relatively low to invest, hoping that the judgment of those indicators is accurate.

As long as they have the necessary skills to correctly assess asset valuations, asset allocators will be able to get through these cycles calmly and even hope to achieve slightly above-average performance-only by a "small margin". Because the opportunity itself can't be significant.

From the point of view of sceptics and critics, they can even say that asset allocation itself is of little importance at such a stage. If at such a stage a manager can choose the right asset category and create more value by making the right choice between different countries, sectors, industries and individual securities, that is certainly the icing on the cake.

However, the real difficulty in asset allocation lies in other periods of time when asset prices are far from fair value. Bear markets are not that bad, because really big bear markets are short-lived and unreasonable. Clients are petrified and do nothing in the early stages of the bear market, while managers can take the opportunity to rearrange their portfolios to keep their business.

What is really bad is the big bull market that has lasted for many years. In this long and slow bull market, asset prices are likely to be above fair value for many years, or even well above fair value for one or two years, or even three or four years. Such a situation can easily make most customers impatient.

At the end of a bull market, asset prices tend to rise so rapidly that increasingly impatient customers begin to feel anxious and envious of other investors. As I always say, there is nothing more exasperating than to see your neighbor making a fortune.

How should clients judge whether the current situation is because there is something wrong with their managers or because of a rare extreme situation in the market? A manager is talented, and the most common evidence comes from his past success record, but in the market, long periods are actually very rare. Making the right decision three times and making the right decision twice is simply not enough to make any statistical sense.

To make matters worse, the major market events in the past are far away from us, and in Japan in 2008, 2000 and even 1989, those seem to exist only in historical records. The wishes of most customers have already changed. Not to mention, no matter how satisfied people are with your past performance, it's not enough to offset the pain they feel right now because of your decisions.

All in all, Keynes is said to have said that it is true that "the irrationality of the market is likely to remain long enough to bankrupt you".

I have retired from the specific work of portfolio management for many years, but I would be more than happy to give my point here as a reference: the US stock market is probably in the midst of a major bubble. this is the kind of bubble that occurs only once in decades, and the last one dates back to the late 1890s. Although it is not certain yet, the probability of a bubble bursting will be frightening.

Sooner or later, investors will be grateful that they left the market in time. This is because, on the one hand, they keep their money and avoid losses, on the other hand, they avoid the risk of wild fluctuations. This is success, and the definition of success should not include accurate point-in-time prediction. (predicting the timing of the bursting of a bubble has no clue in valuations. This time, like all previous bubbles, valuations have already reached extreme levels. In the final analysis, the bursting of the bubble and overvaluation is only a necessary condition, but far from a sufficient condition. )

When will the top appear? It is possible within a week, within a month, or even within a quarter.

I was close to accurately judging the top of the bull market in 2008 and the bottom of the bear market in early 2009. Even if I have been practicing for more than half a century, I must admit that this is more due to luck. For example, my prediction of the Japanese bubble was fully three years earlier than the reality, and this example is actually more typical.

In 1987, when our GMO completely closed our exposure to japan, the valuation of the Japanese market was more than 40% higher than that of the far east, Europe and Australia benchmark, with a price-to-earnings ratio of more than 40, compared with an all-time high of about 25.

Therefore, leaving Japan was certainly a prudent and wise choice at that time. However, over the next three years, the Japanese market rose all the way, with a price-to-earnings ratio of 65, which became 60% more expensive than the benchmark, while we suffered from below-average performance! However, we insisted on staying out of the Japanese market for three years until the top came and finally settled the ledger, and we made a lot of money.

Similarly, by the end of 1997, the S & P 500 had passed the peak price-to-earnings ratio of 21 set in 1929, and we quickly cleared all the positions in US stocks that could be cleared, but then we were surprised by the development of the situation. While earnings continued to rise, the price-to-earnings ratio expanded to 35. As a result, we lost about half of our investment, but in the subsequent market crash, we finally gained more than we lost.

Gentlemen, please believe me. I know some people may say that these are the past, but they do have a direct connection with reality. Today's market is in fact a repeat of the old days. In the summer of 2020, when I said that we might be entering the late stage of the bubble, some people questioned the uniqueness of COVID-19 's collapse.

How to determine whether the late stage of the giant bubble is coming? History tells us that the most reliable indicator is that investors start to go crazy, especially retail investors.

As we all know, the length of this great bull market is a record, and in its first decade, there was no such wild speculation in the market, but now it is really happening. My colleagues Ben Inker and John Pease cited some examples of this in their recent GMO quarterly letters, such as the performance of Hertz car rental, Kodak, Nikolai and other stocks, and the culminator was undoubtedly Tesla, Inc..

As a Model 3 owner, I personally like Tesla, Inc. very much. The problem is that their market capitalization has now exceeded 600 billion US dollars. Divided by the total annual car sales, it amounts to more than 1.25 million US dollars per car, while General Motors Co's figure is only 9000 US dollars. No matter how crazy it was in 1929, it was nothing more than that.

Of course, some people will still say that these are minor details (believe me, they are not), but the overall picture of the market looks even worse.

The so-called "Buffett index", the ratio of total stock market capitalization to gross domestic product, has now broken the previous record set in 2000. In 2020, including the eye-popping 248 special purpose acquisitions (SPAC), the total number of IPO transactions reached 480, up from 406 in 2000.

In 2020, 150 non-micro stocks (with a market capitalization of more than $250 million) rose by more than 200%, compared with less than 1/3 in any year in the previous decade.

The number of small retail call purchases, or fewer than 10 transactions at a time, has increased eightfold since 2019, and it should be noted that 2019 itself is much higher than the historical long-term level.

Perhaps the most disturbing thing is not the above, but the change in the attitude of Nobel laureate Robert Shiller. Schiller, who accurately predicted bubbles in 2000 and 2007, is one of the people I admire most.

But this time, contrary to his long-standing bearish position, he went so far as to claim that his widely watched cyclically adjusted price-to-earnings ratio valuation (readings show that US stocks are almost as overvalued as they were at the peak of the dotcom bubble in 2000). It looks less overvalued when compared with bond prices. The problem is that if you look at the long-term level of history, bonds are more expensive to achieve than stocks. Oh, my God, what was Schiller thinking?

As a result, I am not surprised that US stocks have accelerated since the summer to the extent of today's massive speculative glut. This is typical of the late stage of the bubble-entering an accelerated rally whose length is uncertain, but in most cases not for long. However, no matter how short the end of the bubble is, it will cause great pain for bears and may even ruin their investment careers.

I'm making more bets now, because the fact is that prices are deviating further from the trend at an acceleration, and speculative frenzy is raging, which makes me, as a researcher of market history, all the more convinced that this is the judgment of the end of the bubble, even if more and more people are beginning to think that the bubble actually makes a lot of sense.

One of the strangest features of this bull market is that it is significantly different from all previous super bubbles in one respect. Previous bubbles are often accompanied by a loose monetary environment and a near-perfect economic environment that everyone can perceive, so investors will assume that the future situation will be better and better.

Of course, investors have a misconception that the perfect economy will not last long, or even not at all, so it makes sense for a crash and a massive sell-off.

However, the situation today is very different. The economy is bruised and, at best, partially recovered, growth is slowing, and the risk of a double-dip recession is huge. At the same time, however, the stock market is far higher than a year ago, when unemployment was at an all-time low.

Right now, the price-to-earnings ratio of the US stock market is at one of the highest points ever seen, while the economy is at one of the worst points ever seen. This scene is completely unprecedented, which may be a better indication of how crazy the stock market is today than the SPAC frenzy.

Compared with previous bubbles, investors are unprecedentedly highly dependent on loose monetary policy and zero interest rates, seemingly convinced that such a financial environment will last forever. In theory, this is similar to past bubbles, where investors assume that peak economic performance lasts forever-so it seems reasonable that all assets have high prices and low yields. However, whether it is a perfect economic environment or a perfect financial environment, it can not exist forever.

When almost everyone is convinced that the current bubble will never burst, the bubble will actually come to an end. For example, in 1929, the economist Irving Fisher asserted that the economy had climbed the "permanent highland"; for example, in 2000, the Federal Reserve hosted by Alan Greenspan predicted that productivity would continue to rise and swore to show loyalty to the stock market (moral crisis). For example, in 2006, Bernanke firmly believed that "US housing prices are really just a normal manifestation of a strong US economy" and tied himself to a moral crisis-if investors make money, just take it, and if investors lose money, don't worry. There's the Fed.

From Yellen to Powell, they also have a consistent style. All three of Mr Powell's predecessors have claimed that the asset price bubble they helped inflate has helped the economy hugely through the wealth effect. This help does exist, but the point is that none of the three is willing to stand up for the subsequent bursting of the bubble and the consequences-whether it was the stock market crash in 2000 or the housing crash in 2008. At a time when the economy is already deeply weak, it has created a huge reverse wealth effect. This game is really the ultimate deal with the devil.

Now, investors believe in the reasonableness of high prices because they believe that zero interest rates will last forever, which is essentially the ultimate moral crisis-the market has recognized and begun to rely on asymmetric risk. The curse behind the rise in asset prices in the second half of 2020 is that artificially low interest rates are enough to prevent any price fall, and forever!

However, this is of course a fallacy, 2020 is a fallacy, and 2021 and the future are still fallacies. In the end, the moral crisis failed to stop the bursting of the dotcom bubble, and the Nasdaq fell by 82% in the process-yes, 82%!

The same was true during the global financial crisis, when US house prices fell all the way back to or below the trend line, and the end result was-first, more than $8 trillion in wealth in the housing market went up; second, the economy fell into recession; and third, risk premiums soared and global asset prices plummeted. (see attached picture). It was only when it came to the crunch that investors realized that all their promises were worthless, with one exception-the Fed did do everything it could to push up prices, put the market on the road again, and then inevitably plummeted again. Now, once again, we are on the dance floor of deja vu, dancing the last piece of music until the music stops.

Of course, in both the real world and the investment world, history does not mechanically repeat itself, and so is the bubble. Every irrational exuberance has its own unique characteristics, but at the spiritual and emotional level, it is indeed connected to each other. Even now, I am well aware that the market could soar for weeks or even months-perhaps we are now at some point equivalent to the period from July 1999 to February 2000.

In other words, although a crash could happen any day, the upward trend is likely to continue for a few more months. I think the most likely next development of the situation is that with the widespread spread of novel coronavirus vaccine, the bubble may continue into late spring and early summer.

By then, the most pressing problems facing the global economy will be basically solved. When market participants can finally relax their nerves and look around with a sigh of relief, they will find that the real economic situation is so bad, and the end of the epidemic means that the stimulus will be greatly reduced. High valuations can be particularly ludicrous.

This logic is as the saying goes on Wall Street: "buy because of rumors, sell because you are solid." "but we should also keep in mind that predicting the timing of the bursting of the bubble is the most frustrating of all prediction games.

The truth is that even from the rearview mirror, we are often not sure what punctured past bubbles. The reason for this incomprehensible thing to happen is that the big bull markets of the past often did not slam on the brakes immediately after they encountered really significant and unexpected bearishness. These major changes, such as the collapse of portfolio insurance in 1987, may have had a big impact for a while, but the market has always rebounded quickly.

What really causes the bubble to burst is often an extremely unique, external upheaval that has nothing to do with the ebb and flow of the bubble itself. In fact, when those super-bull markets end, the market environment tends to be very good-but subtly slightly less ideal than the previous moment. Because of this, these nodes are often extremely difficult to capture.

In any case, what is certain is that the current market is already full of too many explicit super-bubble qualities. The firmness of the bullish attitude, the fanaticism of the mood, the range of people covered by stock investments, and the hostility faced by short sellers are excellent examples of these traits. In 1929, for example, a short seller was beaten and kicked and received a letter threatening to assassinate.

In 1999, our company had a similar experience, and that was the only time we were attacked by a large number of customers, as if we deliberately or even maliciously deprived them of the opportunity to get rich. By contrast, 2008 was much milder, but in the last month before the bubble burst, the tone of hostility was also rising rapidly, but ironically, for us bears, that's exactly what we want to hear.

This is the classic prelude to the final bursting of the bubble, and the other classic prelude is that the rise in stock prices has nothing to do with fundamentals, but only because it goes up.

Another historically tested symptom of the late bull market is the accelerated rise in the final stage, from the South China Sea bubble that year to the technology bubble in 1999. The average acceleration in the late stages of previous bubbles was more than 60% in the 21 months before the bust, more than twice the rate of a normal bull market.

This time, America's major indices, the s & p 500, are up 69% in nine months, while the Russell 2000 is up more than 100% over the same period. Perhaps this rally will continue and accelerate in the future, but so far, it is enough to ensure that the threshold of the late bubble is crossed.

As a researcher of market history, I am honored to witness such a big bubble again. The Japanese bubble in 1989, the technology bubble in 2000, the housing and mortgage crisis in 2008, and now the bubble are the four biggest bubbles that I have experienced in my entire investment career, and even sum up my investment career to some extent. In most times, when the market is much more normal, we just work smoothly according to the established policy.

However, every long time, the market will be completely divorced from fair value and reality. The collapse of great wealth makes it almost impossible for investment advisers to justify the existence of their profession. However, as the old saying goes, misfortune and good fortune depend on each other. This time brings not only risks that may endanger your career, but also valuable opportunities for learning.

Now, we are standing in front of such an opportunity. I now hope my bubble predictions satisfy my humble definition of success-one day, you'll be glad you didn't get caught up in a frenzy in the summer of 2020. However, whether it is experts or retail investors, there are always very few people who can really avoid fanaticism.

The uncertainty about the timing of the bursting of the bubble and the regret of more and more customers mean that large investment institutions will pay an unbearably heavy price to fight the bubble. Even if the price-to-earnings ratio of the market inflates to 65 as in Japan, they dare not bet all their bets on being bearish.

In fact, looking at the performance of large institutions in the history of the bubble, only in 1999, UBS dared to be bearish, when their positions were almost exactly the same as those of GMO. Whether this is brave or nonsense can only be judged by the result. Fortunately for us, in February 2000, when the top was approaching, UBS changed course and took all positions in growth stocks. If UBS had not done so, the behemoths would surely have reaped most of the returns they could get from insisting on countertrend analysis. This example is enough to tell investors that there is no need to wait for Goldman Sachs Group or Morgan Stanley to turn bearish, because this will almost never happen.

It's a bet they can't afford, either for them or for other institutions. It is true that investment consultants can help their clients make profits and mitigate risks by implementing such a strategy, but in reality the feasibility is basically zero.

Business is good business, but the ability requirements are too strict. For most investors, the really attractive option is to be optimistic in the face of reality, just as they are in the face of an epidemic. By the time it is over, the team of bulls will always have an overwhelming majority. So, in a bubble, institutions are, of course, always bullish and always happy to be bullish.

However, for managers who are still willing to take this professional risk, as well as retail investors, it is a bit difficult to ask them to accurately identify the point at which the bubble burst. If the threshold for predicting bubbles is raised too high, requiring forecasters to say the exact time, no one will try again.

Instead of doing so, like most other investors or managers, it is easier to let clients' wealth suffer cyclical losses over and over again, even though they drift with the tide.

Coping policy

In 1929, 2000, and 1972, which belongs to the "Beautiful 50" (which can be called a smaller super bubble), similar to the peak of those bubbles, there are huge differences in prices among different companies, different sectors, and different asset categories in the current market. For example, traditional value stocks around the world are extremely cheap relative to growth stocks.

By December 2019, value stocks ended the worst decade relative to growth stocks, and the following 2020 experienced the worst year-in just one year, the relative performance gap between the two can reach 20 to 30 percentage points!

Moreover, emerging market stocks are cheap relative to US stocks for the third time in nearly 50 years. Therefore, we believe that these two ideas, the intersection of value plus emerging markets, is exactly where people should bet, and that they should also take the greatest risks they can take in the workplace and business. avoid US growth stocks as much as possible. Good luck to everyone!