When the Bubble Bursts

Occasionally I take time off from ranting about America’s culture wars to opine about something that really matters-- the state of the markets. I did so most recently two weeks ago, reporting on the views of some of the most savvy market players. On such matters I try to report what the best Wall Street minds have to say. Link here.

Among those whose views I shared the last time, was one Jeremy Grantham. He asserted his view that the markets were in bubble territory. Obviously, he was widely excoriated for holding this view. 

More recently, he expanded his analysis in an interview for Reuters. So, we report his analysis:

Bubbles are unbelievably easy to see; it's knowing when the bust will come that is trickier. You see it when the markets are on the front pages instead of the financial pages, when the news is full of stories of people getting cheated, when new coins are being created every month. The scale of these things is so much bigger than in 1929 or in 2000.

He continues:

 Looking at most measures, the market is more expensive than in 2000, which was more expensive than anything that preceded it.

My favorite metric is price-to-sales: What you find is that even the cheapest parts of the market are way more expensive than in 2000.

So, how do you know when a bubble is going to burst? In truth, you don’t, but caution is a very good tactic under bubble conditions:

Markets peak when you are as happy as you can get, and a near-perfect economy is extrapolated into the indefinite future. But around the corner are lurking serious issues like interest rates, inflation, labor and commodity prices. All of those are beginning to look less optimistic than they did just a week or two ago.

A bust might take a few more months, and, in fact, I hope it does, because it will give us the opportunity to warn more people. The probabilities are that this will go into the fall: The stimulus, the economic recovery, and vaccinations have all allowed this thing to go on a few months longer than I would have initially guessed.

What pricks the bubble could be a virus problem, it could be an inflation problem, or it could be the most important category of all, which is everything else that is unexpected. One of 20 different things that you haven't even thought of will come out of the woodwork, and you had no idea it was even there.

What will happen when the markets go bust?

There will be an enormous negative wealth effect, broader than it has ever been, compared to any other previous bubble breaking. It's the first time we have bubbled in so many different areas – interest rates, stocks, housing, non-energy commodities. On the way up, it gave us all a positive wealth effect, and on the way down it will retract, painfully.

Timing such events is nearly impossible. People like Grantham are often early in their forecasts. But, keep in mind the old line-- forewarned is forearmed.