In his latest letter to clients, which we discussed yesterday, GMO’s Jeremy Grantham found himself defending two irreconcilable contradictions: ever the value investor, Grantham readily admitted that the market has never been more overvalued and thus hardly an attractive investing proposition; at the same time, the investing legend also conceded that stocks are on the verge of a “late bubble surge” melt-up, and as a result the upside from here before the next crash could be as much as 60% during the final phase of the current bubble.
Of course, for someone who is actively and professionally managing money, Grantham – like so many of his peers – had no choice but to admit the gaping cognitive dissonance that results from investing in the current “market”, where one can avoid participating and see their AUM withdrawan promptly, or one can, in the immortal words of Chuck Prince, continue dancing as long as the music plays.
But how to determine if, after nearly nine years of constant market levitation, the music is finally dying down? Conveniently, Grantham also presented his favorite indicator which allows him to determine if “market momentum is increasing to a frenzy” – the acceleration of price, or said otherwise, the non-stop surge that accompanies the final melt-up.
This is how Grantham laid it out:
On the topic of classic bubbles, I have long shown Exhibits 1 and 2. They recognize the importance of a true psychological event of momentum increasing to a frenzy. That is to say, acceleration of price. The average time of the final bubble phase of the great equity bubbles shown in Exhibit 1 is just under 3.5 years, with the average upcycle of real acceleration just 21 months. And the two smaller equity bubbles had gains of 65% and 58%.
They also show an interesting symmetry, don’t you think? Rising and falling at about the same rate, as did the real McCoy – the South Sea Bubble shown in Exhibit 2 – before them. Yes, there is a real danger of being late. And in general, average market declines are considerably faster than average advances. But historically, when dealing with real bubbles, being late has not been materially different in time and pain than being too early, as you can see. Value managers are historically painfully too early over and over again, as I know better than most.
Grantham then doubles down by citing a recent academic paper titled “Bubbles for Fama” which concluded that in the US and almost all global markets, “the strongest indicator – stronger than pure pricing or value – was indeed price acceleration.”
But if upward acceleration is indeed the best bubble indicator, then there is a problem, because as we discussed earlier today when we commented on the Dow’s move above 25,000 for the first time ever, the broader market is approaching exponential “speed” to the upside.
Commenting on the move, the WSJ notes that the most recent 1,000-point rally for the blue-chip index was still a notable run.
The 30-member stock average was on track to close above 25000 for the first time in its 121-year history Thursday, taking just 23 trading sessions to climb from 24000. The blue-chip benchmark added 0.3% to 25013 in early trading.
Putting the move from 24,000 to 25,000 in context, it would go down in history as the fastest run from one millennium marker to the next. The previous record was 24 trading days, accomplished a year ago when the Dow hit 21000 and back in 1999 when it climbed to 11000. Incidentally, it took only 30 days for the Dow to go from 23,000 to 24,000 and 53 days from 22,000 to 23,000.
To be sure, one can counter that the moves are relative, and increasingly less relevant the higher the Dow goes: after all, each 1,000-point milestone gets easier as the index marches higher. The climb from 24000 to 25000 was a 4.2% gain, compared to a 7.1% climb when the Dow hit 15000 in 2013.
However, no matter if one looks at the move on a relative or absolute basis, a clear sign of just how relentless and rapid the market’s recent upward acceleration has been is that the Dow’s latest 5,000-point run – which started roughly around the time 2017 rolled in – was more than three times quicker than its 844-day rally to 10,000. In fact, it will have taken the equity index only 238 sessions to advance from 20000 in January 2017 to 25000 Thursday.
Said otherwise, if upward acceleration in the market is a bubble warning alert, then Grantham is certainly getting worried.
To be sure, in addition to upward acceleration, Grantham laid out several other indicators, all of which we touched upon yesterday, and all of which have been triggered in the current market, however he left his favorite indicator for last:
Keep an eye on what the TVs at lunchtime eateries are showing. When most have talking heads yammering about Amazon, Tencent, and Bitcoin and not Patriot replays – just as late 1999 featured the latest in Pets.com – we are probably down to the last few months.
We may well be, in which case the only question is whether the bubble bursts before the mid-term elections or after. Here’s why it matters, from Grantham’s conclusion: “Living in a hyper-political era, I should mention that if my best guesses are correct, a near-term meltup would obviously help the current administration at mid-term, just as the subsequent and highly probable melt-down would seriously hurt it.“
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