While each stock market bubble is distinctive, some similarities, such as overvaluation and extreme investor behaviour run through all of them, according to veteran investor Jeremy Grantham, who details the key parallels between the current US market and the defining stock bubbles of history.
“The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble,” said Grantham. “Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour.” 
A renowned investor, Grantham (pictured) is the co-founder and chief investment strategist of asset management firm GMO.
While he has long retired from portfolio management, his views a widely sought after and is especially noted for his predictions on bubbles. He has also been a staunch critic of fiscal policy in response to various economic crises, most recently of US president Joe Biden’s $1.9trn stimulus plan, something he believes will further inflate this current stock market bubble.
“I believe this event will be recorded as one of the great bubbles of financial history,” said Grantham. “Right along with the South Sea bubble of 1720, the Wall Street Crash of 1929, and the dotcom bubble of 2000.
The veteran investor is convinced that this bubble will burst in due course, with devastating effects on the economy and portfolios.
“Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives,” he said. “It is intellectually exciting and terrifying at the same time, and a privilege to ride through a market like this one more time.”
Overvaluation and rising asset prices
While Grantham believes that major asset classes are reasonably priced relative to one another “most of the time”, problems arise when asset prices move away from fair value, especially over long sustained periods.
And while bear markets tends to be swift, slow-burning bull markets can spend years above fair value.
“These events can easily outlast the patience of most clients, and when price rises are very rapid, typically toward the end of a bull market, impatience is followed by anxiety and envy,” he said.
Grantham said it may be difficult for investors to tell the difference between extreme market behaviour and a manager who has lost its way – especially ones who have not experienced an event like this before.
“The earlier major market breaks are already long gone,” said Grantham. “2008, 2000 or 1989 in Japan are practically in the history books – most of the players will have changed.”
How does this bubble compare?
While overvaluation is a condition of a bubble, it does not always lead to the burst, with Grantham recalling that in 1997, the S&P 500 passed its previous 1929 peak of 21x earnings, which prompted GMO to sell its discretionary US equity positions, only to see the market rise to 35x earnings.
Grantham explained that the market crashes of history are keenly relevant to the events unfolding today.
“The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behaviour, especially on the part of individuals,” he said. “For the first 10 years of this bull market – the longest bull market in history – we lacked such wild speculation.
“But now we have it. In record amounts.”
The clear example, according to Grantham, is electric car manufacturer, Tesla, which as of 29 January has a market cap of $840bn, which amounts to over $1m per car sold each year versus $9,000 per car for General Motors.
Equally as staggering, is the fact its market cap was at just over $100bn in January 2020.
But the “big picture” metrics look even worse, said Grantham.
For example, the "Buffett indicator” – which compares the total stock market capitalisation to the economy – broke through its all-time-high 2000 record last year. And there were 480 initial public offerings, despite the uncertainty caused by the pandemic.
“I am not at all surprised that since the summer the market has advanced at an accelerating rate and with increasing speculative excesses,” he said. “It is precisely what you should expect from a late-stage bubble: an accelerating, nearly vertical stage of unknowable length – but typically short.”
Despite sharing some similarities with bubbles of the past, however, this bull market differs in one key respect, according to the GMO co-founder.
“Previous bubbles have combined accommodative monetary conditions with economic conditions that are perceived at the time, rightly or wrongly, as near perfect, which perfection is extrapolated into the indefinite future,” he said.
However, this time around the economy and the market are at polar opposites, large-scale stimulus packages prevented an economic collapse in March last year and they will continue to prop up markets well into 2021.
“Today the price-to-earnings ratio of the market is in the top few per cent of the historical range and the economy is in the worst few per cent,” said Grantham. “This is completely without precedent.
“This time, more than in any previous bubble, investors are relying on accommodative monetary conditions and zero real rates extrapolated indefinitely.”
These assumptions of perfect economic conditions lasting indefinitely are dangerous and are often the precursor to a bubble bursting.
While the idea that interest rates will be kept low in the near-term is a fair assumption, rates will at some point have to rise.
“These assumptions didn’t stop the tech bubble decline, when the Nasdaq fell 82 per cent,” he said. “Nor in 2008 did it stop US house prices declining all the way back to trend and below.”
Housing bubble as of 30 November 2011 and Tech bubble as of 28 February 2003
Source: S&P 500/National Association of Realtors, US Census Bureau
The chief investment strategist believes the later stages of the Covid-19 vaccine rollout will coincide with stimulus cuts and the realisation that there is considerable disparity in valuations.
In stark contrast to the intensity and enthusiasm of the bulls, Grantham is clear that the rising hostility towards bears is another key component of a major bubble.
“In 1929, to be a bear was to risk physical attack and guarantee character assassination,” he said. “In 1999, clients reacted as if we were deliberately and maliciously depriving them of gains.
“But in the last few months the hostile tone has been rapidly ratcheting up. The irony for bears though is that it’s exactly what we want to hear.”
What to do next?
According to Grantham, the areas in which investors might be able to shelter from the coming storm is in cheap value stocks and emerging market equities.
Value stocks had their worst-ever relative decade ending December 2019, he noted, which was compounded by the worst-ever year in 2020 as the spread between growth and value grew to historic levels.
Similarly, Grantham explained, emerging market equities are at one of their three, more or less co-equal, relative lows against the US equities for the last 50 years.
“Not surprisingly, we believe it is in the overlap of these two ideas – value and emerging – that your relative bets should go,” he finished. “Along with the greatest avoidance of US growth stocks that your career and business risk will allow.”