Big Bear Turns Bullish

The stock market continues to power to new highs with nary a pullback. It even has Jeremy Grantham, a long-time value investor who has identified excess and bubbles in the past and was calling for a major market correction as recently as 2015, to turn bullish. In a Financial Times article Grantham explains his shift in outlook and almost goes as far to utter those four most dangerous words, “it’s different this time.”

Here’s the full article.

The US stock market has entered an era of higher valuations and probably has further room to rise, according to Jeremy Grantham, the founder of asset manager GMO and a known bearish spotter of financial bubbles.

The S&P 500’s march to record highs, accompanied by political rancour in Washington and signs the US economy is failing to kick into a higher gear, has reawakened concerns over equity valuations — especially in the technology sector that has powered much of this year’s rally.

Mr Grantham, a notoriously bearish “value investor” who correctly called and dodged the Japanese, dotcom and housing bubbles, sees little to worry him in the US market today. Expressing a preference for emerging market equities to US stocks, GMO’s founder points to seemingly durable pillars of healthy corporate profits, low interest rates and any lack of euphoria.

I’ve dedicated my life to financial bubbles, and I don’t think it is a bubble,” he told the Financial Times. “This is the broadest market of all time… That is not the nature of a bubble.”

Moreover, the normally bearish investor — who has built much of his career on the observation that market levels ultimately tend to revert to their long-term average — has even reluctantly conceded that US share prices may have shifted durably to a higher level since the late 1990s.*

A dedicated value investor like me eats, breathes and dreams mean reversion. It’s very hard to see when the world has changed,” he said. “But my job description is to think about markets and not to be a member of a cult.”

That is a sharp change of tone by Mr Grantham, who as recently as 2015 said that global markets were poised for a slump. But the British-born founder and now chief investment strategist of Boston-based GMO — which manages $77bn, down from more than $150bn in 2007 — has admitted having to revisit many of his past assumptions.

He laid out the case for why “this time seems very, very different” in his quarterly letter to investors, pointing out that despite some wild swings in recent decades — caused by the dotcom bubble and subsequent crash, and then the global financial crisis — US price-to-earnings have averaged over 23 times since 1997, compared with nearly 14 times in the preceding decades, when he started his career.

The central reasons are globalisation increasing the earning power of US multinationals, the growing political influence of American corporations and more onerous regulations stifling the growth of disruptive upstarts, in turn leading to increasingly monopolistic US companies, and above all a secular and durable decline in interest rates.

Even a crash like 2008 wasn’t enough to knock the market off this new rail,” Mr Grantham said. “The ground has shifted quite a bit.”

Arguing that this time is different, and valuation metrics have climbed to a long-term new average, is near sacrilege for many value investors, who base their style on seminal work done by academics such as Benjamin Graham in the 1930s and popularised by the likes of Warren Buffett.

Mr Grantham admits his new tone gets “groans from fellow value investors” where it has “rattled a lot of cages”, but argued that previously dependable rules have to be re-examined and some even cast aside, given that the “world has changed”.

You now have to treat previously cast-iron rules with suspicion. They’re more like aluminium rules now.”

— The Option Specialist

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