Jeremy Grantham’s latest update is available and worth reading on the GMO website.
He points out that the current Shiller PE over 34 for the S&P 500 represents the most expensive 1% of all historical incidents. It has happened at a time when profit margins have also been at all-time highs and unemployment near all-time lows. All three are mean-reverting numbers historically. What could possibly go wrong?
Grantham notes that there has never been a sustained bull market starting from a 34 Shiller P/E nor a time of full employment.
“The simple rule is you can’t get blood out of a stone. If you double the price of an asset, you halve its future return. The long-run prospects for the broad U.S. stock market here look as poor as almost any other time in history. (Again, a very rare exception was 1998-2000, which was followed by a lost decade and a half for stocks. And on some data, 1929, which was famously followed by the Great Depression.”
He also notes that the COVID stimulus bubble was bursting in a pretty conventional manner into December 2022, when it was interrupted by a resurgence in market mania around artificial intelligence. An unusual confluence of factors, but not without precedent:
But every technological revolution like this – going back from the internet to telephones, railroads, or canals – has been accompanied by early massive hype and a stock market bubble as investors focus on the ultimate possibilities of the technology, pricing most of the very long-term potential immediately into current market prices. And many such revolutions are in the end often as transformative as those early investors could see and sometimes even more so – but only after a substantial period of disappointment during which the initial bubble bursts. Thus, as the most remarkable example of the tech bubble, Amazon led the speculative market, rising 21 times from the beginning of 1998 to its 1999 peak, only to decline by an almost inconceivable 92% from 2000 to 2002, before inheriting half the retail world!
So it is likely to be with the current AI bubble. But a new bubble within a bubble like this, even one limited to a handful of stocks, is totally unprecedented, so looking at history books may have its limits. But even though, I admit, there is no clear historical analogy to this strange new beast, the best guess is still that this second investment bubble – in AI – will at least temporarily deflate and probably facilitate a more normal ending to the original bubble, which we paused in December 2022 to admire the AI stocks. It also seems likely that the after-effects of interest rate rises and the ridiculous speculation of 2020-2021 and now (November 2023 through today) will eventually end in a recession.”
Market cycles test mental strength in their highs and lows. This cycle’s extremity has been more testing than most.
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