Jeremy Grantham: The Stock Market is Ready For A “Melt-Up”

Photo via Barron’s

Jeremy Grantham, the founder of GMO, an asset management firm, who is credited with the prediction regarding the dot-com bubble of 2000 and the housing bubble of 2007, has warned that the stock market is possibly going towards an imminent “melt-up.”

The sudden improvement in the performance of equities that is driven by investors who do not want to miss out instead of an actual significant uptick in the economy will possibly be followed closely by a bubble-bursting crash in the next six months to around two years,  added Grantham in a 13-page note.

Even though the recent rapid increase in equities pricing signifies a late-stage bubble, Grantham stated, he noted that psychological factors – including a frenzy in trading momentum that is evidenced by an acceleration in price – are “more compelling in this bubble context than the simple fact of overpricing.”

“Just recently, say the last six months, we have been showing a modest acceleration, the base camp, perhaps, for a final possible assault on the peak,” stated Grantham regarding the price acceleration in the S&P 500.

He added that another sign of a bubble is the “unusual outperformance” of various low-volatility stocks and the rising concentration of many investors on “winner” companies as they examine to make further accelerated gains instead of making any long-term value play.

Stressing that this was “absolutely” a personal view, Grantham places the odds of a melt-up at more than 50 percent within the next six months to two years. If this actually happens, he predicted that the odds of a subsequent melt-down would be more than 90 percent – and would wipe off nearly half the stock market’s value.

The distinguished fund manager stated that personally, he would invest in as much emerging market equity as his risk model would permit, and some Australasia, Europe, and Far East equities. He said: “I believe each of these, especially emerging, has more potential than most think.”

Hermes Investment Management, however, released a note stating that it believed that investors would be missing out by offloading US equities.

“The four main US stock barometers have touched a series of record highs, and concerns among investors about ostensibly lofty valuations have prompted many to offload US equities,” stated Michael Russell, a portfolio manager. “In doing so, they have risked a significant opportunity cost.”

Russell pointed to the thriving tech scene of the United States, with thousands of new firms being created each year, and the fact that bear markets have not usually occurred at the same time as a peak in the cyclically adjusted price-to-earnings metric.