I think it’s clear that we’re deep into bubble territory. Bubbles are characterized typically at the end of a long bull market by a period where they accelerate, and they start to rise at two or three times the average speed of the bull market, which they did last year of course. Of course, they’re always extremely overpriced by average historical standards. There are a few people who would still argue that 2000 was higher, but most of the data suggests that this is the new American record for highest priced stocks in history. Then there’s the most important thing of all, which is crazy behavior, the kind of meme stock, high participation by individuals, enormous trading volume in penny stocks, enormous trading volume in options, huge margin levels, peak borrowing of all kinds, and the news is on the front page. This is all characteristic of the handful of great bubbles that we’ve had.
We’ve checked off all the boxes. Now the question is how high is high? Very hard to tell always what the peak will be, but what you do know is that how high the peak is has no bearing at all on what the fair value is. What it does change is the amount of pain that you get to go back to fair value and below. You profoundly do not wish for a super high level to your bubble, and you profoundly do not wish for more than one asset class to be bubbling at the same time. I’ve been very clear about what I consider a definition of success – and that is only that, sooner or later, you will have made money to have sidestepped the bubble phase.
You can very seldom identify the pin that pops it. 1929, no one has agreed yet what the pin was. The biggest cage rattler of all is everything else you haven’t thought about that could go wrong. And my guess is that’s probably the cause, in the end, of most of the bubbles deflating. The mechanics of a bubble is you have maximum borrowing, maximum enthusiasm. And then the following day, you’re still enthusiastic but not quite as enthusiastic as yesterday. A week later, you’re not quite as enthusiastic as last week and last month. And gradually, the enthusiasm level drops off a bit, you have no more money to borrow, you’re fully borrowed, and the buying pressure gradually slows down. And that’s it.
The next time we’re pessimistic, we have more potential to write down asset prices than we have ever had in history, anywhere.
– Jeremy Grantham, GMO, The Top of the Cycle, August 2021
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