The Fourth Great Bubble in a 51-Year Investment Career

By John Banks

Jeremy Grantham thinks we are witnessing the “fourth great bubble” of his investment career.

This matters because of what Grantham did over the course of that career, and how long it has lasted.

Grantham entered the money management business in 1969, using a “quantitative value” strategy long before Wall Street knew what that meant.

Grantham himself called it “dopey value,” although the results were not dopey at all.

His firm would buy stocks based on fundamental factors like discounted price-to-book, price-to-earnings ratio, price-to-cash flow, and price-to-sales.

Buying a large and diverse portfolio of stocks on metrics alone — just looking at the numbers, then buying in bulk — was a radical approach to investing in 1969, even though, according to Grantham, the various factors had been working for 80-plus years by the time he started out.

Over time, Grantham’s business became Grantham, Mayo, Von Otterloo, or GMO for short. For decades GMO has had “top 10” status as a global money manager, though the total asset amount can swing around a bit. In 2015, they managed $118 billion. In more recent years, they managed $60-$70 billion.

Having started in 1969, Grantham now has more than half a century in the business — he is still active —  and, thanks to his investment outlooks and research papers, has long been considered one of the sharpest minds on Wall Street.

Grantham is also well known for having deep conviction and a cast-iron stomach. In the final years of the 1990s tech boom, for instance, GMO’s research had convinced the firm it was a bubble, so they stayed far away from what everyone else was buying.

As dot-com stocks rose higher and higher, GMO began losing assets. It seemed everyone but GMO was drinking the Kool-Aid. Many of the firm’s clients grew angry that Grantham would not drink it, too.

But not only did Grantham refuse to give in, he dug in his contrarian heels — and took on the tech bulls in a very public way. In 2000, Grantham publicly debated the well-known permabull, Wharton professor Jeremy Siegel, no fewer than nine separate times.  

And yet, GMO’s clients kept getting upset because they were “missing out” on the seemingly endless profit bonanza of dot-com stocks headed for the stratosphere.

By the peak of the 2000 bubble, GMO had lost more than half its assets under management — not due to market losses, but to frustrated clients closing out their accounts.

Then something incredible happened. As the dot-com bubble collapsed, the areas of the market where GMO was long surged wildly.

For example, Real Estate Investment Trusts, or REITs, had a 9% yield at the peak of their neglect (because everyone was off buying tech stocks). GMO, naturally, had been buying REITs by the ton. 

And then, as the Nasdaq and S&P 500 melted down in the aftermath of the 2000 top, REITs and emerging markets (another area GMO was heavily long) exploded higher. As the S&P experienced a drawdown of 50%, REITs saw net price appreciation of 30% — an incredible juxtaposition.

It was one of the greatest stick-to-your-guns style contrarian plays of all time, deployed across tens of billions in assets. The exciting stuff that GMO had studiously avoided, even as clients punished them for it, collapsed in value; meanwhile the stuff they were long, which tech investors had seen as dull or pointless, practically went straight up over the course of the next few years.

As one of the first global investment strategists, Barton Biggs, once described it, in the years after 2000, Grantham’s money management firm “blew past everyone else as if they were standing still.”

The dot-com bubble was the second of the four great bubbles Grantham has seen in his 51-year career.

The first one he experienced — and profited from, using patient contrarian instincts once again — was the 1980s Japan bubble, encompassing both stocks and real estate, that burst in 1990.

(At the peak of Japan’s real estate bubble, which may yet stand as the biggest in history by size, the land under the Japanese Imperial Palace was worth more than all the real estate in California. Japan’s bellwether Nikkei index has not recovered its 1990 high to this day.)

The third bubble was the housing and subprime bubble that climaxed in the Global Financial Crisis of 2008.

And the fourth great bubble, Grantham believes, is happening right now, today, in the age of coronavirus.

But this bubble is unique in a peculiar way, Grantham observes.

In the prior three great bubbles, Grantham had a very strong sense of certainty as to how things would end and why. Prices would revert to the long-term average — which, in a bubble, inevitably means a collapse or a crash — and life would go on with some semblance of normality.

This time, though, the interplay of factors is so strange — with so many unknowns and pent-up forces — that one can have very little certainty as to how the bubble plays out, or how life looks on the other side.

Here is Grantham via podcast interview with Patrick O’Shaughnessy, the CEO of O’Shaughnessy Asset Management, describing why “normal” is wholly off the table this time:

“…the entire base of American capitalism has shifted since about 2000, with the emergence of much higher levels of return, many more stock buybacks, and much more conservatism.

The number of people in America employed in new enterprises that are one or two years old has halved since the late 1970s. Halved. We’re simply not as aggressive a capitalist system as we were. So everything has changed.

And now, into the teeth of that, comes the virus. And it doesn’t come at any old time, by the way. It arrives at the end of a 10-year, longest economic upswing in history, with the lowest unemployment for eons, but, with the highest corporate debt levels ever, and some people believe it’s very badly understated in official data, and, with the highest ever levels of sovereign debt in the world, with weakness in the EU, and odd leadership in the U.S. — so a very vulnerable time, at the end of a 10-year cycle exactly when you’d expect things to start going wrong, when you’re exposed to high levels of debt, you’re very vulnerable, you’re not very resilient, and then bang, this thing hits, unique in many ways, not least in that it’s a supply hit and a demand hit simultaneously.

So you can be simultaneously short of customers on one side, and you can’t get the raw material at the other. And far and away the fastest rise in unemployment in history, much faster than the 1930s — and with curlicues, tentacles if you will, stretching out into the future: Will airline travel ever be what it was? Will not a lot of us reconsider the need to make so many long, tiring, infectious type journeys… so some industries will simply change…”

As to whether traditional notions of “value” will ever return, Grantham doesn’t know whether they will.

He notes that his old secret sauce, the stuff that worked so well in 1969, stopped working reliably around the year 2000, as too many practitioners started swimming in the value pool after the tech bubble.

Then, too, Grantham marvels at the FANGs, and refuses to predict what will happen to them either. They represent 17% of the S&P 500, Grantham notes, but they are also cash-generating juggernauts “like nothing else that has ever walked the face of the earth.”

At the same time, Grantham can’t help but let his pessimism shine through.

“This time is not at all knowable like the other three,” he told O’ Shaughnessy. “At the same time, the stock market is in the top 10% of all-time-high valuations and the economy is in the bottom 10%, maybe the bottom 1%.”

In terms of where the market goes next — while fully acknowledging the times are too wild to be confident — Grantham sounds a dark note.

“We’re more pessimistic than we were on the day of the low,” he said. “This is all being carried by paper thrown at the system.”