Can the bull market climb over this wall of worry?
By
Tim Price May 16, 2007
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Probably the most widely discussed investment bulletin this year was issued last week by investment manager Jeremy Grantham of GMO: ‘It’s everywhere, in everything: the first truly global bubble.’ His argument will be familiar to MoneyWeek readers: all three major asset classes of property, stocks and bonds are expensive globally relative to historic averages. Fundamental economic conditions, goes the thesis, are excellent; credit is cheap and widely available; the animal spirits of investors are high; all global assets reflect this optimism; and the inevitable bursting of the bubble will cause significant systemic stress, crush investor confidence and affect economic activity.
Grantham does at least concede that ‘the tricky bit, as always, is timing’. Well, he might; this is the same Jeremy Grantham who warned us in March 2002 that markets would go nowhere for the next seven years. The danger in issuing doom-laden prognostications in this electronic age is that your old predictions tend to return to haunt you. Forget the gods -there is no escaping Google. Having cried wolf at least once before, you will be taken much less seriously by fellow investors second and third time around.
Better, though, to issue doom-laden prognostications that coincide precisely with the top of the most intense speculative mania of all time. Which is exactly the trick Yale economist Robert Shiller pulled off with the publication of his Irrational Exuberance in early 2000, just in time for the Nasdaq peak and subsequent collapse. Ironically, the then Federal Reserve chairman Alan Greenspan used the phrase ‘irrational exuberance’ as early as December 1996, more than three years before equity markets finally succumbed to gravity. Which just goes to prove the truth in Keynes’s dictum that markets can remain irrational longer than we can remain solvent.
Some of the brightest and best hedge-fund managers running short positions in technology stocks were taken out on stretchers just before the markets imploded in March 2000. Their timing was only out by a matter of weeks or months. That tricky bit, timing, again. Some of the factors Shiller first identified that contributed to false thinking about stock valuation are indeed part of our new cultural landscape: the internet, 24/7 news media, and ‘new era’ economic thinking. Shiller cited the fall of the Berlin Wall as a critical building block for the 1990s bull market in that it underlined the primacy of the Western capitalist model. One might now cite the role of China, India and the other so-called BRIC economies (ie, Brazil and Russia) as continuing the same theme: the Western capitalist model has now been joined by another couple of billion people, and is thus truly global. Thomas Friedman’s widely read The World Is Flat expands on this theme.
Grantham is probably onto something, but it is the most widely known secret in finance. Yes, property prices across the world are probably unsustainable, but in the more egregious pockets of overvaluation (such as residential property in the US and Spain) they have started to correct. Government and corporate bond yields around the world look slender given the inflationary pressure that is fuelling asset markets generally, but where those pressures are most acute (the UK is a good example), yields have already started to drift higher. If equity markets do undergo a significant sell-off, a flight to quality will almost certainly send bond markets rallying again. Which leaves stocks. Equity markets may have been somewhat undiscriminating in rewarding the flakiest businesses with premium valuations (private-equity money traditionally targets underperforming rather than solid companies), but the more defensive large caps (which make up a great deal of the FTSE 100) arguably look very attractive now, both in relative and absolute terms. So I would take issue with Grantham’s thesis that the whole world is overpriced. Bottom-up value stock-pickers can really make hay in today’s environment.
Grantham’s attempt to burst an apparent global bubble points to a fundamental deficiency in the investment lexicon. The distinction between a bubble and a bull market is subtle but critical. Bubbles are by definition short-lived and ephemeral. Bull markets can last for ages; the current bull run is into its fourth year. While the dotcom boom was a festival of bubbles, Google is a bull market phenomenon. Nor is the impact of bubbles necessarily wholly malign. In Pop! Why Bubbles Are Great For The Economy, Daniel Gross discusses the benign second-stage effect of entrepreneurs striding into the rubble of the previous bust and wringing value from surplus infrastructure.
A function of bull markets is that they climb what market practitioners call a ‘wall of worry’ -worry not that far removed from Jeremy Grantham’s. Yes, some valuations look a little giddy. Yes, investors -as always -should be prudent and look to diversify their portfolios. But if the world is really going to end, there are more urgent things to worry about than one’s equity portfolio.
Tim Price runs an investment advisory service. Click here to find out more: The Price Report.
Simon Nixon is away
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