Transcription
Jeremy Grantham has sent probably the biggest warning recently about the market. Serious measures of value say that this is the highest price market in the history of the stock market of the US. If you go back and look at the second, third, and fourth most overpriced markets, you're looking at 1929, 1972, 2000, and the housing bubble.
His take on the results of this bubble bursting is very interesting. But they eventually come down to trend and has always caused a recession. If you miscalculate, the recession turns into something really terrible like the depression of 1929 and one should expect something pretty bad this time. And that suggests that the market could easily go down by 50% and be well within its historical boundary. A future historian will look back and say, "My god, look at all the obvious signs of impending doom."
But everything right now is going great. Markets are at all-time highs. The big names are thriving. Why on earth would he call for such a great crash? Now, to understand why, we need to understand the history of market crashes. Because history does not repeat, but it often rhymes. And in 2000, we were right. The PE went to a new all-time high in January 98. And then it just kept going. 21 times earnings, 23, 27, 29, 31. Oh my god, it has to stop. 33, 35. And at 35 times earnings in March of 2000, it finally quit. And how were you to know once you're in new high territory like that in the end, it doesn't change the outcome? It just meant that the break from 35 times earnings was spectacular and the NASDAQ that led the charge upwards went down pretty much 80%.
So 2000 that is obviously what we now know as the dotcom bubble collapse. During this time, everyone wanted to be in the market and the underlying reason was because of the internet. People could see that the internet was going to transform the world. It was a place where we can sell and buy things instantly. It was a place where we could get unlimited information instead of digging through a bunch of books for hours on end in a library. So naturally, everyone wanted to own a piece of the internet. And they did this through the stock market and prices got higher and higher and higher. This was what Grantham would call a typical market bubble where you have a new technology that everyone knows will drive growth which starts a parabolic increase in stock prices. In this video, we'll let Grantham show you how past bubbles occurred, how one is occurring today, and at the end, most importantly, show you how to prepare.
Grandantham just talked about the 2000 bubble. I'll now let him explain the 2008 one. Housing market was unbelievably well-behaved. It went up to, in statistical terms, a three sigma event, which is the kind that would occur every hundred years or so, and then it came all the way back down again. It was beautifully symmetrical. It took three years going up, three years coming down. So, quick look at how the housing crash occurred. Starting around 2004, housing prices started to go up a lot until it peaked in 2007 and then it started to deflate in price basically until 2011. So, that's what he means when he said 3 years going up and 3 years going down. It's almost like something that you would find in a textbook. The reason why it's important to study what occurred in the past is because if you can understand these well, you can better understand if we are in a bubble today. And the same in Japan. Eventually they come down, but getting the timing right just about impossible.
In the US, they all say that the market is about as high in December recently as it has ever been in history. Higher than 1929 and at least as high as 2000 and as high as the recent peak in December 21. And that suggests that the market could easily go down by 50% and be well within its historical boundary.
I do want to give a little bit of context surrounding this. What does he mean? Higher than 1929 and at least as high as 2000. Let me show you some of the metrics that Grantham uses to get these market valuations. One is the Schiller PE ratio. The Schiller PE divides the current price of the S&P 500 by the average earnings over the past 10 years. Basically, it smooths out short-term ups and downs in earnings. A high Schiller PE suggests that the market may be overvalued while a low one suggests it may be undervalued. So what's it at today? Right now the Schiller Pee ratio is very high at 39. As you can see, it is much higher than what it was in 1929 where it was 31. It is also higher than what it was in the 2007 housing bubble where it was 27. The only time that it was higher than what it is today is the dotcom bubble where its peak was 44. So 39 is getting very close to that peak. That is why you have Grantham saying that our market is similar to 2000.
Also, it's not just this one indicator. The Wilshire 5,000 to GDP ratio shows something even more extreme. Historically, the average market cap to GDP ratio has hovered just under 100%. In 2000, the market peaked at 140% before the dotcom bubble burst, and it was 104% before the global financial crisis in 2007. Today that number is sitting above 200%. So it is significantly above both the peak in 2000 and the peak in '07 before those two great crashes. Essentially it means that the market is overpriced compared to what it is actually producing in terms of output.
So the question is why has the market become so expensive? Well, let's ask Grantham.
And it's precisely those wonderful ideas that actually work that suck in the money and give you upfront the biggest bubbles. And AI of course is the real McCoy. AI will change everything. It's going to be the biggest destroyer of jobs that you have even thought about. And people say, well then it's not a bubble. And I say it's quite the reverse. The great inventions like railroads, internet, the more you could see that they were brilliant ideas, the easier it was to see how they would change the world, the more effective it was of sucking in your money. People have the feeling that if something comes in that's new and brilliant that you don't have to worry about a bubble. It's only if it's pipe and it's underneath the surface, not serious, then you have to worry. And that's absolutely not the case. The more serious a new technology is, the more obvious it is that it's serious, the more guaranteed you are to have a bubble.
Most people say that AI is going to transform the world. This in turn will make businesses more efficient and ultimately make them more money. How on earth can this positive phenomena result in a market crash? Market crashes normally occur when a business environment is depressed, right? Well, not necessarily. Sometimes things work in a counterintuitive manner. Market crashes can occur because of what happened before it. If there's a lot of greed in a market and prices have been inflated high, a bubble can start to form. If a bubble gets inflated and inflated and inflated, the inevitable has to happen. Even if AI is coming or way back in the day it was railroads or in 2000 it was technology that was the big thing and I'm not sure if you guys are aware of what happened to tech stocks in that era. It's the opposite of what you'd think. Amazon and the boys, the little flags like pet.com, they all went to nothing in 9 months or so but Amazon believe it or not went down 92% in 2000 and 2001 to the low of that market move. It fell 92%. And out of the wreckage, internet was a terrific life-changing idea. There is nothing like that in 1929. Nothing of that scale. Nothing like that in 2000. The Cisco of the world were pretty serious companies, but they didn't get to this level. Let me point out the most gentiel one was 2000. And what happened? NASDAQ went down 82%, S&P went down 50%, real estate was cheap. It was not involved. The bond market was cheap. It was not involved. Everything that was favorable could be favorable. And still it droned on for three years and the NASDAQ went down 82%. That is what I'm interested in. Profit margins got hammered and the growth rate slowed down moderately.
Okay, he asked us to check it. So, let's do it. So, Amazon went down from a price of $530 to $30. That is a 94% decrease. Microsoft was $36, crashed to $12. Okay, that's a 66% decrease. Pets.com, of course, we know that collapsed and got shut down. IBM crashed from $68 to $27. Etoys went from $84 to $1. That's a 99% decrease. Cisco stock went from being the world's most valuable company at $80 a share to collapsing 89% to $9. And it's been two decades and a half and it still has not recovered to that same price. Intel shares fell about 80% between 2000 and 2002. And Oracle fell nearly 85% in the crash. The list goes on and on. So yeah, these tech companies, despite the fact that they were in such a transformative industry, still managed to crash. Grantham's point is that the same thing can happen with AI. In the same counterintuitive manner that technology made business boom yet made stocks crash, AI could be no different.
I really count on the fact that AI will change everything. Some for the good, some for the bad. It's going to be the biggest destroyer of jobs that you have even thought about. And you would have to think that AI is right up there in the general significance potential. It's hard to imagine that that will not be a bubble. The more serious a new technology is, the more guaranteed you are to have a bubble. Don't be conned into being super optimistic by the professionals, by the industry that makes money from overconfidence, lots and lots of money. Look around for signs of crazy bubbly behavior to the moon to the moon sort of thing, which we have seen as splendidly in this last several years as we have ever seen in history.
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And now we need to talk about how to prepare for the 2025-26 market. As Jeremy Grantham would, the thing that we first need to realize about a bubble, and I totally agree with Grantham on this, is that you never know exactly when the bubble will burst.
So, we're going to have an unknowable bad time. It will depend on how effective the administration is and so on. But the truth is, we come into this with very high profit margins. We come into it with a form of capitalism that was raising prices for the first time ahead of the workers. So that in unexpected inflation very quickly profit margins went up and real wages went down. This is not what happened in the 70s. I can assure you profit margins went down and real wages went up. But this is a corporate system that we could talk about which is really quite interesting. You can't possibly call a bubble or a bust to the right day except once every several lifetimes by sheer luck. What you can do though is identify bubbles that will eventually burst. And that turns out in the past to have been intellectually pretty straightforward.
So how do we prepare for something that we have no idea of when it is going to happen? Well, one thing that we can do is look at the data and see where the good deals currently are sitting where things are not overpriced. And Grantham has two key areas that he says are good places to find deals right now. If you're feeling up for taking risk, I would put a lot of money outside the US in equities. If you're feeling very nervous, I would have cash. And foreign stocks were not that expensive. The same is true today. You could buy a portfolio of European, Canada, Australia, so on and the rest of the world, and you will do okay. The stock market is gloriously overpriced in the US, but foreign stocks are perfectly reasonable. You will make a decent amount of money. But if you do that in the S&P, I think 50/50 you won't make any money at all.
Okay, that is as clear as day that his opinion is that the safer bets are outside of the USA. Why does he say this? Well, because stocks in the rest of the world have lower prices. Everyone's trying to invest in America. The big money is here, which makes stocks very expensive. So, if you look at Grantham's firm GMO, you can see that they have a bunch of different strategies, but most of them involve investing outside of America. They have a global asset allocation strategy. They have an Asian strategy called Beyond China which invests in a bunch of companies in Asia with the exception of China. They have an international value approach. They have a resources approach too. So you can see that Grantham is putting his money where his mouth is, which is good to see. And the interesting thing that you may notice with his strategy is he does have US investing funds, but these are not filled with expensive growth stocks. They're basically filled with the complete opposites. And this comes to the second part to where Grantham sees opportunity to invest.
So the gap between value and growth is as big as it gets. It's in the you know top few percentile of history. And the gap between foreign and the US is at or close to an all-time record. So these are the things you have to do. Emphasize value. So when Grantham says value, he is referring to stocks that are cheap relative to their fundamentals like their earnings, their book value or free cash flow compared to their price as opposed to expensive growth stocks priced on high expectations for the future. So in this market, Palantir would be considered a growth stock and a value stock would be something more like Coca-Cola. Grantham's research with his company GMO shows us that value stocks are really cheap compared to the other ones in this market. It is currently in the third percentile of being abnormally cheap. And the last time value was cheaper than this was in the 2000 tech bubble. Grantham's firm GMO wrote, "But the deep value cohort, the cheapest 20% of stocks, looks particularly compelling today, both in the US and internationally. We believe deep value represents one of the most compelling valuation dislocations we've seen in decades."