Jeremy Grantham: US blows a stockmarket bubble

A new bubble is developing in American stocks, says veteran investor Jeremy Grantham.

Veteran investor Jeremy Grantham dismissed the 2003-2007 upswing as "the greatest sucker rally in history"; warned in 2007 that the housing bubble would burst; and turned bullish on stocks in March 2009. He's now worried that US stocks, which he says in a Barron's interview are 65% overpriced, are blowing a new bubble.

Ever since the 1990s, says Grantham, the US Federal Reserve has come to the markets' rescue with low interest rates and liquidity whenever there has been a panic or downturn.

The bailout of the hedge fund Long-Term Capital Management in the late 1990s led to the dotcom boom; low interest rates after that bubble burst paved the way for the housing and credit bubble, which prompted massive money printing after it burst.

Institutional investors think this serial rescuing and bubble blowing is "wonderful", even though that's akin to praising the captain of the Titanic for helping women and children into lifeboats, "forgetting that it was only his recklessness that caused the accident in the first place". Such is their faith in the Fed that "in each cycle, they use a bit more leverage and take more risk".

If stocks go up another 30%, they would be close to twice their fair value, a level only exceeded in 2000. Given professional investors' faith in the Fed, it will be "very surprising if they don't keep playing this game" until we reach this stage.

Bubbles also don't usually finish until retail investors have rushed in and value investors "have been kicked round the block. So this rally looks unlikely to end just yet".

It's not too late to enter it. Emerging markets and European value stocks are "very close to fair value", while high-quality US ones aren't as pricey as the rest of the market. "So you can patch together global equities and get a semi-respectable-looking portfolio."

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