Jeremy Grantham, we're in one of the greatest bubbles in financial history

Merryn Somerset Webb: Hello, and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine, and with me today I have a special treat. I know I always say that, and I’m constantly being accused of saying everyone is special, but do you know what? This week, it really is special.

We have Jeremy Grantham, who is cofounder and chief investment strategist of GMO. I think he needs very little more introduction, as you will all know him already. Thank you so much for joining us today, Jeremy. We really appreciate it.

Jeremy Grantham: Hi. It’s a pleasure to be with you.

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Merryn: Now, I want to start just by reading a fairly lengthy quote from you, from your website, from the GMO website. It’s GMO.com, by the way. Anybody who doesn’t regularly look at the website, you should.

There is loads of interesting research on it available, unless I have some special entry on my computer, available, I think, to all.

So, here’s the quote: “Today, it is clear to me that this is the most dangerous package of overpriced assets we have ever seen in the US”.

Jim Grant would say that we have the most overpriced fixed-income market in the history of man. That, combined with an equity market that can easily lose $5 or $10 trillion, depending on the magnitude of the break, and is a contender for the highest-priced market in American history.

Then, you talk about the housing market also racing up. So, you’ve got housing, equity, bonds. If they go together, they will carry a write-down in perceived wealth that would have no precedent. I love that phrase perceived wealth, by the way, as opposed to wealth.

So, what you think is that we are now in the middle of one of the greatest, possibly the greatest, bubbles in American financial history. And I just wondered if we could talk a little bit, or rather you could talk a little bit, about what makes it such a great bubble, and then we can move on to what might make it end.

Jeremy: First of all, it’s been the longest economic upswing. Covid is an exceptional little blip. I liken it to the 87 portfolio insurance crash, quickly down, quickly back, but the long, slow build-up had gone on for 12 years, so it’s about the longest upswing we’ve had.

And at the end of a long upswing, you’re likely to have very substantial profit margins, and if history repeats itself, investors are likely to consider that the high profit margins will last forever. And what it takes to make a bubble, traditionally, is very strong economics extrapolated into the indefinite future, and that will do it.

And to get there, you normally need accommodating money supply, an accommodating Fed in general. And in most of the bubbles that we’ve had, in all of them actually, those conditions have been met. And so, here we are again with the economy very strong, above the level of 2019, which is in itself remarkable, with the most accommodating Fed perhaps in history, certainly the lowest rates in history, the biggest increase in money supply, by far, that we have ever had in history, up to 25% year-over-year in America.

And let me point out that the US is far more stimulative than Europe and the rest of the world. Europe and the rest of the world did a pretty good job this time around, of stimulating, a better job than in the Great Financial Crash. However, they are merely at the top end of their historical range. The US, however, has broken way out of its historical range, both for government stimulus and for Federal Reserve stimulus.

So, you have this double whammy, and not only working together, which is not always the case, but having broken way out of the historical range on the upside, in the US.

Merryn: OK, it’s a mixture of all these things, but let’s talk briefly about how we got to the point where these profit margins have become so high in the first place, and how we’ve got to the point where we extrapolate this rise forever. It seems to be a combination of big global trends.

So, we have globalisation itself, we have the entry to the global labour market, of China and Eastern Europe, etc, so we have this wave of low-priced labour. Then we have very low interest rates and the continuation of that, and we have a very friendly tax environment for big companies in the US. So, all those things, which have kept going longer than I expected. I remember first writing articles about how all these things were going to turn at some point, and the share going to capital would shift, and the share going to labour.

All these things that weren’t expected to happen for the last four, five, six, seven years, they do now seem to be beginning to happen. We’re beginning to see the end of these, I suppose, deflationary pulses coming across the world, so we slightly feel like we’re in a turning point at the moment, that might shift that constant rise in profit margins.

Jeremy: Yes, and it’s fair to say that asset class prices have risen, or real estate housing. Housing was in a bubble everywhere, whether it’s London or Vancouver, Sydney, Paris, or San Francisco. And commodities are pretty high, and bonds of course are very high everywhere, and rates are low. The equity market is a little different, in that in the rest of the world they’re merely normally high prices, and one or two countries are barely that, they’re adequate, but the US is a candidate for the highest-price market in its history.

And this is unusual, and we might ask, why is that the case? And the reason it’s unusual, that is profit margins in the US have gone so high. I think capitalism, particularly in the US, is a little fat and happy. It’s extremely monopolistic. The Justice Department has gone to sleep profoundly for a long number of years.

So, every industry is more monopolistic, more concentrated than it used to be, and they’re also less aggressive. They don’t go for market share like they would in the 60s through the 90s, they go for profit margins, so they use their cash flow, they use the reduction in corporate profits to buy their stock back. And buying stock back interacts beautifully with the stock options, it’s very manageable, it’s very low in career risk for the players, and so they love it. And that’s been a big input.

And if you look at the difference between the US and the rest of the world, you can see that it’s concentrated between 2010 and today, and in that window, the rest of the world’s profit margins have stayed reasonably high, and the US has crashed up to record highs.

We have opened up a fairly astonishing 80% gain over the rest of the world in profits, so the stock market doesn’t have to have a massively higher PE, it is mainly being driven by higher profit margins.

When you break the profit margins down, you find that a couple of handfuls of FANGs account for something like 85% of the total, so it’s quite a remarkably unusual setup. The balance of the broad US economy has done just fine, it’s outperformed the rest of the world by 15% or so, which over 11 years is not bad, but it’s in the range of pretty good, and that’s what usually passes for good performance.

But the performance of the FANG has been extraordinary, there’s been literally nothing like it in history, anywhere. The classic example, let us say, would be Apple. Apple, biggest market cap in the world. The last quarter’s sales announcements, sales over a 12-month window were up 50%. Give me a break, this is the largest company in the world.

The largest company in the world, traditionally, has a brilliant year up to six and a half. There is no precedent for the largest market cap in the world being up 50% year-over-year, so one has to admit these are exceptional companies, and they all have elements of monopoly about them, through the Amazons and the Facebooks and so on.

And now the question is, is that going to mean revert? Profit margins, historically, have been the most mean-reverting series. If high profits do not draw in competition, then something about capitalism is wounded or even dead. And it certainly acts as if it’s a little bit wounded here, and these high profit margins have not attracted the normal competition. And let me just say that since 2000, the profit margins in America have averaged 60% higher share of GDP than they did in the 100 years before that, in the era in which I grew up managing money.

This is a major breakout. It hasn’t occurred anywhere else. But it’s still strange that it wasn’t the 2000 to 2010 period where the US was different. It was like a base-building period. The companies were growing and growing, and suddenly in the 2010-until-today period, their profits shot into the stratosphere.

You have to ask the question, why is it that the US has such a dominant share of these great new interesting firms, with China tagging along with the other important two or three?

And my thought on this is, is the venture capital industry. The venture capital industry has, like a lot of great American exceptionalism, has not been doing that well in those indicators that matter, whether it’s in the sense of life expectancy, where life expectancy has fallen way to the bottom of the list, health has fallen to the bottom of the list, number of people in prison and so on, bottom of the list.

But when it comes to venture capital, it is the last great American exceptionalism, and it ties in to the great research universities, of which America has two-thirds or so of the entire world’s supply, and Britain has a decent percentage of the remainder, incidentally.

And venture capital really feeds off that. And better than that, the US society has tailored its risk-taking to be compatible to venture capital. Now, the one thing you have to admit about Americans is they can take risk.

They forgive failure, they go back and try again, and they throw money at new ideas, and they’ll do 20 new deals, where the careful Germans will do one. And so, they have many more failures, but when the smoke clears out of the wreckage of the internet, the Amazons, and for a while the AOLs, tend to be American, and they own these great new enterprises.

So, I look at the FANGs and I say, where did they come from? And the answer is, they all jumped out of the venture capital industry in the last few decades. When GMO was getting going, we hired away, employing potential employee 23 from Microsoft. Now, Microsoft and Apple are the two oldest, and the others are positively teenagers compared to them.

But that isn’t very old. GMO isn’t very old. And these are, in that sense, brand-new enterprises. The FANG types, that make all the difference to American profits and the American market cap, are all pretty recent companies. These are not the products of the IBMs, and the Coca Colas, and the Procter and Gambles, and the General Electrics, the great companies that have been around since 1929 and long before that. No, these are all brand-new enterprises.

Anyway, now the question is, will the world turn against them? We see signs of that certainly in China, which has been bashing its new, special, powerful monopolistic entries. We see signs of it in Europe. We see signs of it in the new administration in America. These companies are incredibly powerful, they have at least very strong whiffs of monopoly, and they are disturbing people by the power and influence that they have, particularly some of the Facebook-type, social app enterprises.

Merryn: But it rather suggests, from what you’ve just been saying about the venture capital industry and the huge vitality of start-ups in the US, that you would expect potentially capitalism to keep working, and competition to appear for these big companies.

You look at something like Facebook today, and you think, how could something compete with that? But actually, from what you’re saying, it sounds like you think that it’s perfectly possible for capitalism to continue to work in the way that it should. So, it looks like we’re about to see various types of government intervention, but maybe it’s not necessary?

Jeremy: Ironically, I think that capitalism is not designed to be left on its own. Otherwise, as Adam Smith would have said, pretty soon you have monopolies and oligopolies. It needs a Justice Department, it needs an administration, it needs a fatherly eye kept on it, and it has not had that.

So, what has happened, driven by the US, but all over the world, there’s an enormous increase in inequality.

The globalisation has been met by a shift in tax in favour in capital, so you had all the basic underlying forces moving in favour of capital, and extreme labour competition weakening the unions and lowering the wages.

And you had the tax structure come in on top of that and decrease the taxes on capital and dividends, capital gains, and also decrease the tax on the very rich, and leaving social security payments the same, basically increasing the ratio of tax on the less well off. And we have a situation in the US that you will not be aware of necessarily, and that is, since 1975, for an hour worked by the guy in the middle, the median worker, is not up as much as 15% since 1975, adjusted for inflation.

In the UK, who has not been the leader of the pack, they’re up about 70%, and in France, over 150% increase in the real return for an hour of work. And what this has done, eventually, is it’s taken the US economy to a situation where Henry Ford would say, how are they going to buy my cars if I don’t pay them a decent wage? They’re not having a decent wage. Their consumption has moved up to the upper-class items, and the economy is beginning to hollow out.

After 40, 50 years of the pendulum swinging against labour and towards capital, we are dangerously lopsided, and I think particularly in the US, but also in Europe to some extent, we’re weakening the strength of the economy by weakening labour, and decreasing.

We have increased the share going to corporate profits by about four points, 4% of GDP, and most of that has come out of the share going to the workers. I think the governments are beginning to worry. I think they’re beginning to express interest in having the pendulum begin to shift back.

And I think it’s absolutely a good idea from an economic point of view that it happens, and that it begins to happen pretty soon.

Merryn: So, it does seem inevitable, at this point, that the pendulum will start to swing back that way. Might the discussion around that be one of the things that possibly prompts the end of this great bubble?

We’ve talked about this. We’ve talked about how very high valuations are in the extent of this bubble. Whether it’s one of the greatest in history or not, we’ll find out when there’s fallout. But what brings it to an end? I know I did see you in the early spring saying that you expect it to be over very soon, but what does very soon mean, and what might be the thing that sparks a change?

Jeremy: The history books are pretty clear, there doesn’t have to be a pin. No one can tell you what the pin was in 1929. We’re not even certain in 2000. It’s more like air leaking out of a balloon. You get to a point of maximum confidence, of maximum leverage, maximum debt, and then the air begins to leak.

And I like to say, the bubble doesn’t reach its maximum and then get frightened to death, what happens is the air starts to leak out slowly because tomorrow is a little less optimistic than yesterday. And gradually, people begin to pull back. And the process is very interesting, in that before the end of the great bubbles, and there’s only been a handful, so we can get carried away with over-analysis.

But before the great bubbles ended in 1929, 1972, and in 2000 in the US, the three great events of the 20th century, there was a very strange period in which, on the upside, the super-risk, super-speculative stocks started to underperform. They never do that in between, ever. And then suddenly, it starts. So, you go back to 1928, the JACI Index, the low-price index, and the S&P were up 80% in 1928, and then the S&P was up, say, 40%. That’s what it’s meant to do.

And then in 1929, the S&P went up another 40% before crashing. The low-price index started early in the year to go down. It couldn’t even get the sign right. It had a beta of about two, and started to go down, and the day before the crash it was down over 30%. Nothing like that happens again until 1972. And let me point out that 73/74 is still the biggest decline, adjusted for inflation, since the Great Depression. It was 62% in real terms.

And in 1972, the last up year, the S&P outperformed the average Big Board stock by 35%, approximately plus and minus 17 points. The average stock was going down steadily all year, and the S&P was going up. Nothing like that happens again until 2000. In 2000, in March, the great TMT bubble starts to peak, and Pet.coms get taken out and shut.

And then in April and May, the junior growth. May/June, the middle growth. June, July, August, the Ciscos. Cisco was the biggest company in the world for eight minutes, I like to say. And the whole TMT block, that was 30% of the market cap, was down about 50% by September.

The S&P was unchanged. Unchanged. Which meant that the remaining 70% was up 17%. That is an amazing deviation. So, bang, bang, bang. It’s only happened three times. It happened leading into the great air leaking out. And finally in September, the confidence termites, as I like to think of them, reached the broad market, and the entire 70% rolled over like a giant iceberg, and down it went, 50% over two years.

And so, where are we today? Those three deviations, by the way, 1929 was eight months, 1972 was 11 months, and 2000 was six or seven months. And on February 9th, the Russell 2000, which had had a crushingly good year, wiped out way ahead of the S&P from March of 2000 until February 9th, way ahead of the NASDAQ. And the S&P has continued on its merry way, having a nice bull market.

Even after yesterday’s great rally, the Russell 2000 was decently down since February 9th, the NASDAQ is five points ahead of it, and the S&P is ten points ahead. This is getting to be a pretty good down payment. It’s February, March, April, May, June, July. It’s five months. I would say this is tracking quite nicely.

And the confidence termites started, once again, exactly where you would expect, they started with my favourite biggest holding, personal holding, QuantumScape. QuantumScape, a solid-state lithium-ion battery company I bought into eight years ago, as a green venture capital. They came as a SPAC, came at ten, went to 130.

At 130, it was 52 times my investment, which is pretty nice. It was also $55 billion, bigger than GM, bigger than Panasonic, if you want to think batteries. There’s nothing like that to compare to in 1929, by the way. The scale of that. They’re a brilliant research outfit, and I’m happy to still hold a quarter of my… But they don’t have a product for four years, and they have no trouble telling you that.

So, here is a research lab that will have no profits, no revenue for almost four years, selling more than GM. $55 billion, give me a break. Anyway, that started down. It’s now down 80%. The SPAC Index is down 30%. The SPACs have started to dry up. Bitcoin, 62,000 to today’s, after a nice rally, 31,000, half price. Tesla, 900. Down to 650.

This is the classic pattern of start with the most speculative, the most heroic, and work your way down carefully until finally you’ve reached the market. I would say it’s lasted longer than I thought. Why? Two reasons. One, the vaccine was simply bigger and better than anyone expected, and we produced it quicker, it was more effective, particularly Moderna, Pfizer, than anyone had ever hoped possible, really for any vaccine of that kind.

And the other reason was the speed and size of President Biden’s stimulus package. He came in with such a roar, and bang, you’re suddenly talking trillions of dollars of stimulus. Those two things, of course, were bound to increase confidence, bound to increase the money in the hands of individuals. Individuals, because of Trump’s stimulus and because of Biden’s stimulus, have been dripping in resources, and they have bought into every setback.

And they’re buying all the crazy stuff, the meme stocks that are just jokes, where they’re whipped up into a frenzy, and they’re buying them just for fun, it seems, ten times more than any underlying value.

And, by the way, every indicator of that craziness, this is a record, this is more impressive even than 2000, and that was more impressive than anything that had preceded it. But the craziness that we have seen in the meme stock, companies being bought on no earnings potential, on no underlying reality, is just amazing.

Merryn: But it’s interesting, isn’t it, the extent of participation in this bubble? Certainly in 2000, the entire population wasn’t participating in the bubble, it was still a marginal activity, but when you look at it now and you look at the numbers in the US, the percentage of household wealth held in financial assets is at its highest ever. Almost everybody seems to be participating, as opposed to a small group. And that means that the fallout, when it comes, it’s going to be much worse.

Jeremy: Absolutely. But, by the way, 2000 was a pretty broad participation. My favourite story, which is completely accurate, was that the local Greasy Spoon for lunch in the Financial District of Boston, the television sets, of which there are always about eight in every one of them, all but one of them would be showing talking heads from MSNBC and CNN and so on, and one of them would be showing replays of the Patriots football team.

And a year earlier, it was eight out of eight were showing the Red Sox. It was quite amazing, and it drove the headline in 2000 from the financial page to the frontpage. And really, one was reading on a daily basis. And that went away for 20 years, and is now back, and now everyone keys on whether the market’s at a new high, and what Bitcoin is doing, and how’s Tesla getting on, and what were its sales.

And the individuals in particular, you’re right, the individual participation as a percentage of trading has tripled in the last 18 months, so this is the real McCoy. This has more spectacular numbers than any market ever in American history, and some of them buy a lot.

The number of options that are traded by individuals, the shares traded, the penny stocks that are traded, have exploded by a factor of ten over two or three years. It is a really splendid speculation, and of course it will end badly. One of the points the listener should take is, in the end, it doesn’t really matter how high these things go in the following sense, that the market has, let us say, a theoretical value, a value on its stream of earnings and dividends, and my guess is it’s about 24 on the S&P.

And whether it goes to 4,500 or 5,500 doesn’t really matter. If it goes to 5,550, or like Japan, 6,500, like Japan in 89, it just means it goes down longer and harder. Japan had the highest stock market in the developed world, by far. It went to 65 times earnings in 1989. 65 times earnings. It had never been above 25 before in its history. And simultaneously, it took the land and real estate even higher. The land under the emperor’s palace really was worth more than the State of California.

The land bubble in Japan in 89 was more impressive than the South Sea Bubble, or Tulips, in my opinion. And what was the price they paid? Today, the stock market is not back yet to 1989 high. The land is not back yet to 1989 high. That is getting to be a long time, 33 years of pain and suffering.

Rule number one, do not bubble two great asset classes together, particularly housing is more dangerous than stocks. And Japan did it, and they paid the price. The higher they went in the stock market, the longer and more painful the crash.

Merryn: But that’s what’s happening now, everything is bubbling together, and that’s what I think makes it very difficult for our readers at the moment, because they look around and they say, where do I hide? Where can I go?

Back in 2000, when MoneyWeek, our magazine, was quite new and we were writing about the Dot-com Bubble, etc, there were also lots of other places we could tell people to go. Some small caps were cheap, lower-value stocks were cheap, houses weren’t that expensive, the bond market wasn’t completely bonkers. There were lots of places we could tell people to put their money, if they weren’t putting it in the Dot-com Bubble.

But when we look around now, we can’t see where we should tell people to put their money, if they’re going to try and get it out of the bubble and safe from the bubble. Is there anywhere that you can see that our readers can hide?

Jeremy: Let me just start by agreeing with you in 2000. REITs, the real estate trusts, they were buying properties below the cost of building them, and the REITs themselves were selling below the cost of the properties that they owned. They yielded 9.1%, 9.1% yield at the very top of the market, when the S&P had a 1.6% yield, the lowest in its history. And so it went on. TIPS yielded 4.3% real, guaranteed by the US government, guaranteed against inflation. The regular bonds.

Merryn: Can you imagine that now? Wouldn’t that be amazing?

Jeremy: Can you imagine? So, bonds were cheap, real estate was desperately cheap, value stocks were not bad. Small cap value did not decline when the S&P was down 50%, at the bottom. The small cap value was plus 2% or 3%. REITs were plus 30% at the very bottom. Plus 30%.

Anyway. So, fast forward. We are breaking the cardinal rule, we are bubbling bonds, stocks, land, and real estate, and if you want to throw in commodities. The ex-energy Goldman Sachs Index, which is metals and food, which are not inconsequential, are almost back to their 2011 high, when everyone says we were in some cosmic, super commodity cycle. So, that’s a lot. And even energy, which is half of the market, has more than doubled from the low. That’s also quite a bit of pain for consumers to absorb.

One day, if we become pessimistic, we have the ability to mark down these enthusiastic prices, more than we have ever had to do. If we stay optimistic, it’s not so bad, but if we become, or when we become pessimistic, we have an awful lot of marking down to do.

The housing in most of the world, and certainly in America, as a multiple of family income, has recently overtaken the Great Housing Bubble of 2006, 2007, which in itself is quite amazing. When that deflated it took away $8 trillion of perceived wealth.

And let me go back to your expression, perceived wealth. I use the word perceived wealth, because everyone knows the house they live in did not change. It doubled in price. It was the same house, kept the rain off just as well as it did, but no better, and then it halved again in many cases, in the extreme bubble markets, and it was still the same house. The shift was perceived wealth, and you can see it very clearly in housing.

In stocks, you indulge more in fantasy. The price of Tesla goes up five times in a single year, and somehow you kid yourself that it’s justified. And of course, either a year earlier it was crazy, or today it’s crazy, take your pick. It is not efficient.

The sales increase was a very splendiferous 35%, and the stock price increase was 500%. That is a shift in perceived wealth.

You see it easily in your house. You see it with great difficulty in your stock. But overwhelmingly, the portfolio of stocks is not changing its intrinsic value very much.

Its intrinsic value depends on the US or global portfolio of dividend power and earning power, and that changes historically at a couple of percent, real, per year. And so, when the market goes up by 100%, you better believe that is mainly air around a modest increase in long-term fundamentals. In fact, the long-term fundamentals have not accelerated since Greenspan’s day.

Greenspan introduced this aggressively pro-asset formula of moral hazard and keeping money supply generous, keeping interest rates down, but what has happened since that day? The growth of the US GDP has actually slowed down. So, lower interest rates introduced an enormous increase in debt, but the increase in debt, which is meant to induce an increase in growth, did not. And the reason is, people didn’t take that increased debt and increase their CapEx. CapEx actually weakened since Greenspan, and stayed pretty weak through Bernanke up until today.

The growth rate of the system has slowed down, but the increase in debt continued up. And what happened to it? It was used for other purposes. It was used for assets. So, asset prices have gone through the roof, whilst the GDP has slowed down a little. And that’s the world we live in. And now the question is, interest rates have come down from 16% long bond, in 1982, until basically 0%. Where do we go from here? Is there still the ability to stimulate? Money supply has gone through the roof. Does that introduce inflation? All of these issues are now buzzing around.

And what are the things that could cause a shock? Obviously, a prolonged uptick in inflation would shock the market.

Obviously, I think we’re vulnerable to another wave of Covid, particularly in the US, which the US market has not realised. It began to realise a little bit last week, but very slow on the uptake. If you study the UK, which I do, you can see how dramatic delta has been, the delta variant. There were 2,000 cases a day in England. There’re now 50,000 cases, multiplied by 25 times. Thank heavens all the old people are vaccinated, so not too many people are dying. But a 25-fold increase.

And the US has only just started to double and redouble, from a very small base. The US has fewer people infected, which is a sixth of the size, so we have a lot to go, and we are not vaccinated here in the US the same way that you are.

Merryn: That’s the problem, the vaccination, isn’t it? Because in a way, you can look at what’s happening in the UK as being absolutely tremendous news, in that we’re seeing this massive uplift in cases, and of course we’re testing an awful lot to get those cases, but we’re not seeing it follow through into deaths. So, the rest of the world could look at the UK and say, this is fantastic, all we need to do is just get everybody vaccinated and this is over. It’s good news, not bad news.

Jeremy: Of course, it’s absolutely fabulous news for the long term, and we’ve known that. If you paid attention to the data, you’ve known that for over six months, that this was an incredible vaccine, and all you had to do was vaccinate people. There’s nothing new, if I may say so, in that.

But in the short term, what is shocking is how little the US, who are really predisposed to wishful thinking, by the way, at the drop of a hat, seem to think they’re going to skate through this thing that has increased so many cases in the UK. They do not have the vaccination thoroughness, by any means, that we have. It’s completely regional.

Massachusetts is like the UK, thank heavens. But Tennessee is not. There are big districts of the Midwest and the South, where 20%, 30% of the people are vaccinated. And a lot of the older people are not vaccinated, and you have factories with 40-, 50-year-olds, as well as 20- and 30-year-olds, where handfuls are vaccinated. They just don’t think it’s cool. They don’t do it. And some of those guys in their 40s and 50s will die, and some of those factories will get closed.

My guess is that this will turn out, in the next two or three months, to be a final real shocker before the good news that you talk about. And we are not counting on that. We’re counting on all systems go now. In case you hadn’t noticed, the market is at an all-time high, and everything in the garden is rosy, and Covid is not as rosy as it seems.

But the third reason that could shock, is what I call everything else that you forgot to anticipate, and there’re always a lot of those things. The disgusting subprime in 2008, much worse than you ever dreamt of. Things come out. The bezel increases, the size of the bezel, as some famous writer wrote about the Great Crash of 1929. And things go wrong, and we have more debt, we have more possibilities of bad debt, of defaults, lurking around in the system.

So, that’s the one that worries me most, and that is all other unanticipated bumps in the night. Inflation and Covid also worry me.

Merryn: Jeremy, what’s worrying me here is that the answer to the question, where can we hide, appears to be nowhere.

Jeremy: My recommendation, fairly standard. For some reason, the equity market is not as overdone as bonds and real estate, and therefore if you stay out of the US, you can own some real estate. Pick it carefully, emphasise emerging markets, and you will make a respectable return. Not as much as you would like, but a respectable return. Log it up for ten years, 20 years, you will make respectable money. And I would do that, precisely that.

And the other thing that is about as cheap as it gets, compared to the other half of the market, is value or cheap stocks versus growth stocks. They have had an ultimately dismal 11 years, they’ve had a few little rallies since then, but the range is very positive for them. If you can combine those two ideas, emerging is about as cheap as it gets, relative to the S&P, and value is about as cheap as it gets, relative to growth.

If you could buy the cheaper low-growth stocks in emerging, and carefully selected other developed countries, and avoid the US. And then, in addition, if you could carry a decent chunk of cash to take advantage of the bargains that will come down the pipeline, in the not-too-distant future.

I used to think we’d be lucky to reach June, July, when finally I would get to sell my QuantumScape, because I was a controlled insider. And of course, it didn’t happen, and QuantumScape and the SPACs began to be weak long before July 1st. And so, by the time I got to sell it, it was down 80%, which was a bit of a curse.

Merryn: It’s a shame.

Jeremy: But now, because of stimulus, because of the success of the vaccine on a global basis, I think the cycle has been pushed a little further. But I would be surprised if the termites, that are eating away at the SPACs, do not reach the rest of the market before the end of the year.

Merryn: And what about the UK market? If you look at that on a cyclically adjusted PE basis, it really looks pretty low down the global scale.

Jeremy: Yes, not nearly as bad as the US. And of course, you’ll come down in sympathy. That’s always the shocker, isn’t it? That when the US tanks spectacularly, witness the Great Financial Crash, it tends to suck in a lot of players. Yes, the UK’s not too bad. It’s overpriced, in my opinion, in our opinion.

Merryn: But not hugely.

Jeremy: Not hugely, no. Compared to your real estate market, now there’s humdinger. One day, there is going to be hell to pay in your real estate market, because you guys have floating rates, like Canada, Australia, and New Zealand.

We have fixed rates. So, yes, our market will crash and it will be painful, but not nearly as painful as it will be in Britain.

Merryn: Although, interestingly, you’re beginning to see much longer, very cheap fixed-rate deals than you have in the past. This week, there was an announcement from Nationwide about a five-year deal on under 1%, and this is new here.

Jeremy: Dear listener, go and get the longest one you can. Pay up a little bit if you can get the ten-years.

Merryn: I did that ten years ago, and boy did I feel stupid. The rates just kept going down and down, and I never paid.

Jeremy: That’s right. Everybody feels stupid at the top of the bull market, basically. No one has taken enough risk, no one has leveraged enough, etc, and the message they draw from that is, they never will again. Just in time to get wiped out. It works very well. The market, in its own way, must have a lot of fun.

Merryn: Every time. Now, all bubbles leave us not just a lousy legacy, but a good legacy too. My favourite bubble that I write about quite a lot is the Diving Bubble at the back end of the 1600s, when everyone was busily inventing new kinds of diving apparatus, so that they could go and dive, salvage ships, and get out the gold, etc. And there was this huge explosion of technological innovation, to try and create a machine that would let someone stay underwater for the longest time.

And of course, it totally burst, everyone lost all their money, but nonetheless it left people with lots of quite interesting new technologies. And of course, the Railway Bubble left us railways, and the Dot-com Bubble left us all sorts of wonderful things. And even the Housing Bubble left us lots of extra houses, which we then went on to use, both in the UK and the US.

Jeremy: Actually, you never built any houses in the UK.

Merryn: That’s true, we didn’t build any. You got lots of new houses, we didn’t. Ireland got lots of new houses.

Jeremy: Ireland and the US did.

Merryn: And Spain. Spain got lots of houses.

Jeremy: And Spain did. And those three markets cracked. And the ones that didn’t, Australia, Canada, the UK, didn’t really crack.

Merryn: They never really crashed, it’s true.

Jeremy: They came down 10% or 15%, and went to new highs. But Amazon is a lovely example in the 2000 mess, where Amazon was the superhero of that cycle, and 100 by Christmas, 200 by Christmas would be making reputations of Henry Blodget and so on. And then it went down 92%, before making everyone an ineffable fortune. And, indeed, if you held it at 2000 and rode it down 92%, you still did very well.

Merryn: So, what do we hold? When this bubble goes, what do we buy and hold? What’s going to be the great legacy of this bubble?

Jeremy: The Grantham Foundation for the Protection of the Environment has moved its assets, contrary to everything I am telling you now, I’m sad to say, for your sake, to 70% venture capital. Now, when you’re in venture capital, you cannot move in and out, you make long-term commitments, it takes years to invest in a programme, it takes years after that to get paid back.

So, whether you like it or not, you’re stuck, and we have been stuck. And we have moved early-stage VC, and we’re aiming half of that to be in a grouping that’s preceded it. There is a wall of global money coming behind decarbonising the global economy. It will take trillions of dollars. It will take carbon taxes, which are coming everywhere, including China last week. It will take rules and regulations, and subsidies and extra research.

And what will happen, in my opinion, is that the early-stage green companies will be a bottleneck. There will be more money trying to get into the new ideas, and there are many new ideas, by the way, and they will really prosper. And the established green companies will also be beneficiaries. GMO has a climate change fund for the last several years. It’s doing extremely well. And it will get hurt in the burst, but it’s a global fund. It will go down less. It will come back quicker. It will run further.

So, right behind that other portfolio, I would consider that as a separate idea. And if you can buy venture capital. Venture capital in the US, it’s far and away the most virile part of American capitalism. It has all the ideas. All the best and brightest now come into venture capital, all starting their new firms, as they should.

Merryn: Interesting. Jeremy, let me ask you one more thing then, partly on this subject. One of the most interesting articles of yours I’ve ever read, I can’t remember when it was, many years ago, it was about soil health, and it was the first piece I’d read on the importance of soil health, both for agriculture and for carbon capture, etc. Do you think that there is a case, even now, for buying land with carbon capture in mind?

I was talking to someone the other day who was telling me that pretty much every estate that changes hands in Scotland now, changes hands with the new owners looking at it with a view to capturing carbon capture subsidies, or selling the capture under the peat, etc. Is there a case for this? For, say, UK residents buying land in the UK for its carbon capabilities?

Jeremy: Scotland is a very special case, because it’s very low-grade agricultural land, but very peaty and very interesting for carbon capture. The trouble with arable land is that the systematic programme of lower rates has driven up the price. And if you back up ten, 20 years, the yields on farms and forests would be 6%, and today it’s 3%, so you’re compounding your money at half the rate. That’s a poor place to start that otherwise very interesting idea from, which is a shame.

However, we are going to have a very devil of a time producing enough food for nine billion people one day, in a world of climate change, where big chunks of Africa and perhaps India, because of weather and governance, are having a hard time growing enough food. And so, I think there is a good long-term future in stable, resilient food growing. It’s just a shame, a real shame that we have to start by buying it at twice the price.

Merryn: We have to start from here. OK, I won’t go and buy a farm then. For now, anyway. Jeremy, I think we’d better leave it there. You’ve been incredibly generous with your time. Thank you very much for joining us. And everybody, if you’d like to hear more from Jeremy, it’s just GMO.com, isn’t it?

Jeremy: Yes.

Merryn: You’re not on Twitter, I’m guessing.

Jeremy: No. GMO.com.

Merryn: Brilliant. Thank you so much. That was fascinating.

Jeremy: No, you’re extremely welcome. Bye bye.