GMO: “Let The Wild Rumpus Begin”

Today houses in the U.S. are at the highest multiple of family income ever, after a record 20% gain last year, ahead even of the disastrous housing bubble of 2006. But although the U.S. housing market is selling at a high multiple of family income, it is less, sometimes far less, than many other countries, e.g., Canada, Australia, the U.K., and especially China. (In China, real estate has played an unusually important and unique role in the extended boom and thereby poses an equally unique risk to the economy and hence the rest of the world if its real estate market loses air exactly as it appears to be doing as we sit.)

Second, we have the most exuberant, ecstatic, even crazy investor behavior in the history of the U.S. stock market. The U.S. market today has, in my opinion, the greatest buy-in ever to the idea that stocks only go up, which is surely the real essence of a bubble. (Interestingly, where other developed countries lead in housing prices, they lag the U.S. in equity prices. Some, such as Japan, by so much that they are merely slightly overpriced today.)

Third, as if this were not enough, we also have the highest-priced bond markets in the U.S. and most other countries around the world, and the lowest rates, of course, that go with them, that human history has ever seen.

Jeremy Grantham

Interesting analysis arguing that U.S. markets are in the fourth superbubble of the last hundred years, just waiting for a trigger to start what might be the largest potential markdown of perceived wealth in U.S. history. And there’s certainly no shortage of reasons for pessimism, from high inflation to the ongoing problems of China’s real-estate giant Evergrande, to geopolitical crisis such as the invasion of Ukraine.

GMO’s model to explain P/E is dominated by two factors: inflation, which multiples hate, and profit margins, which they love. Since the data starts in 1925, inflation surges had always hurt multiples badly… until now. Currently, inflation is 100% ignored… for now.

(Cryptocurrencies leave me increasingly feeling like the boy watching the naked emperor passing in procession. So many significant people and institutions are admiring his incredible coat, which is so technically complicated and superior that normal people simply can’t comprehend it and must take it on trust. I would not. In such situations I have learned to prefer avoidance to trust.)