Few figures in the financial world command as much respect for predicting market bubbles as Jeremy Grantham. As the co-founder and chief investment strategist at GMO, a firm managing $118 billion in assets at its peak, Grantham has built a reputation for calling some of the most significant financial collapses in recent history. From the Dot-Com Bubble in 2000 to the Global Financial Crisis in 2008, Japan’s Asset Bubble in 1989, and the COVID-era bubble, his forecasts have consistently turned heads.
Now, Grantham is issuing another cautionary note. Drawing from a career steeped in market analysis, he points to troubling signs that echo patterns observed before previous recessions. Grantham’s warnings stem from a combination of historical context, current valuations, and structural economic concerns that suggest the market may be heading toward another reckoning.
The Anatomy of Bubbles
Grantham’s often-quoted wisdom is that the bigger the innovation or idea, the more overvalued markets become. He uses Amazon as a prime example, citing its meteoric rise in 1999 before its staggering 92% decline. This tendency for over-exuberance, he notes, is particularly acute when revolutionary ideas like AI dominate the narrative. He emphasises that while transformative concepts generate massive excitement, they also create conditions ripe for a crash as speculative bubbles inevitably deflate.
During the Dot-Com Bubble, nearly 80% of internet stocks failed to survive the bust. Grantham warns that AI is treading a similar path, attracting immense attention and investment that could eventually spiral into a painful correction.
Indicators Flashing Red
Grantham identifies several leading indicators that have historically signalled recessions, all of which are now mirroring past trends:
- Interest rate spreads: The gap between 6-month and 10-year Treasury yields is a classic recession warning, and today’s inverted yield curve is particularly concerning.
- Rising unemployment: Labour markets, while still resilient, are showing signs of softening.
- US debt levels: Ballooning debt continues to weigh on economic stability.
Despite these risks, Grantham argues that government policies enabling monopolistic practices have inflated valuations for major companies such as Nvidia, Amazon, Microsoft, and Meta. Their unprecedented earnings have led to a “double counting” phenomenon, where exceptional profits are met with historically high price-to-earnings (PE) ratios.
The PE Anomaly
Grantham’s model, which tracks profit margins, inflation, and PE ratios, highlights a stark anomaly. Historically, a PE ratio of 23x would align with today’s conditions, yet the market sits at an inflated 38x—an almost 50% discrepancy. He likens this to previous periods of irrational exuberance, including 1925 and the year 2000, which preceded significant market corrections.
This deviation, he suggests, is driven by the United States’ dominance in corporate earnings. For the past 15 years, US companies have outperformed global peers by 15-20%, a typical margin. Today, however, that figure has ballooned to 80-100%, primarily due to monopolistic practices. Grantham sees this as unsustainable, warning of potential consequences when these inflated earnings revert to the mean.
Where to Look for Opportunities
While Grantham is cautious about US equities, he highlights more promising opportunities elsewhere.
- Japan: He praises Japan for its reasonable valuations, effective handling of social challenges, and strong corporate quality. Additionally, the yen’s undervaluation makes Japanese investments particularly attractive.
- Europe: Grantham considers European stocks fairly priced compared to their US counterparts. He singles out several standout companies, including ASML in the Netherlands, Novo Nordisk in Denmark, and Evolution AB in Sweden.
- Emerging Markets: Long a proponent of emerging markets, Grantham sees value in regions like China, India, Brazil, and Southeast Asia. Investors can gain exposure through companies like Alibaba, MercadoLibre, and Grab or through index funds targeting these regions.
A Broader Perspective
Grantham’s concerns aren’t limited to market metrics. He sees the current landscape as a cautionary tale of complacency. Investors, he warns, are overlooking cyclical patterns and focusing too heavily on unprecedented earnings. This mindset has led to dangerously high valuations that could unravel if economic conditions shift.
Grantham’s voice carries weight because his track record speaks for itself. While no one can predict markets with absolute certainty, his consistent ability to identify bubbles and anticipate crashes gives his warnings an urgency that few can ignore. His advice? Stay vigilant, diversify internationally, and tread cautiously in markets dominated by inflated valuations and monopolistic earnings.
As the markets continue their relentless climb, Grantham’s cautionary words serve as a reminder: history doesn’t repeat itself, but it often rhymes.
