Thursday 4 January 2018 11:53 am

Jeremy Grantham, who predicted the last two bubbles, warns the stock market is ready for a "melt-up"

Jeremy Grantham, the founder of asset management firm GMO who is credited with predicting the housing bubble of 2007 and the dot-com bubble of 2000, has warned the stock market is likely heading for an imminent "melt-up".

This sudden dramatic improvement in the performance of equities, driven by investors who don't want to miss out rather than an actual fundamental uptick in the economy, will likely be followed closely by a bubble-bursting crash in the next six months to two years, Grantham added in a 13-page note.

Although the recent rapid rise in equities pricing indicates a late-stage bubble, Grantham said, he noted that psychological factors – such as a frenzy in trading momentum evidenced by acceleration in price – are "more compelling in this bubble context than the simple fact of overpricing".

"Just recently, say the last six months, we have been showing a modest acceleration, the base camp, perhaps, for a final possible assault on the peak," said Grantham of price acceleration in the S&P 500.

Another sign of a bubble, he added, is the "unusual outperformance" of low-volatility stocks, and the increasing concentration of investors on "winner" companies as they look to make further rapid gains rather than make any long-term value play.

Emphasising that this was "absolutely" his own personal view, Grantham put the odds of a melt-up at over 50 per cent within the next six months to two years. If this did happen, he predicted the odds of a subsequent melt-down would be above 90 per cent – and would wipe around half the value off the stock market.

The renowned fund manager said that he would personally invest in as much emerging market equity as his risk model would tolerate, and some Europe, Australasia and Far East equities. "I believe each of these, especially emerging, has more potential than most think," he said.

The other side of the coin

However, Hermes Investment Management today released a note saying that it believed investors would be missing out by offloading US equities.

"The four main US stock barometers have touched a series of record highs, and concerns among investors about ostensibly lofty valuations have prompted many to offload US equities," said portfolio manager Michael Russell. "In doing so, they have risked a significant opportunity cost."

Russell pointed to the US's thriving tech scene, with thousands of new companies being created every year, and the fact that bear markets have not often occurred at the same time as a peak in the cyclically adjusted price-to-earnings metric.

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