Grantham Says Fed "Bound And Determined" To Engineer "Full-Fledged Bubble"

Back in November, we highlighted the accuracy of Jeremy Grantham’s predictions about the trajectory of the central bank liquidity-fueled equity rally. In terms of how far the market can run before reality and gravity finally reassert themselves, bursting the centrally planned bubble and prompting a 2008-style “correction”, Grantham defined a “full-fledged” bubble as S&P 2250 and warned that a retracement of some 50% was possible depending on how assertive the Fed’s response to its real favorite economic indicator (stocks) turns out to be. 

In GMO’s latest quarterly letter, Grantham is out reiterating his view that although US stocks may not have reached their peak in what he accurately calls a “strange, manipulated world” (we prefer “new paranormal”), he’s sticking with the idea that “bubble territory” is likely just around the corner as the Yellen Fed is “bound and determined” to facilitate and inexorable rise in asset prices. He also notes that the Yellen seems no more inclined than her predecessor to take Jeremy Stein’s advice on being careful not to adopt an “implicit policy of inaction” when it comes to bubbles. Here’s more:



To remind you, we at GMO still believe that bubble territory for the S&P 500 is about 2250 on our traditional assumption that a two-sigma event, based on historical price data only, is a good definition of a bubble.3 (As we like to describe it, arbitrary but reasonable, for it fits the historical patterns nicely.) 



It would, in my opinion, be odd to have a Fed-driven cycle end before the economy is working more or less flat out as it was in 1929, 2000, and 2007, to take the three other biggest equity bubbles of the last 100 years.

And here’s Grantham on the balance sheet leveraging that we have said, on too many occasions to count, is driving equity prices by encouraging companies to borrow for buybacks while neglecting capex and depressing wage growth.


And the conclusion:


It appears then, that either one of two outcomes is possible: 1) in the best case scenario, we get a 10-20% correction, which would only serve to forestall the inevitable catastrophic bubble bursting and allow the super-cycle to persist for a little longer, or 2) the Fed successfully pushes the S&P past 2250 at which point we enter full bubble territory and eventually experience a dramatic pullback, the severity of which will ironically be determined by the response from the same central planners who created the bubble in the first place.