Veteran investor Jeremy Grantham has forewarned investors that the Federal Reserve’s push to end accommodative measures will result in either an equity or housing market collapse.
In his latest quarterly note, the GMO founder said the market had been overly pessimistic on the US market at the start of the year but now caution was more warranted.
Offering five reasons as to why a snapback in markets could be expected, Grantham said the conditions are now more amenable towards a bubble forming.
‘We did not then, and do not today, have the necessary conditions to say that today’s world has a bubble in any of the most important asset classes,’ he said.
‘We are unlikely, given the beliefs and practices of the US Fed, to end this cycle without a bubble in the US equity market or, perish the thought, in a repeat of the US housing bubble.’
However, Grantham said it would take an increased degree of bullishness among investors and institutions to push the market into bubble territory, with the equity market expected to continue strongly in the pre-election period.
This, he said, means there could be more emphasis placed on the housing market. ‘The US housing market, although well below 2006 highs, is nonetheless approaching a one and one-half-sigma level based on its previous history.’
Sigma limits being used to identify variations from a mean, with Grantham referencing it as a rational and economic guide to minimum economic loss.
‘Given the intensity of the pain we felt so recently, we might expect that such a bubble would be psychologically impossible…but this is a classic echo bubble, i.e. driven partly by the feeling that the substantially higher prices in 2006 (with its three-sigma bubble) somehow justify today’s merely one and one-half-sigma prices.’
Grantham said prices have risen rapidly recently and believes the market will reach one and three-quarters-sigma this summer.
‘Thus, as unlikely as it may sound, in 12 to 24 months US house prices – much more dangerous than inflated stock prices in my opinion – might beat the US equity market in the race to cause the next financial crisis.’
To read the entirety of Grantham’s latest quarterly note, please click here.