It takes a trigger to burst a bubble: Broad overvaluation alone won’t do it

Source: Marketwatch

Source: Marketwatch

At a recent Morningstar event, Jeremy Grantham of Boston investment firm GMO said stock valuations are high, but we’re not in bubble territory yet.  The current market PE of 21 exceeds the normal 16, and corporate profit margins of 7.3% remain well above the historical norm of 5.7%.  Eventually those will have to revert.  But the markets may well follow the “line of least resistance from the Fed, plodding slowly and steadily higher, waiting for speculation from individuals and deals.”  What’s more, Grantham doesn’t see the psychological euphoria that usually accompanies bubbles, though he does see it starting to pick up in a few pockets like corporate deal-making. 

If we were to get to true bubble territory, high valuation alone wouldn’t burst the bubble.  “You need a trigger to break it,” Grantham says.  “Broad overvaluation [alone] has never done it.”  But, “the higher the prices, the more jumpy people get.”  That means that high valuations can persist for a long time, even as they make the world a little more delicate.

Grantham’s advice: “Be prudent, of course.  Be very prudent . . . I’m going to be incredibly prudent starting closer to the election.  I recommend the same to you.”