Welcome to the Melt Up!

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Melt-up, anyone?  Jeremy Grantham, co-founder and chief investment strategist of GMO, was in the news writing about the likelihood of a melt-up in equity prices and what to look out for. In a 13-page note that he emphasized reflected “a very personal view,” the value investor and co-founder and chief investment strategist of Boston-based asset manager GMO compared the present market setup with the run-up to past bubbles, including the 2000 tech boom and the precursor to the 1929 crash.

“I recognize on one hand that this is one of the highest-priced markets in US history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market,” Grantham said.

He terms the current market run-up the “possible/probable bubble of 2018-19.” In the note, Grantham emphasizes that bubble calls should not necessarily rely on price alone. Instead, he puts emphasis on price acceleration, which captures “the importance of a true psychological event of momentum increasing to a frenzy.”

Grantham favorably cited an academic paper published last year that concluded that the strongest indicator of a bubble in US and almost all global markets was price acceleration.

As for the S&P 500, Grantham says that “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.

Other bubble factors cited by Grantham include increasing concentration on certain stock market “winners,” the outperformance of quality and low-beta stocks in a rapidly rising market, “extreme overvaluation” and the role of the Federal Reserve.

Investors who are more willing to speculate should consider a small hedge of some high-momentum stocks, primarily in the US and possibly including “a few of the obvious candidates” in China. “In previous great bubbles we have ended with sensational gains, both in speed and extent, from a decreasing number of favorites. This is the best possible hedge against the underperformance you will suffer if invested in a sensible relative-value portfolio in the event of a melt-up,” Grantham wrote.

At the same time, in the event of an accelerating rally in line with previous blow-off phases, investors should be ready to reduce equity exposure, “ideally by a lot if you can stand it, when either the psychological signs become extreme, or when, after further considerable gain, the market convincingly stumbles,” he said.

Before I hit the send button, I have always been screaming that it is wrong to focus on making profits. You should focus on risk and profits will come naturally. Focus on profits only and risk will blindside you completely. Just ask the greedy housewives.

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