With the US stock market in a “superbubble”, is a stock market crash now inevitable?

Andrew Mackie considers Jeremy Grantham’s warnings about the US stock market and what it means for his own portfolio.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Last week, the famed market-bubble guru, Jeremy Grantham, published an intriguing article under the eye-catching title “Let the Wild Rumpus Begin”. In it, he argues that the US stock market is now in what he characterised as a “superbubble”. If he is correct, can nothing now stop a huge stock market crash?

Grantham’s warning regarding the frothy nature of the US equity market is nothing new. In January 2021, he penned a similar piece under the title “Waiting for the Last Dance”. There he stated the US market was in an “epic bubble”. So, is it finally time to take Grantham’s doom-monger predictions seriously?

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Lessons from previous stock market bubbles

Grantham argues that the US is in the midst of only its fourth superbubble of the last 100 years. The other three were in 1929, 2000, and 2006. Every superbubble, he argues, has the same underlying characteristics. True to form, he claims, these underlying characteristics are playing out again in this superbubble.

The first characteristic of a late-stage bubble is that stock prices begin to accelerate by two or three times the normal average rate of a typical bull market. In the aftermath of the Covid crash to February 2021, the Nasdaq more than doubled.

The second characteristic of a superbubble is that the speculative part of the market begins to crumble, while the blue-chip market continues to climb. There is evidence to suggest that this has indeed been happening. Since February 2021, large-cap US stocks have significantly outperformed the smaller ones. For example, Cathy Wood’s Ark Innovation ETF, which plays almost exclusively in the more speculative side of the market, is down 56% in this time frame.

However, Grantham argues, safer, large-cap stocks are not immune. At the end of every great bubble, the “confidence termites attack the most speculative and vulnerable first and work their way up, sometimes quite slowly, to the blue chips”. Again, there is evidence of this characteristic starting to play out. Netflix, a supposed safe stock, recently plummeted over 20% over fears that its days of heady growth are over. Although not witnessing as dramatic a one-day fall, the Amazon share price is still down nearly 20% since the beginning of 2022.

One of the hardest qualities to define in a later stage bubble, Grantham argues, is “the touchy-feel characteristic of crazy investor behaviour”. Here, Grantham provides a number of examples. Firstly, the infamous meme stocks. Recall the dramatic rise in the share price for Hertz after it announced it was buying a fleet of Teslas. Secondly, the speculation in cryptocurrencies. The Dogecoin price spiked last year based simply because Elon Musk tweeted about them. A final example has been the craze with non-fungible tokens (NFT).

How am I positioning my share portfolio

Unsurprisingly, I am avoiding US equities for the moment, particularly the mega-cap stocks and software companies. Although trading at significantly lower valuations than just a month ago, they still look expensive to me.

My investment strategy toward FTSE 100 companies has remained unchanged, however. Although jam-packed with ‘old economy’ businesses like oil, banks, and miners, I still believe they will outperform the wider market. I am also keeping some powder dry, because if there is a big correction in US equities, I can hoover up some bargains.

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Andrew Mackie has no position in any of the shares mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Amazon. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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