(Excerpt from Jeremy Grantham's latest quarterly "ViewPoint" report. Mr. Grantham is a well recognized world-class value investor at GMO, a Boston-based investment advisory firm with more than $118 billion under management)
"I find myself in an interesting position for an investor from the value school. 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." January 3rd, 2018 quote from Jeremy Grantham
And David Tepper, a well known hedge fund manager with $17 billion under management, gave an interview to CNBC last Thursday where he proclaimed that U.S. stocks are NOT overvalued and may, in fact, be cheap here!
With this kind of bullish support, every stock investor in the world should be piling into U.S. equities for the historic melt-up ahead. The only problem with this scenario is that most investors are already loaded up with stocks. In fact, many investors (and hedge fund managers) are actually leveraged to the long side!
If everyone is long, who's left to buy?
In his often colorful comments on the U.S. stock market, legendary investment newsletter writer Joe Granville like to use the word "bagholders" to describe uninformed investors who tend to buy at the tops and sell at the bottoms. I am a little surprised at Jeremy Grantham for introducing the possible "melt-up" scenario to regular investors now at a time when they should all be reducing their equity exposure in preparation for the bear market immediately ahead. Will they now be "bagholders" in the next bear market?
One of the greatest investment advisers of all time, Marty Zweig, was famous for saying "Don't fight the Fed!" when considering equity allocations within your portfolio. Maybe we should listen to this great advice now!!
The U.S. Federal Reserve is currently in the process of raising interest rates AND also reducing its bloated balance sheet of more than $4 trillion worth of Treasury securities and Mortgage Obligations. In fact, true to its promise, the Fed actually SOLD $25.38 billion worth of securities from its balance sheet in the 4th quarter of 2017. And through its regular public reports, it is now projecting the sale of $20 billion in securities each month in Q1, $30 billion each month in Q2, $40 billion each month in Q3, and $50 billion each month in Q4 this year. AND, the Fed is also forecasting at least three 1/4-point interest rate hikes this year! In addition to the sale of securities from the Fed's balance sheet, the U.S. Treasury needs to finance approximately $1 trillion in new debt from projected deficit spending over the next twelve months. This amounts to at least $80 billion per month in new Treasury debt offerings on top of the planned liquidations from the Fed's balance sheet. Who is going to buy all these expected offerings?
Wow! Sounds like a pretty significant tightening of monetary policy immediately ahead to me!!
And for the first time since 2012, incredibly, the Bank of Japan actually disclosed last week that total assets on its balance sheet actually declined by ¥444 billion ($3.9 billion) from the end of November to ¥521.416 trillion on December 31.
In fact, central bankers on a global basis are now reconsidering the prudence of extending the massive quantitative easing programs that have been their hallmark for the last 8 years since the great recession of 2008 and 2009.
Bottom line: All the potential bullish news for U.S. stocks is already discounted in record high current equity prices. There won't be a melt-up or even a meaningful advance from here. An unexpected and surprisingly severe liquidity crisis will soon unfold and trigger the next major move in the U.S. stock market to the downside, where a significant correction may very well turn into a melt-down in equity prices as margin calls and forced selling from uninformed leveraged investors exacerbate the decline.
