Most expert observers see the current stock market sell-off as a healthy correction and the rotation out of high growth technology shares into economically sensitive shares as logical given rising rates.

However, two veterans of the investment world see the world rather differently and believe we are seeing the start of the bursting of a one of the largest bubbles in history.

Jeremy Grantham is co-founder and chief investment strategist at $65 billion asset manager GMO, and Carl Icahn, who recently described some stock valuations as ‘crazy’, owns investment vehicle Icahn Enterprises which has a market value of $11.8 billion.

Grantham is a long-time student of asset bubbles and his firm has identified over 300 of them over the last 100 years, from the 1920s stock bubble which led to the Great Depression to the Japanese property bubble of the late 1980s.

One message is crystal clear from GMO’s research and it is a worrying one for investors; every single bubble over the last 100 years has fully deflated with the price moving back to the trend which existed prior to the bubble. No exceptions.

Grantham has flagged 2,500 on the S&P index as the prior trend level, implying a 43% decline from the current 4,410.

GMO defines a bubble as a two-sigma event, which is a statistical measure of dispersion or how stretched prices are around a trend. Grantham has labelled the current market a super bubble because it has reached three sigmas.

BUBBLE TROUBLE

If that weren’t enough to worry about, Grantham thinks risks are multiplied by the existence of multiple bubbles.

Grantham explains that on top of the ‘most exuberant, ecstatic, even crazy investor behaviour in the history of the US stock market’ we also have ‘the broadest and most extreme global real estate bubble in history’.

In his view when you throw in the highest priced bond markets in US history along with the lowest interest rates on record and a side helping of ‘broadly overpriced commodities including oil and most of the important metals’ then you have a toxic recipe for something a lot more serious than a run of the mill market correction.

Grantham argues that at some point, when pessimism rears its head again, as inevitably it does, if all these asset classes merely retraced two-thirds of their way back to historical norms, total wealth losses in the US alone could be in the order of magnitude of $35 trillion.

He suggests avoiding US stocks and turning instead to value stocks in emerging markets and several cheaper developed countries, most notably Japan. He also believes in holding some cash for flexibility and gold and silver for inflation protection.

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