A ‘Superbubble’ Warning Clashes With Good News on Inflation

GMO’s Jeremy Grantham has warned of a ‘superbubble’ that’s about to burst.

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Unlike traders, the most stressful part of my day comes at 4 p.m., just as markets close and I have to make sense of investors’ latest behavior for Barron’s evening newsletter, Review & Preview.

On some days, there are obvious explanations for the market’s action: Stocks move in direct or inverse relation to a data point. Other days, that relationship switches midday, leaving many of us scratching our heads. On slower summer days, as of late, I might struggle to find any relationship at all.

Much of the time, the direction of stocks comes down to what investors’ think Federal Reserve Chairman Jerome Powell will think. That often explains the “good news is bad news” framing.

On Friday, stocks sold off despite multiple threads of good news in the August payrolls report: still-solid job growth, a rising labor-force participation rate, and a slower-than-expected bump in hourly wages, another piece of evidence that inflation has peaked.

The report was just good enough, and unlikely to change the direction of monetary policy. And yet the

S&P 500
index still fell 1.1%, with the

Nasdaq Composite
down 1.3%.

Friday’s selloff suggests that the market’s worries go well beyond the Fed’s next moves. Anyone who read Jeremy Grantham’s latest note has plenty of reason to sell stocks. The famed investor and prognosticator wrote on Wednesday that we’re in the middle of a “superbubble” that’s ready to burst.

“The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing, and stocks all critically overpriced and now rapidly losing momentum), commodity shock, and Fed hawkishness. Each cycle is different and unique—but every historical parallel suggests that the worst is yet to come,” writes Grantham, the long-term strategist at GMO.

The note is worth reading, just not before bed.

Grantham’s report came in the middle of a terrible week for stocks, capping a pretty terrible August in which the S&P 500 fell 4.2%. That follows July’s 9.1% gain, the market’s best month since November 2020.

Now, the question is which month to believe— just another way of asking the same question dominating every strategist report these days: Are we in a bear market rally or on our way to a new bull market?

Jim Paulsen, chief investment strategist at The Leuthold Group, suggests that August—and the past week in particular—is more likely to be the anomaly than July, with much of the market’s biggest influencers and top money at the beach and away from their desks. An average of 10.54 billion shares changed hands in July, versus 10.39 billion in August. The average daily volume this year is 11.9 billion.

Vacation days aside, Paulsen says the focus on the Fed’s every move already feels anachronistic. “The Fed did nothing until March of this year, but, fortunately, all the free market policies started tightening right when inflation started to come up in March of 2001. So, a year later, what happens? Inflation peaks.”

Paulsen notes that on Thursday night, the one-year break-even inflation rate briefly fell below 2%. It closed on Friday at 2.11%. Back in March, the one-year break-even peaked at 6.3%. The break-even rate is the difference between the yields on an inflation-protected bond and the Treasury note with the same maturity.

“We’re back at the Fed’s target,” Paulsen says. “I think that the case for additional Fed tightening is rapidly dissipating.”

Inflation may soon be a sleepy topic again. Here’s hoping the superbubble isn’t keeping us up next.

Write to Alex Eule at alex.eule@barrons.com

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