During his recent interview with The Compound, Jeremy Grantham explained why the market is a coincident indicator of comfort. Here’s an excerpt from the interview:
Grantham: The model suggests it will if the world were to behave like it has behaved in every other major bubble. That’s all it would take.
Host: Are we in a major bubble?
Grantham: Yeah, yeah of course, if you look at a 10-year smoothed average PE, a Shiller PE, you find that there’s a pretty decent spike in 1929.
A much higher spike than that in 2000, and a slightly lower spike than that now.
This is the… approximately the third, approximately the second highest point higher than ’20 ’29. And in each case they they back and fill and they go back to more average levels.
Even if you allow for a moderate increase in the normal Shiller.
Ben Inker and I, 30 years ago he was my assistant at the time, a very good assistant.
I’ve always enjoyed having smart people do the heavy lifting. And the project was we know the market doesn’t like inflation let’s find other things that the market likes or doesn’t like.
And let’s explain on a coincident basis why the market sells high and low, okay.
And I went on a trip and when I came back he tried you know 27 variables etc etc and had a model with a very high correlation coefficient. And it stayed that way ever since.
It turns out the market is a coincident indicator of comfort.
What makes the typical portfolio manager feel comfortable, and number one it loves low inflation, it hates high inflation.
It likes two percent stable inflation. It does not like to see it bouncing around. It doesn’t like to see it spike in the worst way, and it does not like to see it hanging around for multiple years, that’s the most important one.
Secondly, it loves high profit margins, what a surprise.
Now what’s in third way, way down in third place is the stability of growth. The growth rate does not have a positive correlation with PE.
The market is nervous about bursts of high growth. It doesn’t like plus nine, minus two. It would rather have plus three, plus three, plus three, than plus nine, minus two, even though it averages higher.
Comfort is the best description.
You can watch the entire discussion here:
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