A Gambling Parlor?

The following comes from an interview with Jeremy Grantham, in October of 2020. When taken in context, Mr. Grantham’s perspective is even more urgent today. He has made a science of studying asset bubbles, correctly predicting the path of the Japanese, dot-com, and housing overvaluations. Today’s bubble in U.S. equities is unlike any other, he says, but it will burst in months, if not weeks.

“We are in a bubble, but it is unlike any other.” The excessive bubbles of history took a great economic situation and extrapolated it into the future, based on an assumption that today’s perfect conditions will continue.

“My bet is that reality will catch up with the high P/Es”.

According to Grantham, a high P/E is an intrinsically dangerous and risky situation that relies on investor confidence. “If you break confidence and are way overpriced, you are looking at substantial declines”.

“The certainties we used to have no longer exist,” Grantham said. We have seen the most massive move against value in history. Value is not as dependable and useful a weapon as it was prior to 2007. But now the parameters that measure the “cheapness” of value have been pushed to extremes.

“We are going to have a very big reversal in favor of value, sooner or later”.

What has the FED Been Doing?

On August 31, the three-month phase-in period of the Federal Reserve's quantitative tightening (QT) program came to an end. The plan called for the Fed to allow its holdings of mortgage-backed securities (MBS) to decline by up to $17.5 billion per month, primarily as a result of pass-through principal payments, while allowing its holdings of Treasury securities to decline by up to $30 billion per month by letting them mature without replacement.

The Federal Reserve's weekly balance sheet for the week ending August 31, which was published on September 1st, showed a decrease in total assets of $25 billion from the previous week, $48 billion from the balance sheet for the week ending August 3, and $139 billion from the peak on April 13 to $8.83 trillion, the lowest level since January 12.

With the express intention of driving down yields, mortgage rates, and other interest rates, QE generated money that the Fed pumped into the financial markets by buying securities from its primary dealers. These dealers then sent this money chasing assets in the financial markets and other markets, including residential and commercial real estate, which all led to an increase in asset prices.

The reverse of what QE does, QT destroys money, drives yields higher, pulls the rug out from under the inflation of asset prices, and helps to bring inflation of consumer prices back down. - Wolf Street

The following chart illustrates how our raging inflation got its start.

Being ready for whatever comes.

And, being willing to adapt to the constant changes which affect each of us.