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‘Frogs in boiling water’: Urgent warning for 50% market drop

Lucy Dean
·4-min read
A graph showing large selling of global stock markets, crashing in 2020 on global fears including a pandemic and oil prices. 3D illustration
Trouble lies ahead, experts are warning. Image: Getty

The COVID-19 crisis has ripped normality from stock market movements and investors need to be aware of the danger they’re in, famed investors are warning.

Investment legend and co-founder of Grantham, Mayo & van Otterloo, Jeremy Grantham has sounded the alarm over investors’ “euphoria”, warning that they shouldn’t get carried away.

Grantham told CNBC that Wall Street is in a bubble, noting that 280 million shares were traded in November 2020 and 1.15 trillion shares in December as individual traders ramped up activity.

US stocks are also up more than 75 per cent since hitting their low in March 2020.

“We have very seldom seen levels of investor euphoria like this,” he said, adding that there has never been a great bull market and associated bubble that hasn’t led to a 50 per cent correction.

However, it’s difficult to say when the bubble will burst.

“It’s entitled to go tomorrow if you look at all the signs … As soon as the new president gets settled in, that would be a perfectly good time for the bubble to start deflating,” he said.

Grantham’s warning was echoed by the founder of the Baupost Group hedge fund Seth Klarman.

Investors have been convinced that risk has “simply vanished”, but that isn’t true, he told clients in a letter seen by the Financial Times.

Klarman said the US Federal Reserve’s decision to slash rates since the COVID-19 pandemic took control has left the market in a topsy-turvy state.

“With so much stimulus being deployed, trying to figure out if the economy is in recession is like trying to assess if you had a fever after you just took a large dose of aspirin,” he wrote.

“But as with frogs in water that is slowly being heated to a boil, investors are being conditioned not to recognise the danger.”

He said the Federal Reserve’s intervention has left investors blind to the mounting risks, while also triggering worsening inequality.

The recovery will be “K” shaped, Klarman added, meaning, “the fortunes of those already at the top bounding swiftly upward, while those at the bottom remain on a downslope without end”.

Starwood Capitol founder Barry Sternlicht said current market behaviour reminds him of the 1999 dot-com bubble, and that there were a number of concerning trends developing.

Among those, investors looking to social media for investment ideas.

Elon Musk triggered an investment frenzy with a two word tweet in January: “Use Signal”, that saw stocks in medical device company Signal Advance (SIGL) gain a staggering 1,500 per cent in 24 hours.

However, Musk wasn’t even referring to Signal Advance, but to an alternative encrypted messaging app to WhatsApp.

“The dark underside of this market is kids — and I don’t know if they’re kids, we just call them kids because we think they’re less experienced — staying at home and day trading and buying stocks,” Sternlicht told CNBC.

“I keep reminding my youngins, ‘Kids, one thing about getting older is you’ve seen it all before.’ ... It feels a lot like 1999 to me.”

Deutsche Bank strategist Jim Reid told Yahoo Finance US that the enthusiasm with which investors bought up SIGL shares highlights the irrational exuberance of the markets today.

“In years to come we’ll know whether the 2020-21 period saw a historic asset price bubble the equivalent of say 1929 or 2000. If indeed it is eventually proved we were in one, one story that may capture attention [is the move in Signal Advance],” Reid said.

Equity Mates podcast host and co-founder Bryce Leske said reducing the day-to-day hype and speculation is one of the toughest things new investors have to learn.

“[The best investors] are just really good at knowing what’s in their circle of competence and not getting carried away by bubbles and hype, but as a beginner investor it’s one of the hardest things to do - to avoid the emotion of getting pulled into that sort of stuff. That only comes with time in the markets.”

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