Bull market or bear market. Investors are trying to decide

GMO’s Jeremy Grantham has warned of a “super bubble” that is about to burst.

Lane Turner/The Boston Globe/Getty Images

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Unlike traders, the most stressful part of my day comes at 4 p.m., just when the markets are closing and I need to understand the latest investor behavior to Baron’s evening newsletter, Review & Preview.

Some days there are obvious explanations for market action: stocks move in direct or inverse relation to a data point. Other days, that relationship changes at noon, leaving many of us scratching our heads. Slower summer days lately I might have a hard time finding a relationship.

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

Stocks sold off on Friday despite several good news stories in the August payrolls report: still-strong job growth, a rising labor force participation rate and a slower-than- expected 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


the index still fell by 1.1%,

Nasdaq Compound

down 1.3%.

Friday’s selloff suggests market concerns extend well beyond the Fed’s next move. Anyone who has read Jeremy Grantham’s latest memo has plenty of reasons to sell stocks. The famous investor and tipster wrote on Wednesday that we are in the middle of a “super bubble” ready to burst.

“The current superbubble presents an unprecedented mix of asset overvaluation (with bonds, housing and equities all critically overvalued and rapidly losing momentum), a commodity shock and Fed aggressiveness. Each cycle is different and unique, but every historical parallel suggests the worst is yet to come,” writes Grantham, long-term strategist at GMO.

The note is worth reading, but not before bed.

Grantham’s report came amid a terrible week for stocks, capping a pretty terrible August in which the S&P 500 fell 4.2%. This 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 that dominates all strategist reports these days: Are we in a bear market or on the 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 most of the biggest market influencers and top funds at the beach and away from their offices. On average, 10.54 billion shares changed hands in July, compared to 10.39 billion in August. The average daily volume this year is 11.9 billion.

Holiday days aside, Paulsen says the focus on every Fed move already seems anachronistic. “The Fed didn’t do anything until March of this year, but luckily all the free-market policies started to tighten just as inflation started to rise in March 2001. So a year later, what happens? Inflation peaks.

Paulsen notes that on Thursday evening, the one-year breakeven inflation rate briefly fell below 2%. It closed Friday at 2.11%. In March, the one-year break-even point peaked at 6.3%. The equilibrium rate is the difference between the yields of an inflation-protected bond and the Treasury bill of the same maturity.

“We’re back to the Fed’s target,” Paulsen said. “I think the case for further Fed tightening is dissipating quickly.”

Inflation may soon become a sleepy topic again. Here’s hoping the super bubble doesn’t keep us awake.

Write to Alex Eule at [email protected]