A stock market veteran’s view on the AI bubble

**Peter Thal Larsen** (0:03)
Are we living through another stock market bubble? It's a question that comes up in almost every meeting I have these days with executives and financiers. The S&P 500 index of leading US stocks is reaching ever greater heights. SpaceX, Elon Musk's Rockets to Artificial Intelligence firm is planning a record-breaking stock market listing, and fund managers are tripping over themselves to buy in. There are two basic ways of approaching this question. The first states that it's impossible to time the market. No matter how expensive stocks look, it's better to stay invested and ride the cycle. The second takes the opposite view. Stock market valuations fluctuate around a long-term average, and the best way to generate good returns is to buy when shares are cheap, and sell when they are expensive.
My guest today is a committed advocate of the second approach. Jeremy Grantham is the legendary investor and co-founder of the investment firm GMO. He was a pioneer of index investing and an early user of computers in investment analysis. But he's best known for spotting and betting against some of the biggest investment manias of the age. The Japanese bubble of the late 1980s, the dot-com boom of the late 1990s, and the frenzy that preceded the great financial crisis of 2007 and 2008
Jeremy has synthesized a lifetime of investing into a memoir. It's called The Making of a Permabear, The Perils of Long-Term Investing in a Short-Term World. The book, which he wrote with Edward Chancellor, the financial historian and Breakingviews columnist, is full of zingers. Here, for example, it's what he has to say about so-called buy and hold investors. Quote, these are the same people who watch the locomotive coming down the tracks and, in the name of discipline, get run down. So this week on The Big View, we're going to talk about bubbles. So what we do at Reuters Breakingviews, we tap our best sources around the world for fresh insights into the biggest questions in global finance and business and economics. I'm your host, Peter Thalarsen, and I caught up with Jeremy at his office in Boston, Massachusetts.
Jeremy Grantham, welcome to The Big View.

**Jeremy Grantham** (2:20)
Very nice to be here.

**Peter Thal Larsen** (2:24)
So thank you very much for joining us.
There's so much to talk about, but you're obviously a great student of investment bubbles. I think in the book you say, you talk about having identified and studied 27 different episodes where the market's got carried away. So two questions really to begin with is really how do you define a bubble? The crucial question that everybody is asking at the moment is, are we in one at the moment?

**Jeremy Grantham** (2:55)
Starting at the end, yes, we are in one and have been for some time. We realized back in 1999 that we had to define the bubble because it kept coming up.
Being slightly nerdy, we looked around for a statistical way of finding it and very conveniently, there was this concept of two sigma, two standard deviations.
A standard deviation just tells you how rare an outlier is in a field of data. It turns out that it's every 44 years on an annual basis. A two sigma event, upside and downside, is every 44 years you get an outlier. And in the stock market, in real life, you get one every 36 years, which I was surprised how close that was to 44 You know, I'm a great believer that the market is totally inefficient. And the fact that it would almost obey a statistical rule that applies to a random series as if the market were efficient, surprised me. But 36 years seems like, for most people, a pretty workable definition of an outlier, an extreme event, doesn't it? And for most people, that's one in your investment career. And there's some indication that more recently, after Alan Greenspan and his troops, they've initiated a style of federal reserve policy that would make them a little more often. But in any case, they're outrageously easy to measure. You have a trend, you have a data series, and you look for the outliers. And we have had a splendid bubble in 1998, 1999, 2000 We had a really splendid housing bubble, which went way over two sigma to three sigma, one every hundred years or longer. The US housing market basically had never bubbled like that. It took Greenspan and Bernanke working hard to create that situation. And very well behaved, incidentally. It went up for three years and then down for three years. It looked perfect.
And then we had the great financial crash, which also became deep into, I'm sorry, of course, the housing bust and the great financial crash are the same one. And luckily, we focused on the housing side of it, which was the best behaved of everything. The stock market was not an interesting bubble. It didn't quite make it. It was the housing market that caused all the damage and was really the bubble. And then we've had other bubbles. The most important and impressive was really Japan.