Welcome to the world of “melt-up”, a phrase we could be hearing a lot in coming months. It describes the idea that the US stock market, despite currently looking absurdly expensive by traditional yardsticks, could be set for one last euphoric hurrah before the inevitable crash happens.
There are a couple of reasons why the “melt-up” theory may not be as wacky as it sounds. First, it comes from Jeremy Grantham, an investor who has rightly earned a reputation for knowing how to read financial bubbles. He dodged the end-of-the-century dotcom bubble and the 2007-09 blowup in the US housing market – two of the best calls anybody could have made in the past 20 years.
Grantham’s default setting, as you would expect, tends to be bearish, or at least cautious. If he’s talking melt-up, that’s newsworthy. Besides, GMO, the Boston-based fund management group he founded, manages $75bn of assets – he’s a player.
A second reason is that Grantham is certainly not arguing that shares are cheap. “We can be as certain as we ever get in stock market analysis that the current price is exceptionally high,” he states. Instead, his melt-up thinking is driven by a “mish-mash of statistical and psychological factors based on previous eras”.
On the statistical side, he points out that the global economy is in sync, profit margins are fat and president Trump’s corporate tax cuts could make them even fatter and “perhaps provide the oomph to keep stock prices rising”. Then there’s the fact that the current strength in the stock market is fairly broad-based. In past bubbles, the end was nigh when gains were concentrated in an increasingly small collection of “winners”. The likes of Apple are roaring this time, but the same divergence has not occurred – yet.
For “touchy-feely” evidence of excess about to appear, Grantham looks at media coverage. US newspapers and TV stations are getting interested in financial markets (with bitcoin, “a true, crazy mini-bubble of its own”, to the fore) but not yet with the wild obsession of the frenzied dotcom years. “Keep an eye on what the TVs at lunchtime eateries are showing,” he says.
Grantham’s guess is that there is more than a 50% chance of a melt-up, or end-phase of the bubble, within the next six months to two years. If it happens, then there’s a 90% probability of a melt-down, which could mean a halving of share prices from the peak.
A credible theory? Well, yes, anything is possible. A year ago, when the Dow Jones industrial average passed 20,000, few thought it would hit 25,000 within 12 months – but it happened on Thursday. Is that a case of extreme euphoria, or just early signs of it? Given the impossibility of knowing, Grantham’s advice to “brace yourself” sounds reasonable. Brace, and keep a clear eye on the exit.
Eight months ago the chief executive of Debenhams, Sergio Bucher was telling investors he would make the tired-looking department store group “a destination, digital and different”. He didn’t quite disavow discounting, but the tactic would be deployed less often and with more impact.
Nice idea, shame about the results. Even before the completion of one lap of a three-year plan, Debenhams has coughed up a horrible profits warning that imperils shareholders’ dividends, even if nobody is saying so yet. Profits for the full year will arrive at £55m-£65m. Call that a plunge of a third from last year’s £95m.
Debenhams’s Christmas grumbles sound familiar. The report was a long complaint about the “highly competitive” and “promotion-driven” state of the market, especially on “gifts”, which is shorthand for everything from booze to Christmas crackers. That won’t cut much ice with investors. The likes of B&M, with its cheap’n’cheerful sheds, aren’t going away.
One can’t, of course, judge a three-year revival plan on the basis of one bad Christmas. Equally, however, you can’t blame investors for taking a gloomy view – the shares plunged 15% and Debenhams is now worth just £370m. Five years ago, the business was making £139m of pre-tax profits and the downwards trend has been consistent.
Borrowings are lower than they were in the bad old days of private equity ownership, as the company keeps saying, but the current “medium-term financial leverage target” is to reduce net debt to 0.5 times top-line operating profits. The new profits forecast may mean no progress whatsoever from last year’s 1.3 times. That is why a dividend costing £42m a year looks unsustainable – the theoretical (or imaginary) dividend yield of 11% says as much.
Bucher came from Amazon, where they don’t have to worry about excess store space, long leaseholds or even shareholders’ dividend expectations. Good luck – this job looks much harder.