Stock investors could be about to take a bath
by John Coumarianos
When is a bubble really a bubble? Jeremy Grantham, founder of Boston-based asset manager Grantham, Mayo, van Oterloo (GMO), defines a bubble as when a market’s valuation reaches a two standard deviation or “two-sigma” move, from its long-term average.
By that measure, the S&P 500 will hit bubble territory at 2,400 — about 10% higher than where it is now.
To assess whether a market risks being in a bubble, GMO looks at two main valuation metrics: Tobin’s Q (price to replacement cost of assets), and the Shiller PE (price to past 10-year real average earnings). GMO then calculates the long-term averages of these metrics and assesses how far away the market is from them. The firm also uses real price data.