Veteran investor Jeremy Grantham says the U.S. stock market has never been this expensive. The artificial intelligence boom is pushing prices higher than at any point in American history. But Grantham warns that extreme valuations often lead to crashes.
Grantham co-founded the Boston-based investment firm GMO. He has a reputation for calling bear markets. In a recent interview on CNBC's "Squawk Box," he pointed to a simple measure: the total value of all U.S. stocks compared to the size of the whole economy.
It is more than double the country's annual output.
The metric Grantham referenced is commonly known as the "Buffett indicator." It was popularized by Warren Buffett, the legendary investor. That level was touched in 1999 and part of 2000, right before the dot-com bubble.
Grantham also pointed to the Buffett indicator, which measures the total stock market's value against the country's GDP. Grantham said, "while the timing was terribly uncertain, markets could potentially peak."
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He cited Amazon as an example. Yet Amazon later recovered and eventually "inherited the earth," as Grantham noted.
Grantham also pointed to SpaceX, the rocket company founded by Elon Musk. After its initial public offering, SpaceX reached an estimated valuation of $2 trillion. Grantham called the public-market debut "one of the defining peaks of all time." He added, "It's the thing you see around the top."
He believes SpaceX will likely experience a major crash, just like Amazon did. "The long term is complicated, I don't know, but is it going to have a crash like Amazon? Yes, very likely. And then what happens is indeed it may float away debris on the waves of time, or it will inherit a lot of the market, like Amazon did," Grantham added.
This kind of extreme enthusiasm for a single company is a classic sign that the market is overheated. When investors start valuing a rocket company at $2 trillion while the entire stock market is worth more than double the U.S. economy, caution is warranted.
Grantham's track record lends weight to his warnings. He correctly predicted the dot-com crash in 2000 and the housing bubble collapse in 2008. While he acknowledges that timing market peaks is difficult, the current extremes - like a $2 trillion valuation for a yet-to-be-public SpaceX - remind him of previous manias. The 92% decline in Amazon's stock after the dot-com bubble shows how even great companies can suffer devastating losses before recovering, if they recover at all.
Keep an eye on the Buffett indicator. If it stays above 200%, history suggests the risk of a major downturn is real. Grantham's warnings have been right before - he called the dot-com bubble and the 2008 financial crisis. Today he sees the same excesses building again.
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