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Financial market murder mystery: Why are so many so fearful?

Jeremy Grantham, co-founder of GMO and the world’s foremost connoisseur of financial disaster, says that a true bubble begins when the price of an asset reaches a valuation that is more than two standard deviations away from its historical average. By that measure, the S&P 500 stock market benchmark in the United States would have to hit the 2,300 mark to be considered a bubble.

Nicholas Roberts/REUTERS

Take it from a connoisseur of catastrophe: This is no catastrophe.

Stock markets have plunged, gold prices have soared and bond yields have swooned in recent weeks as investors have braced themselves for the worst. What is the worst exactly? Well, um, that's a difficult question.

Unlike previous financial panics, people aren't sure exactly what they fear this time around. Maybe it's a hard landing in China, maybe it's an unwinding of the yen carry trade, maybe it's a retreat by sovereign wealth funds – and maybe, just maybe, it's nothing at all.

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This is not the way financial disaster usually comes calling. The out-of-control lunacy that typically precedes a market collapse doesn't creep into the room. No, it breaks down the door. It's big, it's bold, it's obvious.

Consider the U.S. housing bubble, which was so enormous that only a central banker could have missed it.

A decade ago, you had to read just one story about 25-year-olds flipping million-dollar homes in Southern California to realize that zero-down mortgages and lax underwriting standards had propelled normally sane American householders into la la land.

The dot-com bubble was equally glaring.

When the Nasdaq index quintuples in five years and backers of online dog food stores became overnight millionaires, you don't require a fine-grained analysis of balance sheet footnotes to realize something is awry.

Just as delirious was the Japanese stock and real estate bubble that came before that country's stock market cratered in the early 1990s.

At the height of the bubble, home buyers had to take out 100-year mortgages to afford a house and Tokyo stocks traded for nearly 70 times their earnings. Again, the lunacy was obvious.

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No doubt there are pockets of insanity in today's markets, but it's difficult to see anything that is as massive and out of touch as factors in those previous bubbles.

For confirmation of that, check out the most recent missive from Jeremy Grantham, co-founder of money manager Grantham Mayo & Van Otterloo in Boston and the world's foremost connoisseur of financial disaster.

He has researched the course of many financial booms and, to his everlasting credit, was among the earliest and loudest of the voices urging investors to steer clear of both the dot-com and housing hysteria.

Mr. Grantham says that a true bubble begins when the price of an asset reaches a valuation that is more than two standard deviations away from its historical average.

By that measure, the S&P 500 stock market benchmark in the United States would have to hit the 2,300 mark to be considered a bubble.

The index now hovers around 1,860 – a level that in Mr. Grantham's opinion is overpriced but far from bubble-level exuberance.

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Mr. Grantham has been derided in the past for his skeptical pronouncements but he sounds nearly upbeat these days.

"I think the global economy and the U.S. in particular will do better than the bears believe it will because they appear to underestimate the slow-burning but huge positive of much-reduced resource prices in the U.S. and the availability of capacity both in labour and machinery," he writes.

The real mystery is why so many people are convinced that something nasty lurks out there.

John Authers, the wise and witty investing columnist for the Financial Times, wrote an insightful article in which he asked who killed the market and compared the search for an assailant to Agatha Christie's Murder on the Orient Express.

In his article, Mr. Authers ticks off a dozen possible explanations for the recent slide, ranging from the Federal Reserve's decision to start raising interest rates to Chinese currency devaluation.

Maybe they all helped stick the knife in, he concludes.

Or perhaps not. As any detective will tell you, when you have lots of suspects, you really have none.

A multiplicity of possibilities is just another way of saying we really don't know whodunit.

Until we do, it's wise not to panic. It may be that we're really driving ourselves to distress over – literally – nothing.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More

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