Jeremy Grantham: All the World's a Bubble

"The mechanism is surprisingly simple," he wrote. "Perfect conditions create very strong 'animal spirits,' reflected statistically in a low risk premium. Widely available cheap credit offers investors the opportunity to act on their optimism."

And it becomes self-sustaining. "The more leverage you take, the better you do; the better you do, the more leverage you take. A critical part of a bubble is the reinforcement you get for your very optimistic view from those around you."

It's something to think about the next time you hear someone tell you that the stock market will keep rising simply because the world economy is doing so well. That would make sense only if we were paying a constant price for each unit of world GDP, instead of higher and higher prices for one slice of that GDP -- equity.

Grantham concludes that every asset class is expensive today compared with historic averages and compared with the cost of replacing it. By his calculations, the only assets likely to beat inflation by any significant margin if you hold them for the next seven years are managed timber, "high-quality" U.S. stocks, and bonds.

As noted in this column several weeks ago, Grantham's U.S. "high-quality" stocks include Home Depot (HD Quote), Merck (MRK Quote), Wal-Mart (WMT Quote), AT&T (T Quote), Pfizer (PFE Quote), Johnson & Johnson (JNJ Quote), Exxon Mobil (XOM Quote), UnitedHealth (UNH Quote), Verizon (VZ Quote) and Lowe's (LOW Quote).