GRANTHAM WARNS: The Conditions Are Set For A 'Veritable Explosion' In M&A That Send Stocks To 'True Bubble Levels'

In it, he continues to deliver his message of caution, warning that the stock market is expensive and is priced to deliver paltry returns for years to come.

And he continues warn that we are heading for a bubble.

"[M]y recent forecast of a fully-fledged bubble, our definition of which requires at least 2250 on the S&P, remains in effect," he reiterated.

In this letter, Grantham commits some time addressing the current M&A boom that we have been witnessing this year.

He actually believes the next leg of this boom could be a truly historic one.

"Don't tell me there are already a lot of deals," he writes. "I am talking about a veritable explosion, to levels never seen before."

He gives reasons why he predicts this:

1) Cheap debt: "...when compared to other deal frenzies, the real cost of debt this cycle is lower..."

2) High profit margins: "...profit margins are, despite the first quarter, still at very high levels and are widely expected to stay there..."

3) Young-looking recovery: "...the economy, despite its being in year six of an economic recovery, still looks in many ways like quite a young economy..." Grantham notes that there is slack in the labor market and room for capital spending.

"If I were a potential deal maker I would be licking my lips at an economy that seems to have enough slack to keep going for a few years," he writes.

Grantham, also observes that investors are "just now picking up their courage" after getting crushed in the last crash. Furthermore, the low interest rate environment has forced companies to find new ways to offer growth.

"I think it is likely (better than 50/50) that all previous deal records will be broken in the next year or two," he writes. "This of course will help push the market up to true bubble levels, where it will once again become very dangerous indeed."

So, there you have it. Grantham is forecasting that this bubble could be the one marked by M&A.

Read the whole letter at GMO.com.