Jeremy Grantham Says ‘Easiest Leg’ of Stock-Market Bubble Burst Is Over. Here’s What’s Next.
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Do you think the bear market in US stocks has been rough? The hard part may still be ahead, according to longtime stock market investor Jeremy Grantham.
The legendary co-founder of Boston-based investment firm GMO argued in a Tuesday paper, gleefully titled, “After a timeout, back to the meat grinder,” that “the first and easiest part of the bubble burst we’ve called was completed before a year ago.”
The 2022 price drop caused the most speculative growth stocks that led the market on its way up “to be crushed, while much of the total losses in markets that we expected a year ago have already occurred”.
It gets trickier from here. While the recession has wiped most of the “extreme froth” from the market, valuations remain well above long-term averages, he said, noting that they have historically tended to overcorrect and fall below their long-term trendline as fundamentals deteriorated.
Where would the shares go then?
Grantham estimated the trendline value of the
S&P 500
index, adjusted upwards for trendline growth and expected inflation, will be around 3,200 by the end of 2023. The investor said it was a 3-to-1 bet that the S&P 500 will reach that level and stay below it for at least some time this year or next. A drop to 3,200 would represent a drop of about 17% for the year and a drop of about 20% from the S&P 500 which ended Tuesday at 4,019.81.
Also see: The ‘Mother of all bubbles’ has burst. This strategist sees a Fed-Fueled Recession in 2023.
Such an outcome would not be “the end of the world, but quite brutal compared to the Goldilocks pattern of the last 20 years.
“To be precise, 3200 would be a drop of just 16.7% for 2023 and with inflation at 4% for the year, this would mean a 20% real drop for 2023 – or 40% real from the start of 2022,” he wrote. “A modest overshoot after 3200 would bring this whole decline to, say, 45% to 50%, slightly less than the usual decline of 50% or more from previous similar extremes.”
Such an outcome would not be “the end of the world, but quite brutal compared to the Goldilocks pattern of the last 20 years.
“To be precise, 3200 would be a drop of just 16.7% for 2023 and with inflation at 4% for the year, this would mean a 20% real drop for 2023 – or 40% real from the start of 2022,” he wrote. “A modest overshoot after 3200 would bring this whole decline to, say, 45% to 50%, slightly less than the usual decline of 50% or more from previous similar extremes.”
Grantham said that while such an outcome remains highly likely, investors should have much less certainty about the timing and size of the market’s next leg.
A variety of factors, including the “undervalued and powerful presidential cycle, as well as declining inflation, the continued strength of the labor market and the reopening of China’s economy – speak for the possibility of a pause or slowdown in the bear market,” he said. “How much the company’s fundamentals deteriorate will mean everything in the next 12 to 18 months.”
The presidential cycle means stocks see a pattern over the course of a presidential term, tending to gain ground in the seven months from Oct. 1 of the cycle’s second year through April 30 of the third year, he said. Grantham. In other words, stocks are now in the sweet spot of the cycle.
When it comes to the big picture for equities, long-term issues like declining population, commodity shortages and mounting damage from climate change are “starting to bite hard” into growth prospects, Grantham said.
“Last year’s financial and geopolitical shocks will only exacerbate those problems. And in the coming years, given the change in the interest rate environment, the possibility of a downturn in global real estate markets poses frightening risks to the economy,” he wrote.
The S&P 500 was flat Tuesday afternoon, while the
Dow Jones Industrial Average
tapped 110 points, or 0.3%, after erasing a previous loss. The
Nasdaq composite
loss 0.2%.
This article originally appeared on MarketWatch.
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