- According to GMO’s Jeremy Grantham, the stock market is poised for another 20% drop this year as the bubble enters its final stages.
- Grantham said that in a worst-case scenario, the S&P 500 could fall more than 50% from current levels.
- Grantham believes investors are putting too much weight on the idea that the Fed’s rate cuts are a good thing.
Even a new year can’t shake the bear market of GMO’s Jeremy Grantham, who said in a letter on Tuesday that the stock market will fall another 20% this year.
Grantham said the ongoing deterioration in financial conditions is being limited by a downturn in the housing market, which represents the “final stage” of the stock market bubble that should help propel the S&P 500 to 3,200 by year-end.
In a worst-case scenario, Grantham sees the S&P 500 drop as much as 50% to around 2,000.
“Even the worst case scenario of a 50% drop from here would leave us cheap at just under 2,000 on the S&P or about 37%. To put this in perspective, it would still be a far smaller percentage deviation from the trendline value than the overvaluation we had at over 70% at the end of 2021. So you shouldn’t be tempted to think that this absolutely can’t happen,” Grantham warned.
The key to whether or not Grantham’s bleak scenario plays out this year depends on investor confidence, which has slowly but steadily declined throughout 2022 as every stock rally was eventually sold. Similar to 2000 or 2007, any significant drop in investor confidence could lead to a rapid fall in asset prices, the release said.
Some of the “pegs” that could boost investor confidence are the housing market entering a recession and corporate earnings starting to fall. The debt ceiling is another overhang for investors this year.
“Almost any needle can inspire that much confidence and cause the first rapid and severe decline,” Grantham said. “To burst these bubbles, all you have to do is make investors wonder if their near-perfect economic and financial conditions can indeed be extrapolated forever.”
And investors shouldn’t look to the Federal Reserve for help in the form of rate cuts, Grantham said. Because in 1929, 2000, and 2007, most of the stock market decline occurred after the Fed’s first rate cut.
“Despite… the painful recent experience of the 2000 and 2008 bear markets, we remain hopeful that the first rate cut is guaranteed to kill the bear. We’re really an incredibly optimistic species that these very negative examples, while clear and recent, are so easily ignored,” Grantham said.
On the other hand, Grantham, who describes himself as a contrarian investor, is concerned that so many strategists on Wall Street are also bearish.
“Equally troubling is that this is one of the most predicted recessions of all time. It’s all enough to wake a godly contrarian sweating in the night,” Grantham said. But Grantham takes solace in the fact that, despite all the downside possibilities, estimates of corporate earnings have yet to come down significantly.
“Even so, I would prefer a lot more optimism, which was almost universal a year ago,” Grantham said.