Consider the U.S. stock market’s bear market to be challenging. According to veteran stock market investor Jeremy Grantham, the challenging part may still be to come.
The illustrious co-founder of the venerable Boston-based investment firm GMO stated in a paper published on Tuesday with the cheery title “After a Timeout, Back to the Meat Grinder” that “the first and simplest leg of the bursting of the bubble we called for a year ago is over.”
The most speculative growth stocks that drove the market higher in 2022 were “crushed” by the downturn, and “a major portion of the total losses across markets that we projected to see a year ago have already occurred.”
The next step is more challenging. The most “extreme froth” has been removed from the market by the downturn, but valuations are still much higher than long-term norms, he added, noting that in the past they have a tendency to overcorrect, going below their long-term trend line when fundamentals deteriorate.
So what happens to stocks now?
By the end of 2023, according to Grantham’s prediction, the S&P 500 index’s trend line value will be approximately 3,200 after being raised to account for trend line growth and anticipated inflation. According to the investor, there is a 3-to-1 chance that the S&P 500 will hit that level this year or the following year and at least briefly drop below it. A decline to 3,200 would represent a loss of about 20% from the S&P 500’s Tuesday closing price of 4,019.81 and a roughly 17% decline for the year.
Although such a result wouldn’t be “the end of the world,” it would be cruel in comparison to the Goldilocks pattern of the previous 20 years.
For example, he stated, “3200 would represent a drop of just 16.7% for 2023 and with 4% inflation anticipated for the year would total a 20% real decline for 2023 — or 40% real from the start of 2022.” “A little overrun past 3200 would take this overall decline to, perhaps, 45% to 50%, which is slightly less disastrous than the average decline of 50% or more from prior equally severe heights,” the author writes.
While such a result is still very plausible, Grantham advised investors to have far less conviction regarding the timing and length of the market’s upcoming downward trend.
The prospect of a stop or delay in the bear market is supported by a number of variables, he added, including the “underrecognized and powerful Presidential Cycle, but also included subsiding inflation, the continued strength of the labor market, and the reopening of the Chinese economy.” “How much company fundamentals deteriorate will mean everything over the next 12 to 18 months,” the author writes.
The presidential cycle asserts that stocks follow a pattern during the course of a president’s tenure, with a propensity to increase during the seven months from October 1 of the cycle’s second year to April 30 of the third year, according to Grantham. In other words, equities are currently in the cycle’s “sweet zone.”
The long-term problems of a dwindling population, a lack of raw materials, and increasing climate change damage are starting to “cut severely” into growth prospects for equities, according to Grantham.
“The geopolitical and resource shocks of last year will only make those problems worse. The likelihood of a decline in global real estate markets poses terrifying threats to the economy over the following few years, given the change in the interest rate environment, he said.
The Dow Jones Industrial Average ended the day roughly 104 points higher, up 0.3%, after overcoming an earlier loss, while the S&P 500 dipped 0.1% on Tuesday. Nasdaq Composite prices dropped 0.3%.