Jeremy Grantham, the veteran investor who cofounded GMO asset management, often feels like Crocodile Dundee.
In the eponymous 1986 film, Dundee, an Australian bush dweller, visits New York City. In what is perhaps the most famous scene, a thief pulls a knife on Dundee and demands his wallet. His acquaintance urges him to comply, reasoning that the thief is holding a deadly weapon.
But Dundee doesn’t view the knife as impressive. “That’s not a knife,” Dundee says of the thief’s weapon, smiling and pulling out a much-larger blade. “That’s a knife.”
While Grantham, a suit-wearing investment strategist, isn’t scaring off thieves with machetes, he’s not impressed with the type of rally the market has seen since October 2022 after its peak in January last year.
In January 2022, Grantham published a note titled “Let the Wild Rumpus Begin,” in which he said a bubble in the S&P 500 was due to unwind spectacularly. Since then, the index has been just about flat. But he’s standing by that call, as he’s seen bigger rallies unfold after calling a bubble. Take 1998, for example, when he warned of the dot-com bubble. Despite being at record valuations, the S&P 500 rose another 50% after his prediction.
While he was early, Grantham’s forecast, of course, proved correct in 2000, when the market began its 46% descent. He was also prescient about the 2008 crisis by both predicting the market’s crash and nailing the bottom within days of the low in March 2009.
“I feel like saying, ‘You call this a frustrating two years?’ And then I pull out my jagged knife and say, ‘This is frustrating’ — the period from ’98 and ’99, when from early ’98, we had pointed out that the PE on the S&P had gone to a new world record ahead of 1929,” Grantham told Business Insider on Tuesday.
“Sometimes they take their time,” he added, referring to deflating market bubbles. “This is two years of a complicated, drawn-out ebbing and flowing of the stock market.”
Grantham is calling for substantial downside in stocks. He said he expects the S&P 500 to fall to at least 3,200, and in a more severe recession, 2,200. On the “Merryn Talks Money” podcast in October, Grantham had listed 3,000 and 2,000 as his targets, but said that the slight upward revision reflects the increase in the market’s fair value over time from the underlying growth of the economy and inflation. From the S&P 500’s current levels around 4,600, a drop to 3,200 would represent 30% downside. A decline to 2,200, meanwhile, would mean the market shedding 52% of its value.
That also means stocks are doomed for years, with poor returns on average, in Grantham’s view. He cited John Hussman’s valuation measure of the market cap of nonfinancial stocks to the total value added of nonfinancial stocks. Hussman, the president of Hussman Funds who also warned of the 2000 and 2008 bubbles, said it’s the most reliable indicator of long-term stock-market returns he’d found. Right now, the measure is above its dot-com-bubble levels.
Hussman Funds
It’s closely correlated with long-term stock-market performance. As of early September, its level was associated with negative annualized returns over the next 12 years.
Hussman Funds
Along with high valuations, Grantham said investor sentiment and the economy weren’t yet weak enough for a sustained, long-term bull market to grow from.
“If you want to have a really good bull market, you want to go back to ’09, and you want to see high unemployment, terrible pessimism, and cheap prices,” Grantham said.
He added: “None of those conditions exist. So basically, if you visit the other great bubbles — 1929, 2000, maybe 1972-74, and the housing bubble — you find that in each case, people have very optimistic thoughts, and they have kind of attention-deficit disorder.
“So if the market doesn’t go to hell immediately, they say, ‘Oh, whoopee, it didn’t go to hell. Everything will be fine.’ But when you go from massive enthusiasm like we had in 2021, you know that sometime a few years later, you’re going to have a big drop in general enthusiasm.”
For now, Grantham and Hussman’s stock forecasts outlie beyond the consensus on Wall Street. The lowest 2024 year-end price target among major firms is JPMorgan’s at 4,200, implying a 9% decline from current levels. The most bullish target — from BMO Capital Markets — sees the index gaining 10%.
As for the economy, the list of recession signals continues to grow, Grantham said. Both the Treasury yield curve and the Conference Board’s Leading Economic Index — two indicators with perfect track records in preceding recessions over the past several decades — are pointing to a downturn ahead.
“The leading indicators have been declining forever, and they’re in dreadful shape, and they have been predicting that we will have a fairly usual end to a great bubble that’s taking its time,” Grantham said.
The indicator that’s increasingly catching Grantham’s eye is the gap between gross domestic product and gross domestic income. The former is a measure of how much money was spent in the economy, and the latter measures how much money was earned. Theoretically, they should be equal. However, GDI in recent months has been weaker than GDP, and the gap widened to its largest since 2007, suggesting strong GDP numbers may be overblown.
Where to invest
Given his long-term outlook on US stocks, Grantham said he wouldn’t touch them given the choice.
“I wouldn’t invest in the US, and the fact that I have said that for the last two years, and it’s been brutally wrong, merely makes me more convinced because the gap between the valuations between the US and the rest of the world has become unprecedented,” he said.
The valuation gap between emerging-market stocks and US stocks, he said, is in the top few percentage points in history, as is the global gap between growth- and value-stock valuations, making the latter attractive.
“It’s odd how relatively reasonable stock markets are outside the US,” Grantham said. “This, rather like 2000, is a US event, and particularly a US-growth event, and particularly a US “Magnificent Seven” event. But the rest of the world is not bad, and it’s particularly true of emerging, and, of course, it’s particularly true of value stocks.”
For investors who have to stay in the US, he listed four areas he thought had secular long-term bull trends: natural resources, climate-crisis-adjacent firms, deep-value stocks, and high-quality stocks.
