‘Don’t invest in the U.S.’ says GMO’s Jeremy Grantham, who sees a possible 50% stock pullback coming.

By Barbara Kollmeyer

No small cap stocks, but quality names and climate change are the places to be, says the strategist

“Don’t invest in the U.S. If you have to invest in the U.S…I would urge you to take a good look at quality, and quality has been the mispriced asset for 100 years.”Jeremy Grantham, co-founder of GMO

That was the central advice from the investment strategist who earned Wall Street fame for spotting both the dot-com bubble and global financial crisis, Jeremy Grantham, co-founder of the contrarian and often bearish investment house, GMO LLC.

Warning of yet another bubble to pop in a podcast interview with Bloomberg, the strategist cautioned that the so-called Magnificent Seven tech stocks — Apple (AAPL), Amazon (AMZN), Meta (META), Alphabet (GOOGL), Nvidia (NVDA), Tesla (TSLA) and Microsoft (MSFT) — are unlikely to keep climbing and holding up the stock market.

“What will happen to these new nifty seven? That’s the question that is unanswerable because each one of them depends on a completely different slice of of the economy,” he said.

Given the surge in bond yields, Grantham said just based on “sheer arithmetic,” the stock market would need to drop by more than 50% to out-yield the long bond by 5%. He adds that this is not his forecast, which is “genteel,” calling for anything below 3,000 on the S&P 500 as reasonable.

“And if everything works out badly, which sometimes does, I would not be amazed if it went to 2,000 on the S&P. But that would that would require a couple of wheels to fall off and degrade,” he said, adding that doesn’t mean they have to but it wouldn’t be unlikely to see the index near 3,000.

“Sooner or later, arithmetic suggests you’ll either have a dismal return or you’ll have a nice bear market, and then a normal return. And the nice bear market will be hopefully less than a 50% decline, but there won’t be a huge amount less from the peak than 50%,” Grantham warned in the podcast interview with Bloomberg that aired Friday.

The exceptions to his aversion to U.S. stocks are quality names, which he says often underperform in bull markets, but are worth holding in bear markets.

“In a bull market you want to own Tesla, you want to own meme stocks, you want to own what’s flying. You don’t want to own Coca-Cola, it’s just too boring. In the long run, Coca-Cola (KO) does very well in the bad markets, but that’s the free lunch,” says Grantham.

“When it comes to quality, they have less risk of every kind, they have less debt, they go bankrupt less, they have less volatility, they have a lower beta…that is a free lunch,” he said, adding that they aren’t too expensive right now.

The iShares MSCI USA Quality Factor exchange-traded fund QUAL is up 10% year to date, versus the Invesco QQQ ETF QQQ, which tracks the Nasdaq-100 Index NDX, up 34%.

“Quality, by the way, in a nutshell is your element of monopoly : high returns, low debt. Low debt, of course, goes along with the highest stable returns…it’s another way of saying you’re a price setter, and a price setter is another way of saying you have a monopoly element,” he said.

His biggest warning over U.S. stocks surrounds the Russell 2000 RUT index, which he sees as most vulnerable to higher rates. He estimates around 40% of the companies don’t have positive earnings and are sitting on record debt.

“The Russell 2000 often has no collective earnings at all. It has a very high density of some of these companies that really can only pay the interest payments by issuing more debt…They’ve never had this kind of debt so they’re vulnerable on the debt front, vulnerable on the financial front and vulnerable on the broad economic front,” he said.

Investors looking for opportunity outside of the U.S. might want to check out the U.K. and Japan and parts of emerging markets. He also advises against investing in “universally overpriced” real estate, farms and forest, and fine art.

The strategist has been criticized in some corners over his early 2021 bear market warning. Investors following that would have missed out on a 26% rally for the S&P 500 that year. But the podcast noted that Grantham also offered advice in a Bloomberg interview in August 2021, for investors to secure the longest fixed rate mortgage on their houses that they could find. That would have paid off as the Federal Reserve has hiked interest rates eleven times since March 2022.

Grantham was also asked what he would choose to hold between gold (GC00), bitcoin (BTCUSD) or cash on deposit for 10 years –he chose door No. 1. “I’m not happy with gold but in a world where inflation could come back, I think I’ll take gold. Bitcoin, of course, is an elaborate scam really, but gold is the least bad of the three,” he said.

The strategist had one last piece of advice for investors. “Climate change is going to outgrow the rest of the economy by a lot. That’s going to dominate investing and the need for money for many decades,” he said, though added that that didn’t mean there would be no element of commodities involved.

“It’s intrinsically a difficult, dangerous area, but it will have enormous growth potential. And so if you can find a competent source of investment, I would, of course, recommend climate change over the rest of the U.S. market,” said Grantham.

-Barbara Kollmeyer

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10-06-23 0909ET

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