Jeremy Grantham, co-founder and chief investment strategist at Grantham, Mayo, Van Otterloo & Co., is well-respected among the investing community. When he issues a warning, people listen – and just recently, Grantham signaled a stock-market decline that will be fairly mild at best, and painfully deep at worst.
“The first and easiest leg of the bursting of the bubble we called for a year ago is complete… Now things get more complicated,” cautioned Grantham in a blog posting titled, “After a Timeout, Back to the Meat Grinder!” There’s humor in that title, but the content of Grantham’s posting is dead serious.
In all fairness, Grantham does mention some of the reasons to lean bullish on stocks in 2023. He observes that “the most extreme froth has been wiped off the market,” perhaps referring to last year’s rout in FAANG stocks and Tesla stock, as well as the bursting of the SPAC bubble.
Along with that, Grantham concedes that the positive seasonal tendencies of the presidential cycle, subsiding inflation, the ongoing strength of the labor market, and the reopening of China’s economy bode well for stocks. With that, Grantham acknowledges the “possibility of a pause or delay in the bear market.”
His phrasing, however, suggests that a continuation of last year’s downtrend in stocks is inevitable. Thus, Grantham points to the “issues of declining population, raw materials shortages, and rising damage from climate change,” along with the “resource and geopolitical shocks of last year” as contributing factors to an impending stock market drawdown.
Before you convert all of your wealth into cash, though, note that Grantham’s prior warnings may have been ill-timed. For instance, in June of 2020, when asked what level of exposure investors should have to U.S. equities, Grantham replied, “I think a good number now is zero and less than zero might not be a bad idea if you can stand that.”
S&P 500. Courtesy: Yahoo Finance
That was an unfortunate call as the stock market rallied sharply from June 2020 to November 2021. It’s a perfect example of how extended markets can continue to extend for a long time, whether it’s apparently reasonable or not.
Grantham is even willing to admit that stocks look more attractive now than they did prior to the 2022 drawdown. As he put it, “stocks, whether blue chip or speculative, are a whole lot cheaper than they were a year ago and buying them now will give a much less disappointing return than would have been the case then.”
Of course, Grantham isn’t satisfied with a “much less disappointing return” and seeks to warn investors of the perils that apparently lie ahead. So, Grantham assigns 3-to-1 odds that the S&P 500, which is around 4,000 at the moment, will reach “about 3200 by the end of 2023.”
That, if it occurs, would represent a 16.7% decline for the year, which would actually be less painful than 2022’s S&P 500 drawdown of 19.4%. This, then, is Grantham’s “guess of the most likely outcome.”
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The actual outcome could be significantly worse, though. “Even the direst case of a 50% decline from here would leave us at just under 2000 on the S&P,” Grantham calculates, seemingly suggesting that this wouldn’t be an unreasonable drawdown.
I tend to disagree, and am bullish on stocks in 2023 even though I wouldn’t be surprised if the S&P 500 takes one more leg lower. Interestingly, Grantham articulates my own contrarian thoughts, writing, “I am rather rattled as a contrarian by the enormous increase in pessimism and realism since my letters of a year ago and two years ago.”
“Equally disturbing, it is said to be one of the most widely predicted recessions ever,” Grantham adds, and this echoes my reservations about ultra-bearish market calls for 2023. If you can believe it, the word “recession” appeared in over 650,000 news headlines last year, with the peak occurring in July.
It’s my position that a market crash, which a 16.7% drawdown in 2023 after 2022’s dismal stock market performance would imply, is unlikely. And, even Grantham seems to suggest that a 50% decline in 2023 isn’t the base case.
I’ve found the financial markets to be highly efficient and forward-looking, with a new shock to the system being a necessary ingredient for a full-on market crash. The biggest interest rate hikes are now behind us, and inflation has already peaked.
Most of all, stock market crashes don’t happen when everyone’s expecting one. There could always be a new, unexpected geopolitical shock in 2023. Unless such an event occurs, however, I expect Grantham’s 2023 call, like his June 2020 call, to be well-intentioned but poorly timed.
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