The stock market is set to return to “the meat grinder” this year despite a recent minor rally, with the broad-based S&P 500 potentially falling 50% in the worst-case scenario, famed investor Jeremy Grantham warned on Tuesday.
Grantham, the 84-year-old co-founder of Boston-based asset management firm GMO, told clients in a letter that the “first and easiest step to bursting the bubble” in US equities is now ‘finished’, with ‘the most extreme scum’ wiped out in last year’s liquidation.
It projects the S&P 500 to plunge about 17% to around 3,200 for the whole of 2023, about 20% after the market’s early gains so far this year. But the outcome could be much worse if the global economy slides into a major recession, according to Grantham.
“Unfortunately, there is more potential downside than upside,” Grantham wrote. “In the worst case scenario, if something breaks and the world falls into a severe recession, the market could drop 50% from here. At best, it’s likely there will be at least one new modest decline, which in no way compensates for the risks.
Grantham cited several factors that could spell further hardship for investors, including a major correction in the U.S. housing market and continued uncertainty over the outcome of the Russian-Ukrainian war.
A 50% decline would take the S&P 500 below 2,000 points, down from its current level of just over 4,000.
“To put that into perspective, it would still be a much smaller percentage deviation from the trendline value than the overvaluation we had at the end of 2021 of over 70%,” he said. said Grantham. “So you shouldn’t be tempted to think it absolutely can’t happen.”
The S&P 500 has rebounded around 5% this year, a sign of cautious investor optimism about the economic outlook. This is despite a wave of layoffs hitting the tech sector, including giants such as Microsoft and Amazon.
Last year, the headline index plunged more than 19% as Federal Reserve rate hikes and decades-high inflation undermined confidence.
Grantham said the exact timing of a potential downturn is difficult to assess, given some positive factors that could cause a “pause” in the bear market – including a historical trend of strong yields ahead of the presidential election, signs of slowing inflation, robust employment markets and China’s rebound from a surge in COVID-19 cases.
“How corporate fundamentals deteriorate will mean everything over the next twelve to eighteen months,” Grantham added.
Known for his bearish outlook, Grantham warned last September that investors faced a “tragedy” when a current “super-bubble” in US markets burst.