Legendary investor Jeremy Grantham warned investors of a potential stock market crash in his 2023 outlook letter that was published on Tuesday.
In his bear-case scenario, he warned of a potential 50% decline in the stock market this year as he believes valuations are still too high even after last year’s 20% decline. Grantham’s base-case scenario calls for the S&P 500 to fall 20% to 3,200 by the end of this year.
Despite the bearish outlook, he did say there were some parts of the market investors should own. These are the seven best quotes from his letter:
1. On stock market valuations
“While the most extreme froth has been wiped off the market, valuations are still nowhere near their long-term averages,” Grantham said. “My calculations of trendline value of the S&P 500, adjusted upwards for trendline growth and for expected inflation, is about 3200 by the end of 2023. I believe it is likely (3 to 1) to reach that trend and spend at least some time below it this year or next.”
2. On what could prevent a bear market in stocks
“A variety of factors – especially the under recognized and powerful Presidential Cycle, but also including subsiding inflation, the ongoing strength of the labor market, and the reopening of the Chinese economy – speak for the possibility of a pause or delay in the bear market.”
3. On the long-term outlook for stocks
“The biggest picture remains that long-run issues of declining population, raw materials shortages, and rising damage from climate change are beginning to bite hard into growth prospects… over the next few years, given the change in the interest rate environment, the possibility of a downturn in global property markets poses frightening risks to the economy.”
4. On the housing market
“The bursting of the global housing bubble, which is only just beginning, is likely to have a more painful economic knock-on effect than the decline in equities is having… Housing busts seem to take two or three times longer than for equities – from 2006 for example it took 6 years in the U.S. to reach a low – and housing is more directly plugged into the economy than equities through construction starts and associated expenditures.”
5. On the worst-case scenario for stocks
“Regrettably there are more downside potentials than upside. In the worst case, if something does break and the world falls into a severe recession, the market could fall a stomach-turning 50% from here… Even the direst case of a 50% decline from here would leave us at just under 2000 on the S&P, or about 37% cheap. To put this in perspective, it would still be a far smaller percent deviation from trendline value than the overpricing we had at the end of 2021 of over 70%. So you shouldn’t be tempted to think it absolutely cannot happen,” Grantham said.
“If we… believe a recession will likely not start for 6 months to a year… we can conclude that the final low for this market might be well into 2024.”
6. On timing a potential stock market decline
“There are some complicating factors that seem quite likely to drag this bear market out… The important fact here that for 7 months of the Presidential Cycle, from October 1st of the second year (this cycle, 2022) through April 30th of the third year (2023), the returns, since 1932, equal those of the remaining 41 months of the cycle… Suffice it to say that this positive influence may help to support the market for a few more months.”
7. On what to own in the stock market going forward
“Despite the generally unattractive nature of the U.S. equity market and the extremely tricky global economy, there are still a surprising number of reasonable investment opportunities even if they are not sensational… emerging markets are reasonably priced and the value sector of emerging is cheap,” Grantham said.
“For those with a longer horizon than average, say 5 years and above, I believe stocks related to addressing the problems of climate change and the increasing pressure on many raw materials have a substantial advantage over the rest of the economy as the world’s governments and corporations begin to accept the urgency of these problems.”
