Jeremy Grantham says ‘easiest leg’ of stock-market bubble burst is over. What’s next.

Think the bear market in US stocks has been rough? According to longtime stock market investor Jeremy Grantham, the hard part may still lie ahead.

The legendary co-founder of Boston-based investment firm GMO argued in Tuesday’s paper, titled “After a Timeout, Back to the Meat Grinder,” that “the first and easiest leg of the bubble burst, as we called it, was completed years ago.

The 2022 rout left the most speculative growth stocks leading the market on a “crushed” path, while “a large portion of the total market losses that we expected to see a year ago have already occurred.”

It gets trickier from here. While the recession has cleared most of the “extreme froth” from the market, valuations remain well above long-term averages, he said, adding that they have tended to overcorrect in the past because of their long-term trend line as fundamentals deteriorate. have come down.

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Where will that leave the stock?

Grantham estimated that the trend line value of the S&P 500 index, adjusted upward for trend line growth and expected inflation, would be around 3,200 by the end of 2023. The investor said the S&P 500 reaches that level is a 3-to-1 bet. And spend at least some time this year or next. The drop to 3,200 represents a roughly 17% decline for the year and a roughly 20% decline from the S&P 500’s SPX,
+0.05%
Closes at 4,019.81 on Tuesday.

Such an outcome would not be “the end of the world” but, compared to the Goldilocks pattern of the past 20 years, would be quite brutal.

“To spell it out, 3200 would be a reduction of just 16.7% for 2023 and with 4% inflation assumed for the year would total a 20% real reduction for 2023 – or 40% real from early 2022,” he wrote. “A moderate close behind 3200 would take the overall decline to 45% to 50%, which is slightly worse than the typical declines of 50% or more from similar extreme levels previously.”

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Previously: ‘Prepare for epic finale’: Jeremy Grantham warns ‘catastrophe’ looms as ‘super bubble’ could burst

Grantham said that while such an outcome remains highly likely, investors should have little certainty about the timing and extent of the next phase of the market.

“A variety of factors — including a predictable and powerful presidential cycle, but also subsiding inflation, continued strength in the labor market and the reopening of the Chinese economy — speak for the possibility of a pause or delay in the bear market,” he said. “How significantly corporate fundamentals deteriorate will mean everything over the next 12 to 18 months.”

The presidential cycle assumes that stocks see a pattern during the presidential term, starting Oct. of the second year of the cycle. 1 to April 30 of the third year with a tendency to land in the seven months, Grantham said. In other words, stocks are now in the “sweet spot” of the cycle.

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When it comes to the bigger picture for equities, the long-term issues of a shrinking population, raw material shortages and mounting damage from climate change are starting to “bite hard” at growth prospects, Grantham said.

“The resource and geopolitical shocks of the past year will only exacerbate those issues. And over the next few years, given the changing interest rate environment, the possibility of a slowdown in global property markets poses dire risks to the economy,” he wrote.

The S&P 500 was flat on Tuesday afternoon, while the Dow Jones Industrial Average DJIA,
+0.44%
Ticked up 110 points or 0.3% after erasing earlier losses. The Nasdaq Composite fell 0.2%.

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