Legendary investor Jeremy Grantham warns stocks could drop another 50% this year—but he doesn’t say to stay away from markets entirely

The S&P 500, a benchmark for large-cap companies in the U.S., has officially been in bear market territory since June 2022, when stocks plunged 20% from their previous high. 

The Federal Reserve’s cycle of interest rate hikes to bring down inflation began putting a squeeze on markets last year. Sporadic rallies gave investors hope that the worst was behind them at different times during the year, but each market upswing so far has been followed by a downturn, and now one of the world’s most legendary investors warns not to hold your breath for the bear market to be over soon.

The “first and easiest leg” of a stock market bubble burst is now over, Jeremy Grantham, chief investment strategist at his own asset management firm GMO, wrote in a 2023 outlook letter published last week. 

Now comes the hard part. While the “extreme froth” of speculative and risky stocks has been wiped clean off the market in the past year, valuations for most assets remain well above their long-term averages, Grantham wrote, adding that high valuations tend to correspond to equally drastic overcorrections which can plunge the market into the red.

“I believe continued economic and financial problems are likely,” he wrote. “A continued market decline of at least substantial proportions, while not the near certainty it was a year ago, is much more likely than not.”

Stocks to continue sinking in 2023

Hopes that the bear market is coming to a close have been continuously dashed as the Fed has stayed the course on interest rate hikes, and for many investors, the question is just how low will the market go before it’s over.

Grantham’s forecasted value for the S&P 500 by the end of 2023 is 3200, according to his letter, marking a 20% slide for the year and 40% from the market’s last peak in January of 2022. He put the odds of the market reaching these levels at three to one. In a worst-case scenario and if the market overcorrection is worse than expected, stocks could sink by up to 50% from their previous peak.

Grantham warned of a “long list” of important negatives in the economy to look out for that could exacerbate market downturn, including the U.S. entering a recession or falling corporate profits. But Grantham’s list of risks was headlined by a “bursting of the global housing bubble,” which Grantham wrote is only in its infancy. Grantham noted how housing busts can take longer to factor into the economy than other equity crashes, while housing markets that were once considered “impregnable,” such as in Canada and Australia, have started to decline under the weight of interest rate hikes worldwide.

Grantham’s forecasts may be a tough pill to swallow for those who were encouraged by January’s market surge. The S&P 500 was up nearly 6% year-to-date Monday after a month of positive inflation news that suggested an economic “soft landing” was possible, although Grantham, like other strategists, have warned this is not a sign the bear market is coming to a close.

The January upswing may be yet another bear market rally, Morgan Stanley chief investment officer Mike Wilson wrote in a research note last week, warning that investors shouldn’t be fooled that market momentum has reversed. Like Grantham, Wilson wrote the U.S. is in the “final stages of the bear market” which often tend to be the “trickiest.”

Investors don’t despair

In terms of timing, history suggests that while investors shouldn’t declare victory over the market downturn just yet, this may indeed be its final stretch.

Since the end of World War II, each bear market has lasted on average slightly more than 14 months from peak to bottom, analysts at Glenmede, a wealth management firm, wrote in October. At 12 months in, the end may well be in sight for investors. Grantham did, however, warn that current market conditions could persist much longer than that, potentially “well into 2024,” if the U.S. were to fall into recession in late 2023.

The further market decline to come will be “pretty brutal” compared to the relatively idyllic market conditions of the past 20 years, Grantham wrote, although he also added it would not be the “end of the world,” while pointing out several possible silver linings for investors on the fence.

He noted how stocks are a “whole lot cheaper” than they were a year ago, and investing now would still ensure returns significantly more positive than investors who put their faith in the market last year. 

And while the list of negatives plaguing the economy is long, Grantham pointed to a number of factors that could potentially be a positive shock for markets. Corporate earnings have not significantly declined yet, he wrote, while the reopening of China’s economy and the economic effects of presidential cycles, which tend to see stocks grow during the early months of a president’s third term, could lead to a “pause or delay in the bear market.”

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