Investor Jeremy Grantham says stocks face a 50% free fall in a meat grinder

The stock market is set to “return to the meat grinder” this year despite a recent minor rally, with the broadly based S&P 500 could fall 50% in the worst case, prominent investor Jeremy Grantham warned 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 stage of the bubble burst” in US equities is now “complete” with the “most extreme foam” gone during last year’s sell-off.

He predicts the S&P 500 will fall about 17% to about 3,200 for all of 2023, or about 20% after the market’s early rally this year. But according to Grantham, the outcome could be much worse if the global economy hits a severe recession.

“Unfortunately, the potential for losses is greater than the potential for upside,” Grantham wrote. “In the worst case scenario, if something really breaks and the world plunges into a major recession, the market could drop 50% from here. At best, there is likely to be at least a further moderate decline that does nothing to counterbalance the risks.”

Grantham cited several factors that could make investors more worried, including a major correction in the US housing market and continued uncertainty about the outcome of the Russian-Ukrainian war.

A fall of 50% would send the S&P 500 below 2,000 points from its current level of just over 4,000 points.

“In comparison, the percentage deviation from the value of the trendline will still be much smaller than the overpricing we had at the end of 2021, which was more than 70%,” Grantham said. “So you shouldn’t be tempted to think it’s absolutely impossible.”

The S&P 500 is up about 5% this year, signaling investors’ cautious optimism about the economic outlook. And this despite the wave of layoffs that has swept the technology sector, including giants such as Microsoft and Amazon.

The broad-base index fell more than 19% last year as the Federal Reserve’s rate hike and years of inflation dented confidence.

Grantham said the exact timing of a potential downturn is difficult to estimate, given some of the positive factors that could cause a “pause” in the bear market, including a historic high yield trend ahead of the presidential election, signs of slowing inflation, resilient jobs. markets and China’s recovery from the spike in COVID-19 cases.

“How badly corporate fundamentals will deteriorate will depend on everything over the next twelve to eighteen months,” Grantham added.

Grantham, known for his bearish outlook, warned last September that investors would face a “tragedy” when the current “superbubble” in US markets burst.