Billionaire investor Jeremy Grantham, the co-founder of GMO Investments, is not only a superb investor, but he's also been pretty good at predicting where the market is going in the past. For instance, in early 2021, Grantham predicted that the market was entering a bubble, and in 2022, stocks crashed.
Now, he sees another bubble forming, one that could pop in "epic" proportions, similar to the Great Depression in 1929 or the dot-com bubble in 2000. Here's why.
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Similar dynamics
Grantham believes current market conditions have created a textbook setup for a bubble, and that the market has benefited from "almost perfect" conditions for roughly 10 years now. Specifically, Grantham points out that there has been a long period of economic growth, a bull market, and earnings strength.
"I'm only interested in the really great bubbles, like 1929, 2000, and 2021, [which] are the three senior bubbles in [the] U.S. stock market. We have checked off pretty well every one of the boxes," he recently told WealthTrack.
However, Grantham has lowered his likelihood of a market crash from an earlier prediction of 85% to now 70%. He also thinks the jury is still out on the severity of the crash and how much it will impact the economy and profit margins.
"They have fallen a decent bit already, but they could do a lot worse," Grantham said. "And how badly other economic variables will be -- the trouble within global trade, the trouble with China, the trouble with the war. And how will that play out? It's very difficult to tell."
A bubble within a bubble
The reason the current market bubble hasn't popped yet, according to Grantham, has to do with the artificial intelligence craze, which has created a mini-bubble within the larger bubble. AI and tech stocks have driven the bulk of the market's 16% gain this year and risen to massive valuations, which he finds concerning.
Grantham also said he doesn't know if AI will be "quick enough and strong enough" to prop up the market. He said:
Lord knows, this was complicated before AI raised its ugly head. We had inflation, the Fed, how quickly would rates go up, how far would they go up, how would the war play out -- it goes on and on. Now we have, since ChatGPT and October and November last year, we have a new little flurry of interest that is very concentrated.
Grantham isn't quite sure yet whether AI will be as transformational as some investors are betting, but the 84-year-old thinks that even if it is, there is likely still time for a recession to develop and for profit margins to decline, which would take some of the air out of the current bubble.
Stick to fundamentals
Grantham is certainly an excellent investor, so his guidance is worth listening to these days. But the market is clearly operating in the gray right now, and many of the best investors seem to have conflicting views on what's coming next. At the end of the day, nobody can predict the future.
This is a time when investors need to try and stay vigilant. Stay away from FOMO (fear of missing out), and stick to the traditional long-term investment strategy that has been proven over many decades. Prepare for a potential recession and invest in companies that you think can navigate one.
If you are going to invest in some of these tech companies trading at huge valuations, make sure you can do some basic math to justify these valuations, and run some scenarios of how they might perform in a recession as well. If you can justify some of these valuations under a long-term framework, don't be afraid to hold the stock. But if you can't, that might also tell you something.
