Why This Investing Legend Thinks Stocks Could Drop Another 20%

Brace yourself for further economic woes.

Jeremy Grantham, co-founder and chief investment strategist of asset manager GMO, thinks the stock market could fall considerably in 2023. Grantham has a reputation for calling market bubbles and he's been warning of an impending crash for the past few years. 

Sure, the market has already seen substantial losses, with the S&P falling by almost 20% in 2022. But Grantham says this is only the "first and easiest leg of the bursting of the bubble we called for a year ago." Find out why he thinks there's more pain in store for investors.

Why Jeremy Grantham is warning of a 20% drop in equity prices

In a recent paper, Grantham highlighted what he called "a rare level of uncertainty" and set out the factors he believes could contribute to further stock market losses. These include the war in Ukraine, which he says has an impact on the production of grain, oilseed, and fertilizer. He also raised concerns about the knock on effect on Europe's energy supplies.

In addition to long-term issues, such as a declining population, damage from climate change, and shortages of raw materials, the 84-year-old investor thinks the global housing bubble is only just starting to burst. He says housing busts tend to take longer to unfold than equities and predicts there will be a "painful" economic impact that hasn't yet fully been felt. 

All in all, Grantham thinks there's a 3 to 1 chance that the S&P 500 will decline a further 20% this year. He warns that if any of the negative factors get out of hand, we may see a global economic recession. "Because of the sheer length of the list of important negatives, I believe continued economic and financial problems are likely," he writes. "I believe they could easily turn out to be unexpectedly dire."

Investing during a downturn

As an investor, it isn't easy to hold your nerve and continue to invest against a backdrop of impending doom. But even Grantham admits that his worst-case scenarios may not unfold. None of us has a crystal ball to accurately predict what will happen. Moreover, if the U.S. enters a recession, we don't know how long or how severe it will be.

If you're a long-term investor, economic downturns can offer an opportunity to pick up quality stocks at lower prices. Historically, prices have always recovered eventually. What matters is your timeframe. If you're buying stocks with money you don't plan to touch in the coming five to 10 years or more, there's a good chance you'll come out on top in time. 

Dollar-cost averaging -- investing a set amount at regular intervals -- can make it easier to resist the temptation to time the market. Make regular incremental investments rather than trying to wait for stocks to hit their lowest point, which is almost impossible to do. It takes a lot of the emotion out of your decisions and can make sense in volatile markets.

That said, if your emergency fund isn't in good shape, this needs to take priority over buying stocks or other assets. With a recession looming, many financial experts think the traditional three to six months' worth of emergency savings isn't enough. Some recommend socking away as much as a year's worth of money, or more. Make sure you have enough cash in an accessible savings account to cushion you against the unexpected.

If you're close to retirement, seeing your portfolio drop in value can be particularly nerve wracking. It's a good idea to think about your asset allocation and ensure you're comfortable with the level of risk involved. You might want to consider putting a higher percentage of your portfolio into bonds, which usually generate a fixed income and carry less risk. 

Whether times are good or bad, building a diversified portfolio is another way to build wealth over time. That means holding equities from a mix of sectors and companies, as well as other asset types such as commodities and real estate. The percentage you allocate to different investments depends on you, your financial situation, and your risk tolerance.

Bottom line

It's important not to let pessimistic predictions stop you from building wealth. There are times when investing during a recession can make sense, with some important caveats. First make sure you have enough cash to see you through any immediate emergencies and only invest money you don't plan to touch in the near future.