The stock market has been undeniably friendly to investors. The S&P 500 delivered 20%-plus returns in 2023 and 2024, significantly above the historical 10% average return since 1957.
However, investors may not want to get used to eye-popping gains. Since 1990, the S&P 500 has risen by over 20% in a year, only about one-third of the time. In fact, returns in any given year vary widely, including some pretty drastic losses.
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For example, the S&P 500 delivered three consecutive negative years in the early 2000s dot-com bust and a mind-numbing 38% pummeling in 2008 during the Great Financial Crisis.
Of course, bad years are far less common than good years. Still, they happen. And often, the bad times follow the good times, leaving investors scratching their heads over whether a similar reckoning looms.
Jeremy Grantham is a veteran Wall Street strategist who’s seen more than his share of good and bad times. He founded the money-management firm GMO 45 years ago and previously founded Batterymarch, another asset manager, in 1969.
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His long experience navigating markets and the fact that GMO manages nearly $61 billion suggests that paying attention to his market forecasts may be smart. Unfortunately for investors, his outlook for stocks isn’t very reassuring.
Jeremy Grantham, co-founder and chief investment strategist of GMO LLC, recently unveiled a stark stock market warning.
A stock market that’s surged could soon struggle
A friendly Federal Reserve and surging technology spending on artificial intelligence fueled the stock market’s rally in 2024.
Following sky-high inflation, the Fed raised interest rates in the most aggressive hawkish monetary policy since Volcker broke inflation’s back in the early 1980s. The cudgel worked, slowing economic activity enough to crimp price increases. Inflation fell from 8% in summer 2022 to about 2.4% last September, according to the Consumer Price Index.
Slowing inflation was good news for cash-strapped Americans. However, it also caused cracks in the jobs market. As a result, the Fed shifted gears to focus on limiting unemployment, cutting interest rates in September, November, and December to bolster economic activity and corporate profitability.
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The verdict is still out on whether those rate cuts were enough. Most believed interest rates would fall further in 2024. However, inflation progress has stalled, causing the Fed to press pause on further Fed Funds Rate reductions.
Uncertainty over the direction of rates isn’t the only potential hiccup for stocks, though.Â
Much of the rally in the past two years is due to a technology boom caused by a rapid increase in spending on artificial intelligence. The S&P 500 would only have gained 11% last year if not for the communications services and information technology sectors, according to S&P Dow Jones Indices.
The successful launch of OpenAI’s ChatGPT in late 2022 unleashed a torrent of research and development, forcing cloud and enterprise networks to refresh servers to handle the crushing workloads associated with training and running AI chatbots and agentic AI programs.
For example, Microsoft, Google, and Amazon alone spent $192 million on the stuff necessary to build their businesses last year, up from capital expenditures of $117 billion in 2023.Â
Related: Veteran analyst sounds alarm on Amazon, Microsoft stock
Companies are expected to keep pouring money into AI this year, but following the development of DeepSeek for a reported $6 million, concerns are growing that IT budget growth could slow from its recent breakneck pace.Â
If the Fed stays on the sidelines, or worse, has to raise rates because inflation reexerts, and technology spending growth slows, it could set stocks up for a reset.Â
According to FactSet, the forward price-to-earnings ratio (P/E) is 21.2, much higher than the 10-year average of 18.3.
Jeremy Grantham issues startling stock market prediction
To maintain arguably inflated valuations, a lot needs to keep going right. That’s not a great risk-to-reward recipe.
Grantham understands the point. Recently, on a Bloomberg podcast, he outlined a stock market forecast likely raising some eyebrows among Main Street investors.
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“I’ve always looked at it from the point of view that the longer and the bigger and the higher it goes, the more exciting and dangerous it will be, and this has moved up the rank of super bubbles,” said Grantham on the podcast. “The net result is that every measure of traditional value, the best of the common ones being Shiller PE, is at a record.”
Grantham doesn’t rate the current environment as bad as Japan’s 1980s bubble, but he does rate it among the worst he’s seen, including the Internet bubble and 1929.
How bad could it be if the stock market bubble popped? Grantham thinks it could be very bad.
“The market could drop 50 percent to get back to the normal response of flaky human beings,” said Grantham. “The normal behavioral responses would have this market at a perfectly respectable 18 PE on Schiller, and it’s actually just over twice, it’s 37.”
And what about the artificial intelligence productivity boom saving the day for the S&P 500 and other major indexes? Well, Grantham doesn’t really buy that argument.
“Every really important new technology has had a bubble around it. A classic example in the old days was the railroads, where it was so obviously going to change everyone’s life, and it did,” said Grantham. “And, of course, there was an almighty crash and everyone lost their shirts. It was one of the more spectacular busts.”
Related: Veteran fund manager unveils eye-popping S&P 500 forecast
