Stocks are dangerously overvalued and poised to disappoint, the AI bubble is bound to burst, and a recession appears likely, Jeremy Grantham has warned.
The bubble expert and long-term investment strategist at GMO issued the grim outlook in a Monday report titled “The Great Paradox of the US Market!”
Grantham noted the S&P 500’s Shiller P/E ratio — which divides the S&P 500’s price by its constituents’ average yearly earnings over the past 10 years to adjust for the business cycle — stood at 34 on March 1, a level in the top 1% of the metric’s historical range.
At the same time, corporate profits are also close to record highs. That “really is double counting and double jeopardy,” Grantham said, cautioning that stocks could see their earnings multiples contract and their margins shrink.
The paradox is why stock prices “reflect near perfection” in a “particularly imperfect and dangerous” world, he said. Grantham’s concerns included foreign conflicts, economic weakness in Europe and Asia, unaffordable housing, pressure on commercial real estate, climate damage, dwindling resources, and aging populations.
“The stark contrast between apparent embedded enthusiasm and these likely problems seems extreme, illogical, and dangerous,” he said.
Grantham also noted there’s never been a sustained rise in stocks that started from a Shiller P/E of 34, or full employment.
“The long-run prospects for the broad US stock market here look as poor as almost any other time in history,” he said, comparing the recent run-up in stocks to the rallies that preceded the Great Depression and the dot-com crash.
Booms become bubbles
Grantham recalled how vast amounts of pandemic stimulus inflated a multi-asset bubble in 2021 that deflated considerably in 2022, as he expected. Yet he said the rollout of ChatGPT “rudely interrupted” that process by inflating a whole new bubble around AI.
The veteran investor emphasized that AI might eventually be more transformative than the internet, but predicted it would follow the trajectory of past tech revolutions. That pattern is “early massive hype and a stock market bubble” followed by a “substantial period of disappointment during which the initial bubble bursts.”
Grantham gave the example of Amazon, which saw its stock price soar 21-fold between the start of 1998 and its 1999 peak, then nosedive 92% between 2000 and 2002 once the dot-com bubble popped. Yet Amazon went on to own “half the retail world,” he said.
“So it is likely to be with the current AI bubble,” Grantham said, predicting it would “at least temporarily deflate and probably facilitate a more normal ending to the original bubble.”
Moreover, Grantham said it was likely the delayed impacts of the Federal Reserve’s interest-rate hikes, combined with the “ridiculous speculation” between 2020 and 2021 and between November and now, would “eventually end in a recession.”
Grantham touted high-quality and deep-value stocks, plus those focused on resources or the climate crisis, as the most compelling options in the broadly overpriced US stock market. He also trumpeted foreign markets as offering better value than the US.
It’s worth noting that Grantham has been issuing grave warnings about crashes and recessions for years now, yet markets and the economy have mostly defied his dour forecasts.
For example, he cautioned in October that the S&P 500 could plunge to 2,000 points — a 61% drop from its current level — if a “couple of wheels fall off.” Yet the index has advanced 7% this year and continues to hover close to record highs.
