Jeremy Grantham, the founder and chief investment strategist of GMO and perennial bear, is sounding somewhat optimistic about the U.S. economy and stock market this year.
In his latest quarterly letter, Grantham writes that the global economy and the U.S. in particular will do better than the bears believe,” largely because of the positive impact of depressed oil prices, and that, in turn, makes a “major market break unlikely.”
At worst, Grantham expects “an ordinary bear market lasting a few months, not a major collapse,” although he admits the latter could occur if a major market bubble, which he defines as the S&P 500 near 2,300, develops. That’s about 22% above the index’s current level.
Grantham describes several major indicators of a market bubble, which historically precedes a market collapse. In addition to the “standard-deviation event – which suggests the 2,300 level on the S&P 500 — they include:
- A down week for stocks on the first trading week of the year coupled with a negative January
- Strong defensive buying of blue chips over high-beta stocks
- Massive enthusiasm from the market from individual investors
- An overwrought, over-capacity economy
The only variable that has come to pass is the first one. The S&P 500 and Dow Jones industrial average both lost a little over 6% in the first trading week in January and declined a more than 5% for the full month of January. Blue chips did outperform in 2015, but those gains were due to “offensive buying” following the “superior earnings of this small group,” writes Grantham. They did not reflect “defensive buying,” which is usually the case in building the bubble he describes.
Also, individual investors are not embracing the current stock market. Instead they have been selling equities and buying bonds and gold. Finally, the economy does not appear to be “overwrought.”
Activity in services industries, which dominate the U.S. economy, expanded in January but at a slower rate than the month before and below expectations. And GDP growth is forecast to run around 2% this year. (Grantham is forecasting growth between 1.5% and 2.5%.)
Despite the lack of evidence of a growing market bubble, which precedes a market collapse, Grantham admits to “feeling nervous for this year’s equity outlook in the U.S. We can have a regular bear market … But the BIG ONE? I doubt it.”
One key reason he doubts it is the price of oil. “Everything we buy has cheaper input costs” because of the deep dive in oil prices, writes Grantham. The market overall “is underrating what will very likely become an important economic tailwind for the next several quarters,” writes Grantham, referring to the oil price drop. “The U.S. and global economies are likely to do significantly better this year than recent opinions predict.”
That’s another reason he doesn’t expect a stock market collapse this year. Before the financial crisis of 2007-2008, oil prices reached “cosmic highs” – over $150 a barrel (today there are 80% lower) and the housing market was also highly overpriced, writes Grantham. Those variables are absent today.
The biggest risk, writes Grantham is China. “The market is discounting lower growth. (I believe 4% a year for the next 10 years would be a reasonable target.) But a deep entry into negative GDP numbers might ruin my relatively positive case for global growth.”
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