GMO founder Grantham says markets ‘ripe for major decline’ in 2016

A well-known fund manager who foresaw the Japanese crash, the dotcom bubble and the global financial crisis has predicted that markets will be “ripe for a major decline” some time in 2016, potentially triggering government bankruptcies.

Jeremy Grantham , founder and chief investment strategist of GMO, a $118bn investment house based in Boston, expects the stock market to continue to march higher in the coming year, eventually sucking in retail investors and setting up a serious decline around the time of the US elections in late 2016.

The famously bearish and often prescient money manager said this could trigger a “very different” type of crisis, because many governments had become considerably more indebted and much of the liabilities had shifted to the balance sheets of central banks.

Given that central banks were able to create money to recapitalise themselves, this “could be a crisis we could weather”, Mr Grantham said. “If not, then we’re talking the 1930s, where you have a chain-link of government defaults.”

Unlike many asset managers or analysts, Mr Grantham does not fret greatly over the impact of the Federal Reserve lifting interest rates for the first time in almost a decade this year. He points out that the US central bank lifted interest rates 13 times between 2004 and 2006 without troubling the ebullience of the time. 

“And now we are behaving hysterically at the prospect of just one? It’s a bit of a joke, really,” he said. “We might have a wobbly few weeks when they do move, but I’m sure the Fed will stroke us like you wouldn’t believe and the markets will settle down, and most probably go to a new high.”

However, this will draw in retail investors who for the most part have stayed on the sidelines of the great bull market since 2009. That could push the S&P 500 into valuations that are two standard deviations away from the long-term norm by the time of the US elections, which Mr Grantham classified as a bubble. 

The British-born financier has a reputation for being overly gloomy, and was negative on the US stock market far too early in the late-1990s boom. While he was eventually proved right on the internet bubble, that view dragged on GMO’s performance for several years and led to huge investor outflows at the time.

Mr Grantham is uncertain what could trigger the next crisis, pointing out that bubbles do not burst simply because financial assets are overvalued. But he argued that by late 2016 markets would probably be extremely vulnerable to a crash, given lofty valuations.

“We might get lucky and withstand one more crisis and just have an equity washout, and on the other hand it might just break the system,” he said. “It would be new, novel, and it could result in national defaults.”