Value investing guru Grantham: The "moment of reckoning" for global assets has arrived, and a halving of US stocks is not surprising.

Key Points:Our motto should be "Don't mess with real estate."The super motto should be to never have a real estate bubble at the same time as a stock market bubble, which was a huge mistake made by the Japanese, creating the largest bubble in history in both areas.Although we haven't been blinded by the absurd subprime mortgages, the real estate market is still highly priced, creating long-term vulnerability, along with a stock market bubble that is even higher and more typical than the one in 2007.So far, the VC industry is the only one that has been completely trapped. IPOs have basically come to a halt, and capital inflows have dropped significantly, soon reaching about one-third. Therefore, the VC industry seems to have experienced a major bubble burst, while other parts of the market, especially artificial intelligence, are doing much better.The S&P 500 index may appear high, but the market performance is not as good as people imagine, as painful as any one percentage point of inflation or loss.If we exclude the "Seven Sisters" (the seven major component stocks), the S&P 500 will not rise this year, maybe it will rise, but very little or not at all. All the 10% or 12% rebounds are supported by the "Seven Sisters". Never has there been such a narrow market.If the stock market is to fall to a level 5% higher than the yield on long and short-term bonds, mathematically, the market will have to fall by more than 50%.As far as the S&P 500 is concerned, it is reasonable to be below 3000 points. If everything goes wrong, it may fall to 2000 points, and I wouldn't be surprised. But then there will be big trouble.If I get a negative return in my piggy bank, I'd better look for positive returns. A competition is underway. Global real estate is generally overpriced, just like farms, forests, and artworks.Defensive stocks often perform well in bear markets. Why? Because they're boring. You don't want to buy Coca-Cola, it's too boring. In the long run, Coca-Cola performs very well in bear markets, especially on average. That's the only free lunch. And the current price is not high.I'm not satisfied with gold, but in a world where inflation may come back, I think I would choose gold. Bitcoin is indeed a well-designed scam, but gold is the least bad among the three.Recently, Jeremy Grantham, co-founder of hedge fund GMO and a value investing guru, warned on the podcast Merryn Talks Money that all asset classes, from the stock market to real estate, have huge bubbles, and no one should be investing in the United States right now.Due to his frequent bearish stance on US stocks, Grantham is also known as the "prophet of bubbles." In 2021, he stated that global assets are in the largest bubble in history and a reckoning is coming.He said in the program that the liquidation had already begun in 2022, although it had been suspended for a while this year, but now it has come back again.The following is the original interview, translated and edited by Wall Street News:This time the bubble liquidation hit the window periodHost: The last time we talked was two years ago, at the end of 2021. We talked about why it was one of the biggest bubbles in financial history, which was obvious to you and me, but not so obvious to others.We discussed where investors could hide from the madness of the bubble, although we couldn't find many places. The best advice you gave to my audience at the time was to get out and get the longest fixed-rate mortgage possible for their homes. So, fortunately, many people did that. People who got a 10-year mortgage at the time had an interest rate of 1% to 2%, not 6%.Now let's talk about this huge bubble again, it's a great time. I hope the audience can also get out and sell their overpriced stocks because the bubble started to burst from 2022. I guess what you're going to tell me is that we're just in the process of the bubble collapsing.So how is the whole thing going now?Jeremy Grantham: Well, everything is in progress. A big bubble takes time, a few years to rise and a few years to fall. The market suffers from attention deficit disorder. So it always thinks that every rebound is the beginning of the next bull market.Host: But at this point, there must be other disruptions. The first one is what I call the presidential cycle. Generally, from October of the second year after the election to April of the third year, the stock market does not have a significant retreat. Because this period often has a lot of stimulus policies. The average return of these 7 months is equal to the remaining 41 months, which is quite amazing.Jeremy Grantham: The best example is 2001. The tech bubble was huge. Growth stocks were hit hard in 2000, falling 50%, and then had a slight rebound at the end of the year. Then in January, there was a huge rebound, 8% or 9%. So we should have the same expectation, but our rebound will be less.This situation did not happen in 1929, 1972, 2000, or 2007. They cleverly avoided the seven-month window period. But this time, the bubble liquidation happened to hit this window period.Host: So, we got some probation.Jeremy Grantham: We got a temporary reprieve. We encountered the AI mini-rally. Although there are only a dozen stocks, some of them are large-cap giants, which have driven a significant rebound in the market. With the support of these large companies, how much has the S&P risen this year? I don't know, 15? 16? 17%?Host: A small reprieve for the index.Jeremy Grantham: Is this artificial intelligence thing real? My answer is definitely yes, it is absolutely real. It will have a huge impact. But can it prevent an economic recession? No, I don't think so.Beneath the surface, the economy is deteriorating, debt is increasing, consumer spending and their stimulus plans are disappearing. Except for maybe the richest 10% or 15% of people, most people will be affected. Biden has already canceled the student loan repayment deferment, which is a big deal for Americans.It is becoming increasingly difficult for small companies to obtain debt. The government's debt level is enormous, and rising interest rates are putting a real burden on the budget. Many things continue to worsen. My guess is that there will be a recession soon. I don't know if it will be mild or severe, but it could last until next year.Host: But there is still a prevailing view that this will be a soft landing. I remember you said before, "All landings are soft landings until they become hard landings."Jeremy Grantham: Every bubble is accompanied by cheers of a soft landing. Each cycle has its own surprises.Host: Can you guess what the surprise will be this time?Jeremy Grantham: "We have already had a dress rehearsal, haven't we? Several large regional banks in the United States have just collapsed."Host: But unlike most crises, this one is actually controllable.Jeremy Grantham: The banking crisis does show that the authorities are very aware of the destructive impact because they acted very quickly.Perhaps you could argue that people should be able to discover the vulnerability of Silicon Valley banks and others to VC and high-yield levels. Silicon Valley banks have a large portion of their investment portfolios in low-yield bonds, which happen to coincide with the heavy blow of rising interest rates. VC itself, as well as real estate, will certainly suffer a lot of pain in this cycle.So far, VC is the only industry that has been completely trapped. IPOs have basically come to a halt, and capital inflows have dropped significantly, soon to be about one-third. Therefore, the VC industry seems to be behaving as if there has been a major bubble burst, while other parts of the market, especially artificial intelligence, are doing much better.Overpriced real estate accompanied by a stock market bubbleHost: Do you feel that the most vulnerable right now might be private equity firms? Many companies are burning cash quickly and need more cash. We have heard a lot of news about private equity firms having to borrow at high interest rates. We want to know what will happen to this industry in the coming years.Jeremy Grantham: They may feel the pain the fastest.It's all about real estate. When mortgage rates are lowered, people can afford to pay more, driving up housing prices.At 3% interest rates, you pay $400,000 for your house. When mortgage rates reach 6%, you suddenly realize that you can't afford the house, and you decide to give up. This is reflected in the market as a drop in housing prices. Mortgage loans fill the existing affordability gap, and housing prices are not reliable in the short term, but they are a very reliable leading indicator in the long term.In the past 40 years, mortgage interest rates have been continuously declining while housing prices have been rising worldwide.Housing prices are more important to ordinary families. Their impact on the economy is greater than that of stocks because their returns are more extensive. Real estate is indeed an important component of middle-income households and capital. Our motto should be to not mess up the real estate market.The ultimate motto should be to never have a real estate bubble at the same time as a stock market bubble, which was a huge mistake made by the Japanese, creating the largest bubble in history in both aspects. However, we have not been blinded by the absurd subprime mortgages.But in terms of the actual long-term vulnerability caused by overpricing, the real estate market is overpriced, accompanied by a more typical bubble stock market than in 2007.The US stock market is not as good as it seemsHost: So we can see its role in real estate markets around the world. But obviously, all stock markets are different because they have emerged from bubbles at different valuation levels, and the US may be the most expensive.What will happen to the US stock market next?Jeremy Grantham: The Russell 2000 is a good measure of vulnerability, with a very high density of zombie companies in this index, about 40% of which have no positive earnings. They have record-breaking debt and can only pay interest by issuing more debt. Their proportion has never been as high as it is today, and the scale of debt has never been so large.So these small-cap stocks are vulnerable in many ways. That's the interesting part.If we take inflation into account, the Russell 2000 index did not actually rise last year, nor in the past two years, nor in the past five years.Why don't people adjust for inflation? In the 1970s, 1980s, and 1990s, we always did, but now we have forgotten because inflation has gradually declined to zero over the past 25 years, and we have lost this habit.The S&P 500 index just looks high, but the market performance is not as good as people imagine, and the pain is as severe as losing one percentage point due to inflation or anything else.Host: But that's not the reality, is it? I mean, it's not in people's minds. In a sense, people don't feel like they've lost all their hard-earned money. They don't feel like their housing prices have collapsed, and so on.Jeremy Grantham: Yes, they are more easily misled and think that the situation is still fine until they go to the supermarket.Host: And if your wages rise at the same time, if your wages match inflation, then in a sense, inflation is not too bad for many people. I'm not advocating for it. I'm just saying it's not that bad.Jeremy Grantham: That's what they say, but if you really ask them how they feel, the results are completely opposite. In the UK and the US, people have very low confidence in the economy. If you ask them if they felt better last year, hardly anyone would say yes.No one feels better off, even though a large portion of people are clearly better off in real life. The result is that both the rich and the poor feel a bit tight in today's environment. In this sense, I think your judgment is incorrect, as inflation does indeed affect consumer confidence.Another issue is that because Americans have received a lot of money from government stimulus programs, they have chosen to enthusiastically bid farewell to the pandemic, board planes, and travel to Spain again. Many people have already spent the money they saved during the pandemic. Their credit card debt is also increasing, as if there is no tomorrow, and the overall debt level is increasing. The savings rate in the United States has never been so low.In the worst case scenario, the US stock market will be halvedHost: In your recent memo, you mentioned that quite a few stocks have actually fallen significantly. After adjusting for inflation, the stock prices of companies like Amazon, Alphabet, and Meta must rise by 70% to 150% to return to their peak in 2021. There is a lot of bubble in the market.I suspect that there are some growth-oriented investors who are more enthusiastic than you and me, and when they see these prices, they will say it is a perfect buying opportunity.Jeremy Grantham: Well, they usually do. Once you see a stock selling for $300, even if its intrinsic value is $100, you will think it has the sacred right to return to $300.So when it drops to $200, you will think it is a valuable trade, even though its intrinsic value may be $100. So you buy it, and then it drops to $150, it still looks good, and then it finally drops to $100, you are very sad, and you sell it, and finally it drops to $80, which is below its intrinsic value.Host: But you can't buy anymore because the losses are too severe, and you are afraid.Jeremy Grantham: Yes. But it is important to reinvest in fear. In 2009, when investors were afraid, even though the valuations were the cheapest in over 20 years, they still didn't dare to act.Host: You had to be brave in 2009, right? If you bought at that time, there was a great opportunity to get extraordinary returns in the next ten years, which was difficult.Jeremy Grantham: If you blindly buy when prices are high, you are more likely to lose money. But the real courage is to buy when the market hits its low point.Host: Not now?Jeremy Grantham: No, not now. Look at the most predictive indicators, the top 2% or 3% of all peaks today, there was a peak in 2000, and there was a peak in 2021. Today's peak is higher than in 2000, but lower than in 2021.If the stock market is to fall to a level 5% higher than the yield of long-term bonds, mathematically speaking, the market will have to fall by more than 50%.For the S&P 500, it would be reasonable for it to be below 3000 points. If everything goes bad, it could fall to 2000 points, and I wouldn't be surprised. But that would be a big problem.Host: What can turn the situation around now is, of course, inflation dropping to 2% or lower, which is not impossible, and then interest rates also falling.We know that the market dislikes high and unstable inflation. Most people have an expectation that inflation will eventually return to the target level, and we will see interest rates start to decline. I think this expectation has been tested in the past few weeks. Additionally, the narrative of "higher and longer" is gaining more attraction, but it is relative.Jeremy Grantham: Looking further at the "Seven Sisters" of technology stocks, these seven companies have had unprecedented performance in terms of profitability and in the stock market. These stocks not only have considerable returns, but their PEs are also steadily rising. The sudden appearance of trillions of dollars in market value is a breathtaking sight.If we exclude the Seven Sisters, the S&P 500 would not have risen this year, or maybe it would have risen, but very little or not at all. All the 10% or 12% rebounds are supported by the Seven Sisters. We have never seen such a narrow market.Will they continue to grow and account for 70% of the global market value? Will they face government crackdowns? Will they attack each other and enter each other's markets, lowering their own profit margins? Will new technologies emerge to defeat the iPhone?I noticed that in 1972, the 50 high-quality companies in the Nifty Fifty, such as Coca-Cola and IBM, had a 50% premium in fair value relative to the market. Quality stocks experienced a huge bubble.In 1972, they started to die off like flies. Avon, Polaroid, Exxon, Kodak, and IBM all suffered heavy losses, and then the Nifty Fifty lost their magic. They lost the huge premium they had before and performed poorly for decades. Will this happen to these new "Magnificent Seven"?I think this is an unanswered question because each of them relies on completely different economic sectors. It's a series of very complex questions, and I don't have the answers.Where should one invest?Host: I think we have identified where the bubble still exists, but I hope we can discuss some opportunities. Where should people put their money now?Jeremy Grantham: A few details. Interest rates have been declining for 40 years until recently. You basically spent 40 years pushing up asset prices, led by real estate, as we said. But everything ultimately follows the same logic.If I'm getting a negative return in my piggy bank, I better go look for positive returns. A competition is underway. Global real estate is generally overpriced, just like farms, forests, and art.The peculiarity of stock markets outside the United States is why they perform so ordinary, which confuses me a bit. I think the tech bubble in 2000 was somewhat similar.From Canada to Australia, your typical assets, such as real estate, are clearly overpriced, while the stock market is performing mediocrely. It's not just emerging markets, developed countries outside the United States have been and are still investable.Host: Japan, most parts of Europe, the UK, I mean, we always look at the UK and Japan, I think they are the cheapest markets.Jeremy Grantham: They certainly appear to be the cheapest. Overall, the rest of the world seems invisible. Do your analysis, make your mistakes, and so on. But it's reasonable, so don't invest in real estate, don't invest in the United States, and if you must invest in the United States, I advise you to take a good look at assets that have been mispriced for the past 100 years.Defensive stocks often perform well in bear markets. Why? Because they're boring. In a bull market, you want to make money on Tesla, you want to buy meme stocks, you want to make money on things that can take off.You don't want to buy Coca-Cola, it's too boring. In the long run, Coca-Cola performs very well in bear markets, especially on average. That's the only free lunch. And the current price is not high either.Host: Finally, Jeremy, our show will have a Q&A session, and everyone has to answer. If you could have something to hold onto for 10 years, I'll give you only three choices: gold, bitcoin, or cash, what would you choose?Jeremy Grantham: I would choose gold. I'm not thrilled about gold, but in a world where inflation may come back, I think I would choose gold. Bitcoin is indeed a well-designed scam, but gold is the least bad among the three.