'Don't invest in the US': Jeremy Grantham just issued a warning over American stocks, saying S&P 500 could crash by over 50% if 'a couple of wheels' fall off — here's where to look instead

“Don’t invest in the U.S,” he said, pointing to the nation’s $33 trillion debt crisis, elevated interest rate environment, unsustainably high yield levels and the immense challenges in the real estate and mortgage markets.

Instead, he pointed to developed markets like the United Kingdom, Japan and most of Europe as being good and “cheaper” alternatives to investing in the U.S.

“In general, the rest of the world seems investable,” he said. “Do your analysis, make your mistakes et cetera, but it's reasonable.”

Here’s why Grantham is so concerned about the state of the U.S. stock market and how you can adapt your investing strategy if you share his bearish views.

The state of the US market

Grantham has a classically bearish outlook on the U.S. market. As Somerset Webb pointed out, the investment strategist is known for his analysis of bubbles and for his bearish forecasts that have come at useful times, such as 2000 when the dot com bubble burst and 2007-8 with the subprime mortgage crisis.

According to Grantham, the “most vulnerable area” in the U.S. market at the moment is the Russell 2000 Index, a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 index. This is often considered a bellwether of the U.S. economy because of its focus on small companies that make up the bulk of domestic business.

“It has a very high density of zombies — companies that really can only pay their interest payments by issuing more debt,” he said of the Russell 2000. “A very high ratio — something like 40% — don’t have positive earnings and they have record debt.”

Grantham had little better to say about the S&P 500. He's forecasting a dip to below 3,000 points, which would be “reasonable” in his mind. The index is currently hovering around 4,300 points.

“If everything works out badly, which it sometimes does, I would not be amazed if it went to 2,000,” he said. “But that would require a couple of wheels to fall off.”

Really, it's the “Magnificent Seven” — the seven largest U.S. companies by market capitalization: Apple, Microsoft, Amazon, Google, Nvidia, Tesla and Meta — that are carrying the U.S. market and asserting its global dominance, according to Grantham.

He said the Magnificent Seven’s “unprecedented” earnings and stock market performances this year — with the help of “a steady rise in PE [private equity]” — lead to “the sudden emergence of multitrillion-dollar market caps.”

But if you took them out of the equation, “the S&P 500 would not be up for the year,” Grantham said.

“There has never been such a narrow market,” he told Somerset Webb. “What will happen to them is a very interesting question. Will they continue to grow and become 70% of the entire world's market cap? Will they be attacked by governments? Will they attack each other, grow into each other's markets and beat down their profit margins? … Who knows.”

Amid such uncertainty, there are various ways you can mitigate risk in your investment portfolio.

If you must invest in the US — do this

If you remain confident in the U.S. stock market conditions and want to continue investing in domestic companies, Grantham said it’s critically important to “take a good look at quality.”

“Quality has been the miss-priced asset for 100 years,” he said.

He gave the example of AAA bonds, which are deemed to have the highest creditworthiness and the lowest degree of investment risk. “They outperform in bear markets and they underperform in bull markets … because they’re boring,” he said.

“In a bull market, you want Tesla, you want to own meme stocks, you want to own what's fly,” Grantham continued. “You don't want to own Coca-Cola. It's just too boring. In the long run, Coca-Cola does very well.”

He added: “When it comes to quality, they have less risk every time. They have less debt, they go bankrupt less, they have less volatility, they have a lower beta, yet they out-perform.”

A quality investment, according to Grantham, would be a company with low debt and high, stable returns. And he’s not the only high-profile investor to preach such advice.

Warren Buffett is a huge advocate for value investing and backing high-quality businesses with low capital needs — his favorite seemingly being Apple, which makes up over 45% of Berkshire Hathaway’s investment portfolio as of June 30, 2023, with holdings worth over $160 billion.

If you’re bearish about the US — look elsewhere

It’s relatively easy to invest in global stocks these days — and doing so has three big advantages: diversification, an expanded universe of opportunities and global growth potential.

There are a few different ways to access foreign stocks, including buying them directly in a “global account” offered by brokers such as Fidelity, E*TRADE or Interactive Brokers. But that method isn’t ideal for average investors. Direct foreign investing comes with added costs, tax implications, currency converting and a whole host of support issues.