Jeremy Grantham thinks US stocks could crash next year.

Grantham is the founder of GMO, a firm that manages $118 billion. He’s widely respected for warning about the 2000 market crash and the 2008 financial crisis.

Although most large money managers will tell you to always be in the market (which means you will always pay them fees), Grantham is willing to speak his mind, even if that means telling people to get out of the market.

Grantham just made another bold call. He thinks the US market is “ripe for a major decline” in 2016. He says it could spark the worst crisis since the Great Depression. The Financial Times explains:

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 recapitalize 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.”

It’s an ugly picture. Grantham doesn’t know exactly what will ignite the next crisis. But high valuations will contribute to the selling pressure.

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.”

Global markets are fragile right now. Since the last financial crisis, governments have tried to print away their problems. They’ve piled on debt. And most are devaluing their currencies.

•  Rising real estate prices are one of the many side effects of government money printing…

US commercial property prices are at an all-time high.

The Financial Times reports that “[commercial real estate] values have risen over 12% in the past year to surpass their boom-time peaks.” They’re now 18% higher than they were during the last real estate bubble.

Easy money is helping to drive this hot market. The Wall Street Journal explains:

Low interest rates and a flood of cash being pumped into economies by central banks have made commercial real estate look attractive compared with bonds and other assets. Big US investors have bulked up their real-estate holdings, just as buyers from Asia and the Middle East have become more regular fixtures in the market.

The Federal Reserve cut interest rates to nearly zero percent after the 2007-2008 housing crash to try to stimulate the economy. It has held interest rates near zero ever since.

Regular Casey readers know that this is unprecedented in modern history. Interest rates have never been this low for this long. And because interest rates are the price of money, money has never been this cheap for this long.

This chart shows that commercial real estate prices bottomed very soon after the Fed cut rates to near zero. They’ve risen 93% since bottoming in 2009.

•  Real estate is one of the only places investors can earn a decent yield…

Real Capital Analytics reports that the average capitalization rate for New York commercial real estate is 5.7%. This “cap rate” is essentially the yield on commercial real estate in New York.

It doesn’t sound like much, but 5.7% is more than investors can earn in many stocks and bonds. Because the Fed is still holding interest rates near zero, 10-year US government bonds pay just 2.16% today. That’s less than half of their historical average of 4.61%.

Stocks aren’t any better. Investors have piled into dividend-paying stocks, pushing prices up and yields down. The S&P 500 yields just 2.0% today.

The Wall Street Journal is one several sources warning that the commercial real estate market looks overheated.

The surging demand for commercial property has drawn comparisons to the delirious boom of the mid-2000s, which ended in busts that sunk developers from Florida to Ireland. The recovery, which started in 2010, has gained considerable strength in the past year, with growth accelerating at a potentially worrisome rate, analysts said.

“We’re calling it a late-cycle market now,” said Jacques Gordon, head of research and strategy at Chicago-based LaSalle Investment Management, which oversees $56 billion of property assets.

While it isn’t time to panic, Mr. Gordon said, “if too much capital comes into any asset class, generally not-so-good things tend to follow.”

Even the Federal Reserve is warning about this frothy market it helped to inflate. Last month it said that “valuation pressures in commercial real estate are rising as commercial property prices continue to increase rapidly.”

Chart of the Day

We explained earlier that Jeremy Grantham is worried a stock market crash could wipe out major world governments. He thinks governments could go bankrupt trying to bail out the financial system during the next crisis.

It’s a real concern. Governments are far more indebted today than they were before the last financial crisis. They have less room to borrow…which means they have less ammunition to fight a crisis.

Today’s chart shows the US government’s debt compared to its gross domestic product (GDP). Debt is 102% of GDP today. Which means even if the US government confiscated every penny of US output for one year, it still wouldn’t have enough money to pay off its debt.

The US debt/GDP ratio is now at its highest level since World War II. As Grantham explained, there’s a very real chance that the government won’t be able to save the financial system when the next crisis hits.

We share all of our best advice on how to protect yourself from the next crisis in our new book, Going Global 2015. This book usually retails for $99. But we’re currently offering it for a nominal $4.95 processing fee until we run out of copies. Click here to request your copy today.


Justin Spittler
Delray Beach, Florida
August 13, 2015