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Is the ASX headed for a massive crash?

Legendary investor and chief investment strategist at Boston-based fund manager GMO, Jeremy Grantham certainly believes that equity markets are headed for a crash unlike any other.

Speaking to Fortune magazine, Mr Grantham says he wouldn’t invest his clients’ money in US stocks for at least the next seven years. “Over the next seven years we think the market will have negative returns,” he said, adding, “Assets are overpriced generally. They will become cheap again. That’s how we will pay for this. It’s going to be very painful for investors.”

Mr Grantham says the US Federal Reserve’s bond buying program, or quantitative easing, has slowed the US recovery, failed to stimulate the economy, and instilled investors with the view that if anything goes bad, the US Fed would come to the rescue.

Mr Grantham also believes that low interest rates have failed to stimulate capital spending. At the same time, he says central banks around the world (mostly Europe, Japan and the US) have taken on all the leverage out of markets and put it on their balance sheets. “We have never had this before,” he says.

But despite his bearish view, Mr Gratham thinks the market could still climb around 30% before crashing again.

Having predicted the bubble in the early 2000’s and the US housing bubble, Mr Grantham has a decent track record when it comes to predictions.

Our view though, is that he is likely to be proved wrong this time. While US markets are at all-time highs and by no means cheap, there are early signs that the US economy is slowly recovering and US unemployment falling.

Of course the Australian market generally follows the lead of the US market, and another equity market crash in the US would have serious implications for the S&P/ASX200 Index (Index: ^AXJO) (ASX: XJO).

With the four major banks, ANZ Bank (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) making up a sizeable percentage of the market, fears of the Global Financial Crisis part II could see them hit particularly hard.

Foolish takeaway

While it’s always possible that stock markets will crash, it doesn’t hurt to make sure your portfolio is well diversified, and investors have at least some cash on the sidelines to take advantage of bargains that will surely be available.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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