Could the ASX 200 be poised for a historic crash?

Overt central bank support for share markets could be nearing an end… for now.

ASX shares COVID the words crash with a declining arrow on top

Image source: Getty Images

Key points

  • ASX 200 down 5.9% year-to-date
  • Nasdaq down 10.3% year-to-date
  • Jeremy Grantham expects more pain ahead

The S&P/ASX 200 Index (ASX: XJO) is down 2.5% in afternoon trading.

With today’s intraday losses factored in, the ASX 200 is now down 5.6% since the opening bell on 4 January.

That comes after gaining 13% during calendar year 2021.

And it’s not just the ASX 200 that’s well into the red in the new year.

In United States markets, the Nasdaq closed down 1.3% yesterday (overnight Aussie time). That puts the tech-heavy index down 10.3% year-to-date, which is officially in correction territory.

The S&P 500 has fared a bit better, down 6.5% so far in 2022.

Like in the US, ASX tech shares have also taken a larger hit here in Australia, as witnessed by the 14% decline in the S&P/ASX All Technology Index (ASX: XTX) since 4 January.

What’s dragging on the ASX 200 lately?

Atop increased fears that the Omicron variant may delay the global reopening, analysts are broadly pointing to the likely winddown of quantitative easing (QE) along with rising interest rates from central banks as throwing up headwinds for global share markets.

Now, after 2 years of easy money, the US Federal Reserve and other leading central banks like the Reserve Bank of Australia look set to tighten policies this year.

Indeed, as Bloomberg reports, Jeremy Grantham, co-founder of asset manager GMO, says the days of the US Fed actively supporting stock markets from large losses look to be near an end. At least for now.

With inflation running hot and looking more structural than transitory, the Fed and many other central banks may have little choice. Not that they won’t attempt to prop up markets, according to Grantham.

“They will try, they will have some effect. There is some element of the put left. It is just heavily compromised,” he said, referring to the Greenspan put named after former Fed chair Alan Greenspan.

“Everything has consequences and the consequences this time may or may not include some intractable inflation” Grantham added. “But it has already definitely included the most dangerous breadth of asset overpricing in financial history.”

Where the S&P 500 goes the ASX 200 often follows

While the ASX 200 doesn’t move in lockstep with the S&P 500, the 2 global indexes do tend to move in similar patterns over time.

And if Grantham, well known for calling out market bubbles, is correct, the S&P 500 could have a lot further to fall before hitting bottom.

In saying that, US shares are in a “super bubble” – only the fourth in 100 years – and he predicts some big losses before shares markets revert to their statistical norms.

According to Bloomberg, Grantham believes that could see the S&P 500 fall another 45% from Wednesday’s close, with the Nasdaq potentially falling even further:

I wasn’t quite as certain about this bubble a year ago as I had been about the tech bubble of 2000, or as I had been in Japan, or as I had been in the housing bubble of 2007. I felt highly likely, but perhaps not nearly certain. Today, I feel it is just about nearly certain.

Now some analysts point to the fact that the Russell 2000, comprised of mid-cap shares, only gained 13.7% in 2021 compared to the stellar 26.9% gain posted by the S&P 500. This is important as mid-cap shares tend to outperform blue-chips during bull markets.

However, Grantham says that this is even more cause for concern:

This has been exactly how the great bubbles have broken. In 1929, the flakes were down for the year before the market broke, they were down 30%. The year before they’d been up 85%, they had crushed the market.

Signs that US markets, and by extension perhaps the ASX 200, are nearing the end of a massive bubble include the rapid gains in some meme stocks, the non-fungible token (NFT) craze, huge interest in cryptos with little real-world use, and “a buying frenzy in electric-vehicle names”.

According to Grantham, “This checklist for a super bubble running through its phases is now complete and the wild rumpus can begin at any time. When pessimism returns to markets, we face the largest potential markdown of perceived wealth in U.S. history.”

What’s an investor to do?

Investors who believe that Grantham’s bubble call is correct may be thinking of reallocating more funds into bonds. But Grantham believes that’s a mistake, with bonds also looking at a serious correction while global real estate is in “the broadest and most extreme” bubble ever.

So what’s an ASX 200 investor to do?

Bloomberg reports that Grantham favours stocks trading at cheaper valuations in Japan and emerging markets. He also recommends investing in some gold and silver and owning resources to serve as inflation protection, along with increasing cash allocations to invest once the bubble has burst.

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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