AI Bubble Warning: Jeremy Grantham Predicts Market Crash

Legendary investor Jeremy Grantham has sounded a dire alarm about the artificial intelligence boom, declaring it a historic bubble that will inevitably burst. The co-founder of Grantham, Mayo & van Otterloo (GMO) believes the AI surge mirrors the most destructive market manias in history.

During a recent podcast appearance, Grantham laid out a simple yet chilling thesis: the AI frenzy meets every condition of past bubbles, from the railroad mania to the internet boom. His prediction carries weight given his track record of forecasting market downturns, including a major crash warning four years prior.

I think it's obviously a bubble, and I think it's quite a simple story.

Grantham draws direct comparisons between today's AI excitement and two world-changing inventions that previously sparked investment manias: the railroad and the internet. Both technologies fundamentally transformed society, yet their early adoption periods were marked by speculative excess that ultimately devastated investors.

The veteran market historian notes that bubbles don't form around trivial ideas. Instead, they cluster around transformative technologies with genuine potential. This makes them more dangerous, not less.

All the bubbles are associated with serious things, and the more serious, the bigger the bubble.

When these bubbles popped, Grantham observes, they "brought the economy to its knees for a year or two" and "everybody lost their money." The pattern suggests AI, despite its genuine utility, is following the same destructive trajectory.

Grantham emphasizes what he calls the iron law of market valuations: when an asset doubles in price, the return from holding it forward halves. This mathematical certainty underpins his pessimistic outlook for AI stocks, which have seen meteoric rises in recent years.

The logic is straightforward yet often ignored during bull markets. Investors who chase assets after they've already doubled are essentially locking in diminished future returns, regardless of the technology's long-term potential.

If you want to have the highest market in history, you will have the lowest returns in history going forward.

Grantham believes this law will manifest inevitably in the AI sector. The more prices rise now, the steeper the eventual correction will be, potentially wiping out years of gains in a matter of months.

Grantham traces the current AI frenzy to OpenAI's ChatGPT release in late 2023, which generated "immense buzz" and sparked massive capital outlays across the tech industry. These investments, while potentially productive, also served to stave off an economic slump, creating a feedback loop of optimism.

Big Tech companies have leveraged their dominant market positions to boost profit margins to what Grantham calls "excessive levels." Yet he argues this strength won't prevent the bubble from bursting—only delay and amplify the eventual collapse.

The probabilities that AI will not bust are slim to none.

He specifically identifies Nvidia as the likely leader of the downturn. "My guess is Nvidia will lead it down, and all the others will follow for a while," Grantham stated, predicting a cascade effect across the sector.

Perhaps most damning is Grantham's analysis of why professionals remain silent despite obvious overvaluation. He identifies institutional inertia and herd mentality as powerful forces preventing market correction.

Industry professionals understand the market is "silly," yet they continue participating for career preservation. The fear of underperforming rivals, damaging reputations, and losing clients or jobs creates a collective paralysis.

They all look around nervously at each other, but they keep going. As long as the music's playing, they're going to be dancing.

This psychological dynamic means the bubble will likely inflate further before collapsing, as few are willing to be the first to exit the party. The longer the music plays, the more devastating the eventual crash.

Despite Grantham's warnings, the market continues its upward trajectory. The S&P 500 has risen approximately 80% over the past five years, defying skeptics and reaching new highs regularly.

Other high-profile investors disagree with Grantham's assessment. Kevin O'Leary of "Shark Tank" fame argues that AI's productivity gains are measurable and real, unlike the dot-com bubble's speculative promises. Tech investor Ross Gerber contends that current valuations are justified by AI companies' enormous growth potential and "insane" profitability.

This divide between bears and bulls highlights the fundamental uncertainty. While Grantham sees historical patterns repeating, others believe AI represents a genuine paradigm shift that warrants premium valuations.

Grantham's warning presents investors with a critical choice: heed historical patterns or embrace the new paradigm. His prediction that "the market will become a whole lot cheaper" suggests significant downside risk for those fully invested in AI-related stocks.

The veteran investor's track record lends credibility to his concerns. Having predicted previous market downturns, his analysis forces a sober assessment of current valuations versus long-term fundamentals.

Ultimately, Grantham believes that "out of the ashes several of them will once again inherit the world," suggesting that while the bubble will burst, the underlying technology will survive and thrive. The question remains: how much wealth will evaporate before that happens?