Jeremy Grantham: Avoid bonds and stick to quality stocks

Jeremy Grantham has plenty of reasons to feel happy. After all, his investment firm GMO has enjoyed a good year, with its largest share fund up almost 10%. Moreover, many of Grantham's personal predictions, such as a short-term dip in commodity prices, have been borne out. But he's worried. The British-born US-based investor is gloomy about the world's, and particularly America's, growth prospects.

His view that Europe is in a "terrifying situation", won't come as a surprise to his followers, and is shared by many mainstream pundits. But his pessimism on America, where recent positive economic news has nurtured hopes of a revival, is striking.

Two years ago Grantham predicted that America was in for "seven lean years" as its economy recovered from the financial crisis. Now he warns that the developed economies, led by America, have "permanently slowed in their GDP growth". One reason, according to the 72-year-old investor, is age. "Slowing population growth, an ageing profile, and an over-commitment to the old, which leaves inadequate resources for growth." Another reason is financial recklessness. Grantham singles out the UK and the US for their poor savings rates.

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But it is America that bears the brunt of Grantham's pessimism. "The US in particular has rapidly acquired relative deficiencies over the last 20 years that will hamper the effective functioning and growth of its economy." Failing infrastructure, poor education and a less-effective government are all inflicting long-term damage to the US economy. As a result, he thinks the US is "sliding in some key areas that threaten loss of competitiveness" against the emerging economies.

Another less tangible problem is also bothering Grantham - fairness. He worries that rising income inequality in the US which "has become quite quickly one of the least equal societies" and "the stickiness of economic position from one generation to another", is eroding the sense of fairness in American society. That matters because with "a growing feeling of social injustice, a weakening of social cohesiveness, and, possibly, a decrease in work ethic" a healthy growth rate becomes "more difficult."

Grantham's advice? Stick to quality stocks and "tilt, where possible, to safety". Also avoid most long-term bonds as "they are deeply unattractive". And don't be too proud or too greedy to maintain a healthy cash reserve.