What If Jeremy Grantham is Right?

by Alexander Green, Chief Investment Strategist

Jeremy Grantham, president of investment management firm GMO LLC, has been getting a lot of press lately.

At the market’s top, he warned of an impending bear market. At the bottom in March, he forecast a historic rally. Today, he says the market is 25% overvalued.

Should you be worried? Perhaps not.

Let’s start with Grantham’s track record. He’s made a couple of good calls lately. But does he get it right all the time? Of course not. No one does.

But even if he’s right, it wouldn’t necessarily be negative. It all depends on your time horizon. Here’s why…

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If you own stocks on margin, call options, or LEAP options, a market downturn could be devastating. A 50%

I concluded a post on stock markets over the weekend saying: “After equities’ seven-month climb, stock markets certainly look vulnerable for a decline. Two downside reversal days - on Wednesday and Friday - would seem to indicate that stocks could commence a pullback to work off the overbought condition, allowing fundamentals to reassert themselves.”

Global stock markets, as well as other risky assets, closed sharply lower over the past few days as concerns mounted over the sustainability of the global economic recovery and the outlook for central bank policy.

The performance of the major asset classes is summarized by the charts below, with the top one showing the period from the March 9 stock market lows until October 19 peak and the second one the subsequent period. The numbers indicate an all-change pattern in the performances as risk aversion re-entered financial markets and government bonds and the US

[Editor's Note: As Money Morning Investment Director Keith Fitz-Gerald's market analysis demonstrates, success as an investor requires knowing when to act.

But it also requires knowing where to look.

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Back in mid-June, more than 75% of the investors responding to a CNNMoney poll said they were planning to buy stocks – many of them aggressively.

Of the 41,572 people polled, it now looks like those 31,179 bullish investors kept their word.

The Standard & Poor’s 500 Index has zoomed 15% since those investors were polled (and 53% from its March 9 market bottom).

Let’s face it. A 75% bullish inclination is a disproportionately high percentage. It’s way out of the norm.

What those 31,179 bulls are telling me is … well … we’d better watch out. Statistically, the individual investor excels at making the wrong decision at precisely the worst possible time. I view this survey as yet more evidence that the “herd” may once again be heading down the wrong path.

After the collapse of Lehman Brothers Holdings Inc. (NYSE: LEHMQ) investors yanked

Risk aversion has re-entered the investment equation with risky assets such as equities and commodities bearing the brunt of the selling orders, while gold bullion, government bonds, the US dollar and the yen are attracting safe-haven money.

The global stock market pullback seems to be gathering momentum with three markets on my radar screen now trading below their 50-day moving averages, indicating a reversal of the secondary trend. These markets are China, Hong Kong and Chile, with most others uncomfortably close to this intermediate support level (see table below). I am of the opinion that more markets will fall below the 50-day lines and that we will at least see some degree of reversion to the key 200-day moving averages (often used to distinguish between primary bull and bear markets). The table provides the key levels, as well as the declines since the recent highs.

Click here

Jeremy Grantham has become a familiar and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, the co-founder and chairman of Boston-based GMO has just published the July edition of his quarterly newsletter, entitled Boring Fair Price.

Grantham’s 2Q 2009 letter includes the topics “Boring Fair Price” (or, “Waiting for Markets to be Silly Again”) and “Running Out of Resources”, which looks at slower economic growth in light of the recent financial crisis and dwindling resources.

Grantham starts the newsletter with the following paragraph:

“A year is certainly a long time in markets, and so is a quarter. A year ago, equities globally - and everything else for that matter - were very overpriced, particularly if they were risky.

“Timing is everything” goes the old adage. But all investors and traders know that timing an entry point or exit point of an investment idea and strategy is like predicting the weather without sophisticated radar equipment. In fact it might be more difficult.

Why? Not only because the fundamentals these days are enormously complicated, whether we are speaking of the stock markets, the bond markets, or the commodities markets, but because there are so many factors beyond our control and knowledge.

The “usual suspects” come to mind. The exchange specialists, the large instutional traders, the big financial firms with their trading desks, and now we are all competing with the Federal Reserve and the U.S. Treasury, who appear to be able to buy and sell anything they decide to whenever they want. Isn’t that your perception as well?

So none of us can effectively “time the markets”. We can look back with

Jeremy Grantham has become a familiar, and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, a fascinating interview with the co-founder and chairman of Boston-based GMO has just crossed my path. It comes in the form of a mega five-part interview recently conducted with the legendary investor.

This interview is not to be missed.

Part I: Grantham on getting back into the market He offers his take on re-entering a market that seems neither too expensive nor too cheap.

Part II: How Grantham defines “high quality” Grantham says to keep it simple when finding top-notch businesses and offers his take on high-quality’s recent lagging performance.

BULL - June 1: Deutsche Bank US equity analyst Binky Chadha forecasts S&P 500 at 1060 by 2009 year-end, citing improving corporate profit margins.  He said aggregate profit margins for S&P 500 “remains well below the average of the last few years, implying considerable potential upside over the medium term.”

BULL - June 1: JP Morgan Chase analyst Thomas Lee forecasts 2009 year-end S&P 500 index at 1100.

BULL - June 1: Bank of America/Merrill Lynch analyst David Bianco forecasts 2009 year-end S&P 500 index at 1100.

BEAR - May 30: Morgan Stanley equity analyst Jason Todd says sell this S&P 500 rally. He says Morgan Stanley does not see large upside above 825-850.  He said,  “In the rush to buy a cyclical recovery, it seems earnings or valuation no longer matters. We would be comfortable with this view if the earnings trough was closer, but it is not.”

BEAR - MAY 28: Berkshire

The opinions of Jeremy Grantham, veteran investor and founder of Boston-based money-management firm GMO, have been featured regularly in posts on the Investment Postcards blog. Against the background of his general disregard for  conventional wisdom, his turnaround in early March from a perma-bearish stance to a more bullish demeanour was particularly closely followed.

“… be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle less black than the day before,” he said in March in a newsletter entitled “Reinvesting when terrified“. He also cautioned investors not to fall prey to “terminal paralysis” that often sets in after a financial crisis.

A recent interview by SmartMoney with Grantham provides insight on why he has changed his mind and his prognosis for the future. A