Grantham Says S&P 500 Could Rise to 1,500 in 2011

Last Updated Nov 10, 2010 7:08 PM EST

Jeremy Grantham routinely takes potshots at Ben Bernanke and his Federal Reserve colleagues for what he sees as policies that encourage - almost guarantee - the formation of market bubbles and poor decisions by investors, businesses, homeowners and consumers. Grantham has the Fed in his sights again in his latest quarterly newsletter, "Night of the Living Fed," but this time he's firing a rhetorical blunderbuss.

But for all his disdain for the Fed, Bernanke and his predecessor, Alan Greenspan, and his concern about the economy and financial markets, Grantham, chief investment strategist of the fund manager GMO, has some curious advice for investors considering buying stocks: Pull the trigger. Bubbles are dangerous creatures, and one very well may be forming in the stock market now, he warns, but there's something to that adage about not fighting the Fed, especially when, if you'll forgive another weapons-related figure of speech, the Fed is firing so much ammunition. That's one of the messages in the newsletter, and Grantham is expected to reiterate it Thursday in a CNBC interview.

The $600 billion of quantitative easing, or QE2, the Fed's policy of trying to boost the economy by buying Treasury bonds, could provide enough support for stocks to keep them rising well into 2011, Grantham says. That happens to be the year before the presidential election, traditionally a period of exceptionally strong returns. If ever there were an occasion to think that this time is different, this is it, he acknowledges, what with the remarkable strength of the last two years, normally a time of subdued returns in the presidential cycle. Still, he thinks that stocks will continue to rise, thanks to his least favorite zombie:

Third Year's the Charm
"I expect that the bottom line will come down to short rates. Surely they will stay low for the entire Year 3. And, if so, the line of least resistance is for the market to go up and for risk to flourish. In the last six months I've guessed on separate occasions that levels of 1,400 or 1,500 on the [Standard & Poor's] 500 are reachable a year from now; this still seems a 50/50 bet. If we include more moderate market advantages, the total odds would be well over 50 percent."
Grantham warns that certain events could radically alter his forecast, say a bout of protectionist sentiment in Washington, a dollar crisis ignited by QE2 or maybe a double dip for the economy. Even if stocks do get as high as he envisions, he writes, "we once again face the consequences of a badly overpriced market and overextended risk taking. . . . And this time the government's piggy-bank is empty. It is not a pleasant prospect."

Yet figuring the balance of probabilities, he finds stocks to offer a decent risk/reward opportunity, especially high-quality stocks (those of big, financially strong companies). That segment of the market, which has long been one of Grantham's favorites, has become so cheap, in his view, that it may generate returns close to those of trashier stocks, which tend to outperform in frothy markets, while continuing to provide a cushion in a downturn.

Heavy Investment by Canines
He would also opt for stocks in emerging markets, which remain cheap, at least compared to the riskier issues of the S&P 500. But he urges caution, noting that "everyone and his dog [is] now overweight emerging equities, and most stated intentions are to go higher and higher." Such uniformity of opinion often precedes a move in the other direction.

Grantham may be predicting another strong run for stocks in 2011, but it's clear that his heart isn't in it, for he fears grim times after the rally ends. He thinks the markets would be safer and ultimately more rewarding if the Fed guided the economy with a lighter touch that made it, well, a less scary institution:

"If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times - the Greenspan/Bernanke put. It would be a better, simpler and less dangerous world, although one much less exciting for us students of bubbles. Only by hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke's next scheduled reappointment hearing."