Jeremy Grantham's Losing His Growl

OK, Grantham still believes Wall Street, based on long-term earnings and multiples, is about 50% overvalued. He believes house prices will have to "fall 25% tomorrow, or stay flat for five years," to get back in line with long-term measures. He believes pretty much everything else, from bonds to emerging markets, are overvalued too.

Ominously, for the first time in 20 years he is now worried about inflation as well. And he joins a small but growing number who distrust the benign "official" consumer price data.

But the bear seems to have lost his growl. His prediction for the next 12 months? "A modest up year, with a mixed return to risk-taking but strong emerging market performance, would be my guess."

He suspects Wall Street might eke out a small gain, even if earnings fall modestly. "Any major bearish behavior is likely to wait for another 12 or 18 months," Grantham writes, though he adds: "accidents do happen." He advises cautious asset allocation spiced up with some emerging markets.

Grantham has always been a watcher of the presidential cycle, which has tempered his fears of immediate declines. Wall Street has usually done well in the third and fourth years of the presidential cycle. And perhaps I am reading too much into his tone. But this is surprisingly sanguine.

What's changed? In a word: Bernanke. Grantham hoped the new Fed chairman would take a tougher line on bubbles and easy money, but at the first test he brought back the punchbowl with no resistance.

"For a short while I had touching faith that the more 'academic' Bernanke would take a tougher line than Greenspan," Grantham writes, "and he did sound fairly fierce early on, but as the heat turned up he overcame any qualms and threw in the towel quickly enough."

The fact that the party has found a new friend in Ben Bernanke may be a good reason for being more bullish for a while, regardless of fundamentals.

For a peek at Grantham, Mayo Van Otterloo's holdings, check out this portfolio on Stockpickr.