Jeremy Grantham: ‘This Could Be the Buying Opportunity of a Lifetime’

Long before the credit crisis, you warned stocks were overvalued and housing was a bubble. Any surprises?

Even going back to 1998, I was counting on the market coming back to what we consider a long-time normal price, around 900 for the S&P. We can’t say we were enormously surprised, though now it’s trading below that level, because after a big bubble, markets have always over-corrected.

And I was saying in 1998, when we were horrible early sellers, for which I took a lot of grief, that my next great mistake would be buying too soon. I have no doubt that will happen. And we were buying in October, happily from a very low base of equities. We added a big dollop of U.S. blue chips and two small dollops of riskier assets — emerging markets and small-cap international — to our asset mix.

Looking out over the next seven years, we see annual returns in the range of 7 [percent] to 11 [percent] for all three asset classes.

Is it time to buy stocks? Or could they fall further?

If you’re tough enough to hang in there for a while, you’ll eventually get a decent enough return. On the other hand, I think there’s a 2-to-1 chance it will go to new lows in the near term. You need to build up some cash, though, because the market could drop another 30 percent. We think it’s perfectly capable of hitting 600 or below in the next year or so, which would be a great buying opportunity for stocks. In the meantime, the market could be pretty brutal.

Will asset valuations revert to their historical means?

Yes. Reverting to the mean is a pretty slow, mild process, but it’s dependable in the long run, say over seven to 10 years. The market will go back up, the valuations will increase from today’s levels, and over the long term you’ll do pretty well. That said, it would be nice to have some ammunition to buy some strong stocks when the S&P 500 hits 600 or lower. And that’s what we’re planning.

We’ve kept some pretty substantial buying power in most of our accounts — money in fixed income so we can transfer into equities. If the market continues to drop at this pace, we will be fairly steady buyers at intervals on the way down. We’ll throw in most of our lot and buy stocks when the market hits 600.

What if you’re disillusioned by diversification?

is better than picking a single asset class. Always. The problem this time is that the bubble was centered in risk taking. Every risky investment had bubbled under the pressure of too much money, too low interest rates, and too many hedge funds.

That meant that every risky category of investment went down together. The only diversification that mattered this time was in anti-risk asset classes, such as cash and government bonds. Long government bonds last year were up 30 percent. That was a huge diversification. And cash was cash. And that was one bet we got right that helped a lot. Had we not diversified, things would’ve been much worse.

No, not . It’s a response to value. If it’s cheap, you buy it. If there’s a sale on and you go and buy, I guess you could say that’s timing. You time it for when the market is cheap. People think of market timing as hopping in and out of the market, day-by-day tactical stuff. I’m talking about long-term strategic moves.

We were overweight emerging markets for 12 years, because they were cheap for 12 years. And when they get expensive, we get out. I call that sensible asset allocation based on risk and return.

Market timing, by the way, is a tag some buy-and-hold investors use to put down anything that involves using your brain. These are the same people who like to watch the locomotive coming and get run down in the name of discipline.