Grantham sees opportunity

Jeremy Grantham says he's spotted the third great investing opportunity of his career. The first was small caps in the 1970s. The second was real estate, Treasury Inflation-Protected Securities, and value stocks during the tech bubble in 2000. Before you get too excited, I should make clear that the main opportunity today, in Grantham's view, is getting out of the way and watching the markets plummet in what he calls a slow-motion train wreck. Grantham made this call in a report published July 25--a day before the Dow got 300 points sliced off the top (talk about instant gratification!).

Grantham calls this new opportunity "anti-risk." He says the opportunity lies more in bonds than stocks. "The ideal way of playing this third great opportunity is perhaps to create a basket of a dozen or more different anti-risk bets, for to speak the truth, none of us can know how this unprecedented risk bubble with its new levels of leverage and new instruments will precisely deflate. Some components, like subprime and junk bonds, may go early, and some equity risk spreads may go later."

I asked Grantham what else individual investors could do to make some anti-risk bets of their own. The wagers he's making for clients are too complicated for individuals, but he did offer a few ideas in addition to buying TIPS.

• Hold a lot of cash so that you'll have plenty of dry powder to take advantage of cheaper markets in years to come.

• Regular bonds are not too bad to own. (This means core high-quality bonds, such as corporate or Treasury bonds.)

• Short the Russell 2000 and go long on the S&P 500.

The final notion reflects Grantham's view that low-quality small caps will be terrible after many years of outperformance and high-quality large caps will fare well after years of lagging. The S&P 500 isn't a perfect proxy for GMO's definition of high quality, but it's close. Grantham notes that 80% of the companies they consider high quality are in the United States. "If the economy weakens substantially, these stocks will be pure gold," he said.