GMO’s Jeremy Grantham has released the second half of his first-quarter letter, and in it he recommends dialing back risk — though he admits he may in the end prove to be a bit early on his call.

Previously, Grantham had said he expected an already overvalued S&P 500 to push into the 1,400 to 1,600 range by October 1, riding the coattails of the Federal Reserve’s monetary policy. “The market may still get to, say, 1,500 before October, but I doubt it, especially without a QE3, although the chance of going up a little more by October 1 is probably still better than even,” he now says. “And whether it will reach 1,500 or not, the environment has simply become too risky to justify prudent investors hanging around, hoping to get lucky.  So now is not the time to float along with the Fed, but to fight it. (his emphasis).

Grantham says investors should use a “hard-nosed value approach, which at GMO means having substantial cash reserves around a base of high quality blue chips and emerging market equities, both of which have semi-respectable real imputed returns of over 4% real on our 7-year forecast.” He says he thinks the current fair value of the S&P is about 920, some 40% below its current level.

Grantham does note that he has a history of being early on market calls, jumping into undervalued markets that become even more undervalued, and jumping out of overvalued markets that become even more overvalued. But several main factors have him leaning to the more cautious side: spiking oil and commodity prices; unrest in the Middle East; the longer-term impact the Japan earthquake and tsunami will have on the global economy; and the fact that, while the third year of the Presidential cycle tends to be the best for stocks, we’ve already reached the average third-year gain this year.

As for longer-term recommendations, Grantham continues to be high on forestry and good agricultural land, and resource efficiency plays.