GMO’s Jeremy Grantham has released his fourth-quarter 2010 letter to shareholders, and Part I of his always-intriguing commentary is filled with short-term bullishness and long-term bearishness.

“Be prepared for a strong market and continued outperformance of everything risky,” Grantham writes, citing stimulative Federal Reserve policy and the fact that we’re in the third year of the Presidential Cycle, which traditionally bodes very well for stocks. “But be aware that you are living on borrowed time as a bull; on our data, the market is worth about 910 on the S&P 500, substantially less than current levels, and most risky components are even more overpriced.”

Two big long-term threats Grantham sees are commodity price surges due to resource shortages, and global warming, which he says is already causing extreme weather shifts that are contributing to those resource shortages. “Russian heat affects wheat prices and Australian floods interfere with both mining and crops,” he writes. “Weather-induced disappointment in crop yield seems to be becoming commonplace. This pattern of weather extremes is exactly what is predicted by the scientific establishment. Snow on Capitol Hill, although cannon fodder for some truly dopey and ill-informed Congressmen, is also perfectly compatible. Weather instability will always be the most immediately obvious side effect of global warming.”

Grantham also discusses how the lack of right whale sightings in the Bay of Fundy this past year could be a sign of climate-related changes that could alter the investment landscape.

While Grantham says smaller stocks and lower-quality stocks may well continue to outperform for much of the year due to the Fed’s stimulus policies and the Presidential Cycle, he says that longer term, big, high-quality blue chips remain the most attractive area of the market. He also says natural resource-related stocks are “likely to be fine investments for the very long term”.

The second part of Grantham’s letter deals specifically with historical asset bubbles, and why they are so important for value investors to understand. We’ll dive into that in a future post.