Seth Klarman manages Baupost, a hedge fund based on Boston. The fund has assets of about $30 billion under management. Klarman is a relatively low-key fund manager who rarely speaks out. Don’t let this fool you though. He is one of the greatest value investors of all time. Warren Buffett has publicly praised Klarman and Economist magazine has termed Klarman as the “Oracle of Boston.” Klarman wrote the value investing classic book, Margin of Safety (see it on my reading list).
So what did Klarman do recently?
He wrote a private letter to investors on January 20th discussing the current state of the stock market and Trump’s potential impact on it. Andrew Ross Sorkin of the New York Times covers it here. I’ve been trying to get a copy of the letter but haven’t been able to yet.
Klarman goes on to state, “President Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces…While they might be popular, the reason the U.S. long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”
This echoes a similar sentiment to what I discussed in my post, A World Run by Robots. That automation is inevitable and it actually increases efficiency and the overall standard of living for everyone.
Some other interesting points that Klarman makes in his letter:
– Trump’s stimulus “could prove quite inflationary, which would likely shock investors.”
– “The Trump tax cuts could drive government deficits considerably higher… The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels.”
– “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan… If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”
What to gather from these quotes?
Well, it looks like if things go awry because of Trump’s policies, stock markets could be in for a shock – even if the shock is not in the immediate short-term. A rapid increase in interest rates and inflation may be a negative for stocks and households, particularly leveraged companies and households as they encounter difficulties repaying debt because of rising interest rates. This would stump the Canadian dollar against the US dollar. He also takes a stab at Trump’s leadership style which may lead to volatility and instability in the markets – investors hate volatility. I think investors shouldn’t hate volatility because it can provide buying opportunities. But human nature as it is hates volatility. I say embrace it.
Klarman also has some thoughts on index investing which is becoming increasingly popular these days:
– “One of the perverse effects of increased indexing and E.T.F. activity is that it will tend to ‘lock in’ today’s relative valuations between securities.”
– “When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership).”
– “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings.”
Why do these statements on indexing matter? Because over the years, there has been a mad rush of investors into index ETFs and funds. These ETFs and funds indiscriminately buy into all of the stocks in an index, regardless of valuation. I saw this happen last year with oil stocks, such as Exxon and Chevron which didn’t fall as much as other oil companies because of their presence in the S&P 500. When these index investors run for the hills during the next market correction, it should provide an investment opportunity in these companies.
What do I think the overall message of Klarman’s letter is with respect to US stock markets? I think there may be a correction sometime in the near future. Klarman’s fund currently has 30% of its funds in cash. I haven’t sold any of my investments but I’m accumulating cash from dividends that my investments throw off and from my employment as stock valuations seem just too rich at the moment. I think an opportunity will come to buy my favorite stocks at significant discounts from today’s prices. When? I don’t know but I’m willing to be patient.
On an unrelated note, I thought it was interesting that Klarman started his letter with the following three quotes:
– “In matters of style, swim with the current; in matters of principle, stand like a rock.” — Thomas Jefferson
– “The world, that understandable and lawful world, was slipping away.” — William Golding, “Lord of the Flies”
– “Do I really look like a guy with a plan? You know what I am? I’m a dog chasing cars. I wouldn’t know what to do with one if I caught it. You know, I just … do things.” — The Joker, “The Dark Knight”
From these quotes, I gather that Klarman is taking a stand for what he believes in and it certainly isn’t what Trump believes in (see first quote). The second quote is relevant because instability may soon creep up around the world. The last quote essentially describes what Trump is doing right now with his plethora of executive orders and tweets – he seems to be doing things for the sake of doing them without having a vision or direction. Unless his vision or direction is instability and chaos…