"Can we say when it will end? No. Can we say that it will end? Yes," noted Baupost's Seth Klarman in the past, warning "And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”
It appears that moment is nigh, as NYT Dealbook reports the 59-year-old value investing legend - who manages $30 billion - is following in the footsteps of Bridgewater's Ray Dalio (who recently flip-flopped on Trumphoria), and Bill Gross, reinforcing a countervailing view to the euphoria that has buoyed the stock market since Mr. Trump took office, describing “perilously high valuations.”
“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.
“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,” he continued. “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.”
In particular, Mr. Klarman appears to believe that investors have become hypnotized by all the talk of pro-growth policies, without considering the full ramifications. He worries that Mr. Trump’s stimulus efforts “could prove quite inflationary, which would likely shock investors.”
Unlike seemingly anyone else these days, Klarman also was deeply concerned about the swelling US national debt that he suggests could undermine the economy’s growth over the long term.
“The Trump tax cuts could drive government deficits considerably higher,” Mr. Klarman wrote. “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.”
Much of Mr. Klarman’s anxiety seems to emanate from Mr. Trump’s leadership style. He described it this way: “The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.”
He also linked this point to what “Trump style” means for Mr. Klarman’s constituency and others. “The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”
While Mr. Klarman clearly is hoping for the best, he warned, “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.”
Why did the notoriously publicity shy Klarman take this political coment departure? In his letter, he explained for the first time his decision to say something publicly.
“Despite my preference to stay out of the media,” he wrote, “I’ve taken the view that each of us can be bystanders, or we can be upstanders. I choose upstander.”
Three years ago, Klarman concluded his letter to investors rather ominously and it seems, under Trump, circumstances have become more ominous...
Someday, financial markets will again decline. Someday, rising stock and bond markets will no longer be government policy – maybe not today or tomorrow, but someday. Someday, QE will end and money won’t be free. Someday, corporate failure will be permitted. Someday, the economy will turn down again, and someday, somewhere, somehow, investors will lose money and once again come to favor capital preservation over speculation. Someday, interest rates will be higher, bond prices lower, and the prospective return from owning fixed-income instruments will again be roughly commensurate with the risk.
Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.
Six years ago, many investors were way out over their skis. Giant financial institutions were brought to their knees...
The survivors pledged to themselves that they would forever be more careful, less greedy, less short-term oriented.
But here we are again, mired in a euphoric environment in which some securities have risen in price beyond all reason, where leverage is returning to rainy markets and asset classes, and where caution seems radical and risk-taking the prudent course. Not surprisingly, lessons learned in 2008 were only learned temporarily. These are the inevitable cycles of greed and fear, of peaks and troughs.
Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.
According to Andrew Ross Sorkin, Baupost currently has more than 30% of its funds in cash. He has lost money in only three of the past 34 years. Sorkin also notes that how Klarman wants investors to behave in the age of Trump remains an open question, but a hint is visible at the top of his letter where he included a quotation attributed to Thomas Jefferson: “In matters of style, swim with the current; in matters of principle, stand like a rock.”