Seth Klarman's bearish thoughts on the current market climate

I'm working on reducing the beta of my portfolio, including a shift to low-beta dividend-paying equities, e.g. SO. Most equities worry me, as P/E gets nose-bleed high. Most bonds worry me, with poor yields and only one way the their price can go (down). International investing is also a minefield right now.

Frankly, this is one reason I think TSLA is doing well now. Savvy investors are looking for opportunities to invest in well-managed growth companies that are likely to weather volatile economic conditions.

Another good macro read:
Hussman Funds - Weekly Market Comment: It Is Informed Optimism To Wait For The Rain - March 10, 2014

It would not surprise me to see a 50% market drop in the very near future. I love Tesla and have given them gobs of money for their products but if you can tell me TSLA is worth it's stock price with a straight face you are flat delusional. Same goes for Facebook, Twitter, Amazon, etc. Fed policy has sent everyone on a search for yield that is creating asset bubbles all over the place.

I mean, come on, 1999 and 2008 weren't that long ago. You can't tell me that this time it's different. You're picking up nickels in front of a steamroller if you're long this market.

strider said:

Another good macro read:
Hussman Funds - Weekly Market Comment: It Is Informed Optimism To Wait For The Rain - March 10, 2014

It would not surprise me to see a 50% market drop in the very near future. I love Tesla and have given them gobs of money for their products but if you can tell me TSLA is worth it's stock price with a straight face you are flat delusional. Same goes for Facebook, Twitter, Amazon, etc. Fed policy has sent everyone on a search for yield that is creating asset bubbles all over the place.

I mean, come on, 1999 and 2008 weren't that long ago. You can't tell me that this time it's different. You're picking up nickels in front of a steamroller if you're long this market.

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Presumably, you're short TSLA or the market with such strong conviction. I see at least a hold in share price for TSLA.
If the market doesn't crash in the next two years, you'll miss out.

EnergyMax said:

Presumably, you're short TSLA or the market with such strong conviction. I see at least a hold in share price for TSLA.
If the market doesn't crash in the next two years, you'll miss out.

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Read my Sig. I have likely been involved with and a customer of Tesla for longer than you. There are few people who are more pro-Tesla than I am.

I am not short. I am just walking around w/ my eyes open. But the fact that any time anyone says something negative everyone leaps on them for being short means that deep down you realize that the current share price is unjustified and you're scared someone will notice.

The current market is rhyming w/ 1999 and 2008. Deteriorating fundamentals as retail sales and all other objective measures of the economy continue to disappoint yet assets are being bid up by delusional investors and cheap money. Oh but wait, it's the weather right? Like it's never been cold or snowed in January? I'm just telling you that if there is a broad macro event like in 2008 TSLA will be affected. So keep your eyes open to what's going on in the broader economy. It is NOT good.

strider said:

Read my Sig. I have likely been involved with and a customer of Tesla for longer than you. There are few people who are more pro-Tesla than I am.

I am not short. I am just walking around w/ my eyes open. But the fact that any time anyone says something negative everyone leaps on them for being short means that deep down you realize that the current share price is unjustified and you're scared someone will notice.

The current market is rhyming w/ 1999 and 2008. Deteriorating fundamentals as retail sales and all other objective measures of the economy continue to disappoint yet assets are being bid up by delusional investors and cheap money. Oh but wait, it's the weather right? Like it's never been cold or snowed in January? I'm just telling you that if there is a broad macro event like in 2008 TSLA will be affected. So keep your eyes open to what's going on in the broader economy. It is NOT good.

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I'm not scared. It's just unusual for someone to be so certain in a direction when they have no skin in the game. Thus, the deduction that you're short. If you not even holding the stock, then feel free to express whatever you want.

I am very comfortable with Tesla's share price. I am concerned about potential for recession.

I think the situation is more complex than bears admit. Amazon is taking over retail. I buy nowhere else these days.

EnergyMax said:

I think the situation is more complex than bears admit. Amazon is taking over retail. I buy nowhere else these days.

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But Amazon in fact LOSES money from its retail operations. The only place it makes money is from media sales and those are declining. It will be forced to raise prices on Prime before too long and has stated as much in it's last quarter release. If people abandon Prime and choose free shipping the numbers get even more negative. Taking a money losing proposition and trying to "make it up in volume" is a classic 1999 move and will fail just as it did back then. And with a P/E of 625 it will not be pretty when the market figures this out.

I am not short because as the saying goes, "the market can remain irrational longer than you can remain solvent." This market has lasted far longer than I thought it would and I'm not willing to risk my money betting on when it will fall because I simply don't know. I am in capital preservation mode at the moment, waiting to buy back in after the crash.

I was early in calling the .com crash and I was early calling the housing crash and certainly missed out on some (sometimes sizable) upside. But in the end I was right. See my comment above about picking up nickels in front of a steamroller. If you're nimble there's money to be made but it's not for me.

One thing in common with both 1999 and 2008 was the Fed reversing course on interest rates. We've had zero percent interest rates since 2008 stimulating the current bull market and turning it into a bubble IMO. The Fed has begun tapering but is still printing quite a bit of money each month and interest rates are still close to zero. At some point in the next year or two, this will change and the market will be affected. The high flyers like Tesla will be affected more than others.

We're a long way from the Fed raising interest rates. The current Chairwoman is quite doveish. Moreover, the language the Fed has been using these days suggests they will do pretty much everything the markets want, which is to keep rates low and money supply loose. We aren't suffering from inflation, even if asset prices are rising. There is nothing that suggests they will reverse course in any meaningful way until fundamental economic data improves dramatically. Quite the contrary, in fact, because they have made it clear that they are willing to loosen further if needed along the way.

So, regardless of what you think about the economic benefits of QE, even if you postulate that asset price increases are due mostly to QE, how can you argue that QE is going to end or be curbed in a meaningful way anytime soon? Everything the Fed has been saying suggests that it won't happen anytime soon. Economic data has been terrible for a while, but asset prices continue to appreciate. What makes you think that markets will care about bad or worsening economic data as long as we have loose money? They won't.

772 said:

We're a long way from the Fed raising interest rates. The current Chairwoman is quite doveish. Moreover, the language the Fed has been using these days suggests they will do pretty much everything the markets want, which is to keep rates low and money supply loose. We aren't suffering from inflation, even if asset prices are rising. There is nothing that suggests they will reverse course in any meaningful way until fundamental economic data improves dramatically. Quite the contrary, in fact, because they have made it clear that they are willing to loosen further if needed along the way.

So, regardless of what you think about the economic benefits of QE, even if you postulate that asset price increases are due mostly to QE, how can you argue that QE is going to end or be curbed in a meaningful way anytime soon? Everything the Fed has been saying suggests that it won't happen anytime soon. Economic data has been terrible for a while, but asset prices continue to appreciate. What makes you think that markets will care about bad or worsening economic data as long as we have loose money? They won't.

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I agree with you. They will not raise interest rates anytime soon. My prediction is that they will be forced to in the "next year or two" because I believe inflation will eventually take hold. Remember $150 oil in 2007? The reason they will be forced to is because the bond market will demand it. It might take longer than that if we continue to see subpar economic performance, though.

We can agree that Tesla and other high beta stocks are enjoying the benefits of QE and low interest rates which allow hedge funds to borrow cheap and invest long. This is the definition of a bubble. But a bubble can go on a lot longer than anyone would expect.

772 said:

, regardless of what you think about the economic benefits of QE, even if you postulate that asset price increases are due mostly to QE, how can you argue that QE is going to end or be curbed in a meaningful way anytime soon? Everything the Fed has been saying suggests that it won't happen anytime soon. Economic data has been terrible for a while, but asset prices continue to appreciate. What makes you think that markets will care about bad or worsening economic data as long as we have loose money? They won't.

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The Fed is being forced to taper by the bond market. Look at a graph of fixed-rate mortgages. They started climbing sharply last year. The taper is the Fed's response to that. Remember that QE is not printing money in the strictest sense. It is all debt. Technically it must be paid back which would extinguish the money that was created at the beginning. As long as the bond market believes that this money will be paid back then interest rates will remain low. If they start to doubt the ability of these debts to be paid interest rates will spike regardless of what the Fed does or wants.

You're right in that markets won't care about bad or worsening economic data.... until they do. Just like they did in 2000 and 2008...

marvinat0rz said:

The big question is, is there a sensible, balanced way to hedge this risk? If you're right (which to my reasoning is still an if, but one that we should seriously consider), it is a question of timing. Investors suck at timing. I have ~30% of my assets in cash at the moment, and this obviously avoids everything except the exchange rate risk. But it yields zero returns. Historically, selling just as we roll past the previous all-time high of years ago has been a bad decision.

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I guess it depends on how fancy you want to get. Holding cash is a great idea in a deflationary crash (I am in 80% cash, 15% gold, and 5% stocks in the form of my employer's RSU's). There will be a flight to safety that will be positive for strong currencies like USD (The Krone should also be ok since the Norwegian government's fiscal house is strong). The idea would be to buy back into the market at or near the bottom when very few people have cash/capital and assets become cheap. The other thing you could do would be to take some profits from your equities.

strider said:

The Fed is being forced to taper by the bond market. Look at a graph of fixed-rate mortgages. They started climbing sharply last year. The taper is the Fed's response to that. Remember that QE is not printing money in the strictest sense. It is all debt. Technically it must be paid back which would extinguish the money that was created at the beginning. As long as the bond market believes that this money will be paid back then interest rates will remain low. If they start to doubt the ability of these debts to be paid interest rates will spike regardless of what the Fed does or wants.

You're right in that markets won't care about bad or worsening economic data.... until they do. Just like they did in 2000 and 2008...

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I think you have this backwards. The hint of a taper (less QE) prompted rates to go up since the Fed is buying bonds to keep rates low. By tapering QE and eventually stopping all QE (due later this year at their current taper rate), the thought is that rates would go up to what would be normal market conditions.

Submit for your approval.... From market-ticker.org:

4Q 2013 GDP was $17.081 trillion. One year ago it was $16.420 trillion. That is an increase of $661 billion, more or less, which doesn't sound so bad as it's right at 4% advancement annually.

However, The Federal Reserve added $1.112 trillion in credit (unbacked by anything) during the same period of time; that's a debasement of the units in which GDP is reported of 6.51%.

So the real change in the economy is in fact negative 2.51%.

We are factually in a recession.

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strider said:

Submit for your approval.... From market-ticker.org:

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Incorrect interpretation of data. The real GDP is a measure of goods and services produced, and so it's unaffected by monetary rebasing. Real GDP rose from $15,539.6 billion in Q4 2012 to $15,932.9 billion in Q4 2013 (all expressed in chained 2009 dollars), an increase of 2.5%. Source: https://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp4q13_2nd.pdf Table 3

The article seems incensed that the increase in the money supply is "unbacked by anything." Does the author understand that the entire US monetary stock is "unbacked by anything"? We went off the gold standard decades ago.

Robert.Boston said:

Incorrect interpretation of data. The real GDP is a measure of goods and services produced, and so it's unaffected by monetary rebasing. Real GDP rose from $15,539.6 billion in Q4 2012 to $15,932.9 billion in Q4 2013 (all expressed in chained 2009 dollars), an increase of 2.5%. Source: https://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp4q13_2nd.pdf Table 3

The article seems incensed that the increase in the money supply is "unbacked by anything." Does the author understand that the entire US monetary stock is "unbacked by anything"? We went off the gold standard decades ago.

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Isn't real GDP growth deflated by the GDP deflator to account for inflation?

dmunjal said:

Isn't real GDP growth deflated by the GDP deflator to account for inflation?

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Real GDP is adjusted for inflation; the numbers I quoted are adjusted for inflation using a "chain" method, which is generally considered the best method to compare figures across time. The actual calculation is that you adjust the nominal GDP for inflation and then find the CAGR of the resulting adjusted series, but it's a very close approximation to subtract the rate of inflation from the nominal growth rate.

(fwiw, I used to be employed as an economist at the Federal Reserve Bank of NY)

Robert.Boston said:

Incorrect interpretation of data. The real GDP is a measure of goods and services produced, and so it's unaffected by monetary rebasing. Real GDP rose from $15,539.6 billion in Q4 2012 to $15,932.9 billion in Q4 2013 (all expressed in chained 2009 dollars), an increase of 2.5%. Source: https://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp4q13_2nd.pdf Table 3

The article seems incensed that the increase in the money supply is "unbacked by anything." Does the author understand that the entire US monetary stock is "unbacked by anything"? We went off the gold standard decades ago.

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I agree the term debasement is a poor choice. However, deficit spending by the government does add to GDP as they provide money for things like new fighter jets and things are counted in GDP. The author is saying that if the government had to live within its means that we would end up w/ -2.51% GDP growth.

But speaking of debasement, in the "old" days (prior to 1980) the dollar was backed by the tax receipts of its citizens. Though for the last few decades this has not been true as the government has run deficits as far as the eye can see. Now deficits in and of themselves are not bad as long as the real economy is growing faster than the deficits but that has not been the case for awhile now. That situation has ALWAYS ended badly for all countries that have done this for any length of time. We have the benefit of being the world's reserve currency so the game has/will go on longer than other countries but at the end of the day, an economy is about energy. The laws of thermodynamics apply and both sides must balance.

strider said:

I agree the term debasement is a poor choice. However, deficit spending by the government does add to GDP as they provide money for things like new fighter jets and things are counted in GDP. The author is saying that if the government had to live within its means that we would end up w/ -2.51% GDP growth.

But speaking of debasement, in the "old" days (prior to 1980) the dollar was backed by the tax receipts of its citizens. Though for the last few decades this has not been true as the government has run deficits as far as the eye can see. Now deficits in and of themselves are not bad as long as the real economy is growing faster than the deficits but that has not been the case for awhile now. That situation has ALWAYS ended badly for all countries that have done this for any length of time. We have the benefit of being the world's reserve currency so the game has/will go on longer than other countries but at the end of the day, an economy is about energy. The laws of thermodynamics apply and both sides must balance.

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Hmmmm. I think the deficit has been in reduction the past fews years no?