Seth Klarman, founder of the hedge fund Baupost Group, told clients central bank policies and government stimulus measures convinced investors that the risk was “simply gone,” leaving the market unable to meet. its role as a price discovery mechanism.
His fund’s private letter to investors, which was seen by the Financial Times, amounts to a damning criticism of recent market behavior by one of the world’s leading value investors.
Mr. Klarman criticized the Federal Reserve for cutting rates and flooding the financial system with money since the onset of the coronavirus pandemic, arguing that the central bank’s measures have made it difficult to assess the health of the U.S. economy.
“With so much stimulus on the table, trying to determine if the economy is in a recession is like trying to assess if you had a fever after taking a high dose of aspirin,” he wrote. “But like the frogs in water that slowly heats up to a boil, investors are conditioned not to recognize the danger.”
U.S. stocks have risen more than 75% since their March lows, while corporate debt spreads – a measure of how much additional interest corporate borrowers have to pay relative to the U.S. government – have returned to pre-Covid levels this month.
Mr. Klarman – who founded Baupost in Boston nearly four decades ago and raised it to $ 30 billion in assets under management – underperformed the market in 2020.
For several months he has been intensifying his criticisms of the interventions of American central banks. In the last quarterly letter, Mr. Klarman called the Fed the “800 pound gorilla” that has ousted investors who typically provide liquidity in times of distress.
“The biggest problem with these unprecedented and sustained government and central bank interventions is that the risks to capital become masked even as they increase,” he said.
Mr. Klarman also said that the Fed’s policies had exacerbated economic inequality, referring to a “K” shaped recovery which has seen “the fortunes of those already at the top leap rapidly upwards, while those at the bottom remain on an endless downward slope.”
Taking Tesla as an example, Klarman said shares of the “barely profitable” electric automaker had skyrocketed “seemingly beyond all reason,” briefly making company founder Elon Musk the richest person in the world. Low interest rates have made projected cash flow more valuable, he said, a point many investors have recklessly used to justify valuations of companies that are well above historical norms.
“The further away the end result, the more the current value increases,” he wrote. “When it comes to the value of cash flow, the vast and unlimited future, which has yet to be revealed, has gained ground in a more firmly anchored present.”
The Fed’s policies and programs “have directly contributed to exceptionally benign market conditions where almost everything is on the rise while the downside volatility is truncated,” he added. “The usual role of the market in price discovery has effectively been suspended.”
Mr Klarman said investors were now in a constant search for yield that took them to riskier corners of the markets, including investment grade corporate debt, private credit or bad bonds.
The Fed’s drastic measures have helped boost economic activity and save struggling businesses, Klarman said. “But they also sparked two dangerous ideas: that budget deficits don’t matter and that no matter how much debt we can effortlessly, safely and reliably accumulate more of.”