Danger ahead

"I'm more worried about the world broadly than I've ever been in my whole career”

These words were uttered just a few days ago at a CFA conference by one of the most consistent investors of our time, none other than Seth Klarman of Baupost Group, who for over 25 years has delivered consistent 20%+ annual returns to his fortunate investors. When someone of this caliber and usually cool, detached demeanor makes so bold a statement, we’d better listen.

The fact remains that macro concerns are almost too numerous to mention. Our governments and central banks have tampered with the wrong levers and more worryingly in the wrong direction. Since the first signs of stress made their way into full public view in early ’08, the actions taken by those with political, monetary and fiscal clout have been, for the most part, misguided.

Some argue, rightly perhaps, that the risk of no intervention at the point of maximum stress (i.e. Sept, 15th ’08) as Lehman Brothers collapsed and credit markets froze, would have led us to a complete meltdown. Be that as it may, the aptly named “stimulus” packages brought on to re-vive the dying patient, (western economies in this case), have been in place well beyond the required duration. In the same way that methadone serves a purpose for a recovering drug-addict, there’s always the risk that the replacement medicine further exacerbates the addictive nature of the patient.

As I write these lines, some 20 months after the nadir reached on Sept’08, both the macroeconomic landscape AND the investment picture look awfully bleak.

On economic terms, most major industrialized economies have delivered meager upticks in GDP. Most of these however, are directly derived from the extraordinary level of public sector spending. Growth of this type can hardly be considered healthy, dependent as it is on external and by definition temporary forces. More serious are the consequences of said public sector debt frenzy. To put it bluntly, throwing good (and expensive) money after bad money was never a good idea and this time it’ll be no different.

Except it will. It will be even worse.

Adding the burden of public sector debt to escape from a situation where debt had been the originator of the crash, strikes me as deadly dangerous. From an investment point of view you’d think these would be the jolliest of times in the value-seeking crowd. Mr. Buffet himself taught us to be “greedy when others are fearful and fearful when other are greedy” and it holds that when thinks look the bleakest the seed of great investments is often sown. So what’s the problem then?

Well, the time for greed actually was terribly short-lived and lasted the 4th quarter of ’08 and the first half of ’09. This was a period of pessimistic contagion and, for once, reasonable valuations. Today, however the general state of the economy is only marginally better than then, (we may not be about to fall off a cliff but we remain awfully close to the proverbial edge!), but equity prices have rallied as if it were 2006 all over again!. Once again the wise words of JK Galbraith come to mind:

“There can be few fields of human endeavor in which history counts for so little as in the world of finance”.

All in all we may be heading into another “lost decade” in stocks and potentially a negative returns scenario for long dated bonds if, or should I say, once inflation returns.
Amidst all this gloom and doom it pains me to end the post on a negative note. Therefore I urge would be investors to search long and hard for areas of opportunity, which, given the erratic and emotional nature of our would-be trading counter-parties, will continue to arise.