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Seth Klarman: The bulls and the bears

May 18, 2014

In a recent post, I unpacked some quotes from a much-discussed investor letter from investing guru Seth Klarman. Because I think his perspective is sound and his advice is, at the very least, worth listening to, I think it’s worth digging in a little deeper to some of the ideas he has expressed in the past—specifically his thoughts on bullish versus bearish outlooks on today’s market (as outlined in a ValueWalk.com article by Mark Melin):
 

The Bulls
 

Klarman is tough on the eternal optimists here, pointing out that, for those who are “born bullish”, there is never a market that they don’t seem to like. He cites their “consistently short memory”, and a tendency to ignore the negatives and focus on the positives. That said, his presentation of the bullish perspective touches on the following items: PE ratios are not through the roof, deficits are shrinking, the housing market is recovering, the Fed will keep interest rates low, which will encourage people to continue to buy stocks. In essence, say the bulls, Quantitative Easing (QE) has worked!
 

The Bears
 

Despite the sunny-side-up version of reality outlined in Klarman’s explanation of the bullish mindset, he points out that a closer look at some of those issues paints a dramatically less rosy picture. He talks about how a more cautious approach is generally more focused on return of capital instead of return on capital, about how the near zero interest rates perpetuated by Fed policy have distorted reality, and about how there is not likely to be a soft landing when QE comes to a close. Fiscal stimulus and outside programs have artificially enhanced corporate earnings and, as a result, there is a growing gap between the markets and the economic reality.
 

While neither perspective is 100% correct, “The Bears” outlook should give us all pause and incentive to rethink our investment position in today’s market.

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