Portions of Seth Klarman's shareholder letter have been circulating around the web this week. I am a big fan of Klarman and his deep value buyer of last resort approach to the markets. I pay close attention when he speak or writes about the market.
In the letter he addresses the growing complacency that has crept into the markets of late. In his words, "Investors have clearly grown weary of worrying about risky scenarios that never seem to materialize or, when they do, don't seem to matter to anyone else." In my words there is a lot going in the economy and the world that have the potential to bring markets down around our ears but no one cares.
I have working in and around markets for almost 30 years now. In the past, things like the growing conflicts in the Middle East, the mess in the Ukraine, slowdown in anticipated housing recovery and negative GDP print would have bought markets tumbling down.
There would be a lot more concern about the Scottish Independence vote on Thursday as well. However, when I talk to traders and traders disguised as investors these days all any one cares about are the central banks and what they might do in the near term.
According to some who have read the entire letter and not just portions, the fund has high cash balances right now and has returned some cash to investors. There just are not a lot of opportunities. I talked about the diminishing pool of deep value situations. Klarman is apparently seeing the same thing, although he emphasizes that there are pockets. He is telling his investors that "money flows rapidly to perceived opportunity, but just as rapidly out of other areas, which may leave opportunity like seashells on the beach at low tide."
At this moment the only seashells I am seeing are in community banks, oil and gas related companies and miners.
I was discussing Klarman's comments with a friend with more of a trading bent than deep value types like Klarman. He reminded me that Klarman and others such as Sam Zell and Carl Icahn who have recently expressed concerns about the market have been doing so since last fall. That is quite true and I have been cautious and noting the lack of opportunity and absence of much inventory creation of deep value situations.
Being early does not make any of us wrong for being cautious. I do not make market calls or predictions and let the size of the opportunity set determine my decisions. But being aware of elevated risk levels is smarter than just ignoring everything but today's price action. That's the market equivalent of Red Sox fans making plans to attend the World Series because they won Sunday.
The majority of non-community banks in my portfolio right now are ones I have been involved in for several years and cash levels are rising even in old money portfolios as it is difficult to replace companies that reach fair value and are sold. There are some thing to buy like Couer Mines (CDE), Republic Bancorp (RBCAA), International Shipholding (ISH) and HomeTrust Bancshares (HTBI). But the world is not awash in attractively-priced stocks right now. Combine that with the risk factors Klarman lists like yield seeking, high yield issuance, debt related ETF proliferations and global hotspots and a certain amount of caution just makes sense.
Is this a siren song to sell stocks and go to cash? I don't make those kind of calls. It is a suggestion that it might be time to take a hard look at your portfolio and ask why you own what you own. Ask questions like why I do like this stock and what this company is really worth.
If you own stock trading triple-digit price-to earnings ratios, how comfortable will you be holding them if things reverse and markets go down and volatility actually goes up?
If you have blue chip stocks with single-digit growth rates and premium multiples you purchased to collect 3-4% in dividends, will you be okay if it should drop 20 or 25%. Or will you panic and sell your shares in a declining market? If you could buy the whole business at the current price, would you?
Seth Klarman is cautious. So are some other smart, successful investors. Risk factors are high and there are not many opportunities. That does not mean these conditions cannot last for some time longer. However, it doesn't mean that things can't go south suddenly and swiftly and you need to be ready should that happen. Caution does not mean panic it means prepare.
Be careful what you buy and question what you own.