Like many of the best market analysts, Seth Klarman looks at both sides of the issue, the bull and bear case, in depth. “If you’re more focused on downside than upside, if you’re more interested in return of capital than return on capital, if you have any sense of market history, then there’s more than enough to be concerned about,” he wrote [recently]. Citing a policy of near-zero short-term interest rates that continues to distort reality and will have long term consequences, he ominously noted “we can draw no legitimate conclusions about the Fed’s ability to end QE without severe consequences,” a thought pervasive among many top fund managers. “Fiscal stimulus, in the form of sizable deficits, has propped up the consumer, thereby inflating corporate revenues and earnings. But what is the right multiple to pay on juiced corporate earnings?”

Seth Klarman Baupost Idenix

Seth Klarman: Bubbles inflating in junk bond issuance, credit quality, and yields

As he outlined the bear case, he started to divulge his own analysis that “on almost any metric, the U.S. equity market is historically quite expensive. A skeptic would have to be blind not to see bubbles inflating in junk bond issuance, credit quality, and yields, not to mention the nosebleed stock market valuations of fashionable companies like Netflix, Inc. (NASDAQ:NFLX) and Tesla Motors Inc (NASDAQ:TSLA).”

Comparing the economy and the Federal Reserve’s management of it to the movie The Truman Show, where the lead character lived in a false, highly-orchestrated environment, Seth Klarman notes with in-sight, “Every Truman under Bernanke’s dome knows the environment is phony. But the zeitgeist is so damn pleasant, the days so resplendent, the mood so euphoric, the returns so irresistible, that no one wants it to end, and no one wants to exit the dome until they’re sure everyone else won’t stay on forever.” Then he quotes Jim Grant who recently noted on CNBC, the problem is that “the Fed can change how things look, it cannot change what things are.”

Seth Klarman: Fed Created Truman Show Style Faux Economy ValueWalk (3 March 2014)

Seth Klarman: Global equity capitalization

While the U.S. may be rejoicing its daily stock market all-time highs day after day, it may come as a surprise to many that global equity capitalization has hardly performed as impressively compared to its previous records set in mid-2007. In fact, between the last bubble peak and mid-2013, there has been a $3.86 trillion decline in the value of equities to $53.8 trillion over this six year time period, according to data compiled by Bloomberg.

Alas, in a world in which there is no longer even hope for growth without massive debt expansion, there is a cost to keeping global equities stable (and U.S. stocks at record highs): that cost is $30 trillion, or nearly double the GDP of the United States, which is by how much global debt has risen over the same period. Specifically, total global debt has exploded by 40% in just 6 short years from 2007 to 2013, from “only” $70 trillion to over $100 trillion as of mid-2013, according to the [Bank of International Settlements’] just-released quarterly review.

Global Debt Exceeds $100 Trillion as Governments Binge, BIS Says Bloomberg (9 March 2014)

The Risk of a Mere Correction – Or of a Severe Bear Market?

“The Australian share market notched up a fresh near six-year high at [today’s] open,” reported Business Spectator on 24 April 2014. “The S&P-ASX200 now sits at its highest intraday level since the week of June 9, 2008, eclipsing the intraday high of 5,521 set yesterday.” Is this good news or a bad omen? According to Shane Oliver (The Risk of a Correction or New Bear Market in Shares? Oliver’s Insights, 23 January 2014),

While shares might see a brief 10-15% correction at some point this year, a new bear market is unlikely and as such returns should remain favorable through the year as a whole. … I have applied the definition that a cyclical bull market is a rising trend in shares that ends when shares have a 20% or more fall that takes more than 12 months to be reversed. A typical cyclical bull market since 1950 has seen shares rise 126% … and [lasts] four years. So far we are up 37% over 28 months. So history suggests more [upside of share prices] to go.

See full Seth Klarman: Leithner Letter in PDF format here.