Seth Klarman’s investment thesis that the stock market is headed lower could be accurate, says BTIG Chief Global Strategist Dan Greenhaus – it just might not be due to US Federal Reserve tapering.
ValueWalk was the first media to report on Klarman’s private investor letter, where the legendary fund manager said the Fed stimulus-based economy reminded him of the “Truman Show” for its false pretense.
Greenhaus considers history of Fed involvement in market stabilization
“At the root of Seth Klarman’s recent observations on equities is a fundamental disagreement that has persisted since the first moment the Federal Reserve engaged in ‘unconventional’ and extraordinary monetary policy,” Greenhaus politely noted in a research note to investors. “For many, the economic recovery and rise in equity prices contains some amount of ‘artificiality,’ since low interest rates have been, for those in question, the proximate cause for the turnaround.”
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Regardless of Fed, stocks appear overvalued
Greenhaus makes the point that regardless of the cause, the stock market could be overvalued. “Leaving aside the justification, or lack thereof, surrounding Fed intervention, the question for investors five years later what a reversal, or a moderation, of these policies means for investments,” he wrote. “Most prominently of late is what we believe to be the most credible of bearish arguments; that the Fed’s low interest rate policy has, among other things, permitted corporate buybacks at a level sufficient to boost EPS growth even with modest revenue growth.”
Harken back to 1940s
Greenhaus harkens back to the Herbert Hoover Great Depression days, when then US Treasury Secretary Andrew Mellon had accumulated a significant dose of “artificial stimulus” to bolster the economy. “Put simply, what the Fed is doing, while unusual, is causing an entirely usual response,” he wrote. “This is not to say the Fed is too easy, or not loose enough, or causing bubbles or anything along those lines. Simply, what the Fed is doing to asset prices is, in their view, normal.”
While many may look at the depression, Greenhaus says the 1940s are the historical period to consider: “In April 1942, in an effort to support the war effort, the Federal Reserve committed to maintaining a ceiling of 3/8 percent on Treasury bills. For longer term securities, the ceiling was set at 2.50% and the Fed committed to purchasing any assets necessary to peg rates at these levels and did so until raising the peg in 1947. Such a promise eventually contributed (along with wartime price controls which ended in mid-1946) to a surge in post war inflation,” he wrote, potentially noting a precursor to inflation in today’s US economy.
What could happen to stocks in such an economic environment? Greenhaus pointed to a digestion period at the conclusion of 1949s before stocks resumed their upward bias. “As the Fed winds down its asset purchase program and as the expansion matures, taking a more defensive stance is surely the most prudent course of action,” Greenhaus concludes.