Klarman’s strategy could give you an advantage in the current investing climate
The Covid-19 pandemic has caused many investors to become cautious when it comes to buying equities. They may worry, for example, that the S&P 500 will return to a downward trend after its recent rebound from the three-year low it recorded in March.
Baupost Group chairman Seth Klarman’s advice on buying stocks could prove useful in the current climate. By using cycles to your advantage, focusing on the long term and being selective in terms of which stocks you buy, it is possible to invest effectively during an uncertain economic period.
Using cycles to your advantage
A brief glance at a long-term chart of the S&P 500 highlights that the stock market operates in cycles. For example, following a bull market that lasted over ten years, the index has experienced a bear market in 2020 in response to economic uncertainty caused by the Covid-19 pandemic.
“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.”
By accepting that investors overreact to positive and negative news, it is possible to buy stocks when they are trading at low levels. Over time, the past performance of the stock market suggests that they will trade at excessive price levels during the next bull market.
The next period of sustained growth for the stock market may be many months, or even years, away. Therefore, investors should take a long-term view of their holdings and avoid trying to make a quick profit – particularly since short-term market movements are impossible to predict.
Seth Klarman believes that adopting such an approach can lead to investors maximizing their competitive advantage:
“The single greatest edge an investor can have is a long-term orientation.”
Losing money on your holdings over the short run can be a galling experience. But timing the market is near-impossible, which makes a buy-and-hold strategy far more attractive over the long term.
When the stock market trades at a relatively low level, there are usually a large number of companies that offer margins of safety. This makes it easier to find prospective purchases.
However, being selective in terms of what you buy can be highly useful according to Seth Klarman:
“As Graham, Dodd and Buffett have all said, you should always remember that you don't have to swing at every pitch. You can wait for opportunities that fit your criteria and if you don't find them, patiently wait. Deciding not to act is still a decision.”
Through selecting only the most attractive stocks based on their risk/reward ratios, you can give your portfolio the best chance of outperforming the market over future years.
Holding cash is an unprofitable move at the best of times. However, now that interest rates are near-zero it is likely to be viewed as a highly unattractive prospect by most investors.
Despite this, cash savings that provide you with financial security in a period of market turmoil can help you to maintain a clear head when making investment-related decisions. If you are not reliant on the performance of your portfolio to make ends meet in the short term, you may be able to make more efficient decisions regarding capital allocation.
Seth Klarman’s take on investing suggests that he adopts a similar mentality when it comes to managing his personal finances:
“Ultimately, nothing should be more important to investors than the ability to sleep soundly at night.”
Cash may be detrimental to your overall returns, but having an emergency savings account may provide your portfolio with the time it needs to recover from the current downturn.
This was first posted on ValueWalkPremium