Stocks are still too expensive and rising rates could shock the financial system, warns Seth Klarman

Investing legend Seth Klarman returned to his Harvard Business School roots to say the stock market is still too expensive even with its fall this year.

“You have a stock market that is one of the most expensive ever,” the chief executive of the value-focused Baupost Group said in an interview published Friday. The S&P 500 SPX,
is now down 23% for the year.

He said there are cross-currents hitting the market right now, identifying rising interest rates first.

“Interest rates are starting to rise, and they should rise, because they’ve been kept artificially low for a very long time,” he told Harvard Business School professor Das Narayandas. “I think it’s going to shake up some people, and even the system, when they start going higher.”

“It’s been a 35-year bond bull market, so it’s going to be a big shock that’s going to test, I think, financial institutions that have been hedged, that have written derivatives that they shouldn’t write, that have exited to take more risk in their portfolio, because if you can’t do it in bonds, people try to do it elsewhere.

Inflation, he adds, is a challenge because investors don’t like getting guaranteed losses from their safe portfolio. The war in Ukraine – “clearly a war of aggression” – is another problem.

Klarman also identified another risk. “I am also worried about the major divisions in American society. It’s not just north and south, big cities and suburbs and countryside, it’s not even just red and blue. The gaps are really huge and they go to greater technology and who is able to benefit from it and who is not,” he said. “They’re going towards a very rapidly changing labor market and the destruction of a lot of jobs, they’re going towards changes in the media, where there are so many different channels and we’re not all listening to Walter Cronkite.”

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He always thinks of the US dollar DXY,
will remain supreme as he rejected the Chinese yuan, Japanese yen, euro and cryptocurrencies as viable alternatives. And he covered his own response on the division in the United States

“We’ve clearly seen worse here,” he said, noting the Great Depression, World War II and the lack of civil rights. He also pointed to innovation, not just in Silicon Valley, but in biotech Boston, New York and Philadelphia, as well as world-class educational institutions.

Klarman said he views value as gold for security, although he acknowledges the points made by Warren Buffett and others that gold does not earn interest. “It has history, it’s very hard to mine, it’s random that someone has settled on the gold and we can’t get more than this very limited supply that we have,” a- he declared.

“I don’t see the point of crypto,” he added. “It makes me feel like catnip for the technicians.”

“The idea that we’re using more energy than the country of Iceland, to mine more crypto, to solve math problems that don’t need to be solved, sounds crazy to me.”

Watch the full interview here:

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Don F. Davis