As the latest market rally continues undeterred, with stocks like Tesla (TSLA, Financial) and Virgin Galactic (SPCE, Financial) exploding out of their previous trading ranges and stock indexes making new all-time highs, I am reminded of what Seth Klarman (Trades, Portfolio) said during the dotcom bubble: “it’s hard to leave the party early if all your friends are having a great time.”
For value investors, these kinds of markets create a difficult situation: there are fewer undervalued stocks to buy, but at the same time the bull movements make it difficult to short overvalued ones. The fear of missing out can also create a powerful incentive to throw caution to the wind and get swept up in the buying frenzy. Here’s why you should resist the temptation.
Lessons from the dotcom bubble
In 1999, Klarman warned investors of his Baupost Group that:
“Unprecedented gains in large capitalization growth stocks continue to generate a mistake faith among individual investors in the safety of owning stocks, as well as an erroneous impression of the potential future returns from equity ownership.”
Seeing stocks go up 10%, 15% or 20% in value in one day tends to draw in a lot of people who have little experience with investing. This phenomenon has been exacerbated by the emergence of zero-commission brokerages and easy-to-use mobile applications. While ease of access to the stock market is certainly a boon to some, in many cases it has arguably led to more harm than good. It’s one thing to make it easier for experienced and qualified investors to deploy capital; it’s quite another to make it easier for laypeople to lose money.
Klarman also pointed out that in a manic environment, value strategies based on fundamental analysis will underperform, even if in the long-term their efficacy has been demonstrated. For instance, for the six months ended April 30, 1999, the Baupost Group generated returns of 8.62%. Not bad, but that still underperformed the broader market: the S&P 500 returned 16.26% over the same period.
So what did Klarman do in this environment? While other asset allocators were busy chasing the runaway dotcom bubble, Baupost Group was content with being overly cautious and protecting its downside, rather than taking on more risk and potentially putting its clients' capital at risk.
“More and more, stocks are seen as apart from the businesses underlying them, with capital gains a product of investor money flows rather than corporate profit growth...While everyone else on Wall Street motors ahead at a frenetic pace, we are intentionally going slowly, unafraid of missing out on speculative gains and intent on protecting capital.”
Today’s market is not so different from the one of the late 1990s. Investors would be wise to heed Klarman’s advice.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Joel Greenblatt: 3 Mistakes That Investors Make
- Do Successful Investors Need to Be Great Forecasters?
- Charlie Munger: How to Be a Rational Investor
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
