Combing through the valuable archives of ValueInvestorInsight, I recently stumbled across this gem of an article, which is an extract from Seth Klarman (Trades, Portfolio)'s letter to Baupost investors in 2009.
The subject of the letter, and of this article, is a section in which Klarman lays out the top investment lessons he learned, and the lessons he believes investors took away from the 2008 crisis.
Split into two parts, Klarman lays out the "true" investment lessons learned and the "false" lessons, which were unique to the 2008 crisis because of the way the world reacted during and after the event. The false lessons are, I believe, the most interesting and valuable.
As one of the most successful value investors of all time, Klarman knows a thing or two about the market. The actions of investors throughout 2009 clearly concerned him, as evidenced by the first false lesson (the rest of the so-called lessons are presented in no particular order) from the crisis:
"There are no long-term lessons – ever."
It also seems the "Margin of Saftey" author was, to some extent, annoyed at the way authorities had reacted to the crisis, bailing out troubled lenders and reducing interest rates to help the most indebted companies. These actions may have helped the economy, but they lulled investors into a false sense of security:
"Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure because declines will quickly be reversed."
He issued a similar warning about the state of financial stocks:
"In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come."
Why do I believe Klarman was criticizing the government's reaction to the crisis in the above quotes? The lesson below leads me to that conclusion. In 2009, Klarman believed that one of the biggest false truths learned by investors in 2008 is the government can always intervene to make things better. Next time, things might be different:
"The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost. (Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
Klarman was clearly frustrated about the way policymakers reacted to the 2008 financial crisis. While we will never know what might have happened if central banks hadn't acted the way they did, we do know that since 2008, the S&P 500 has been on one of the most significant bull runs in history. Investors have rushed to get in on the action via passive funds, buying every dip in the belief that the bull market will continue forever.
This is something Klarman was warning against back in 2009. While he didn't use these exact words, one of his few false truths learned from the crisis was that "There is no amount of bad news that the markets cannot see past." He also believes investors embraced the notion: "If you’ve just stared into the abyss, quickly forget it: the lessons of history can only hold you back."
These are some interesting takeaways from one of the world's best value investors -- which still seem to be relevant today.
