Famed value investor Seth Klarman of Baupost Group thinks that 2016 “made no sense” in two very obvious ways, says the Dealbreaker blog. In a recent letter to clients, Klarman notes that, firstly, “$13.4trn of debt worldwide (largely sovereign) traded at negative interest rates”.
In short, bondholders were willing “to pay interest to issuers for the privilege of tying up their capital for a significant interval while still bearing the risk of default”. Even Italy, facing “political uncertainty and a slow-motion banking crisis”, and Saudi Arabia, stuck in “an oil-price slump”, were able to issue cheap debt. Austria sold 70-year bonds at a yield of just 1.5%.
Secondly, markets cheered when US voters “gave the middle finger to the establishment and the status quo by narrowly electing Donald Trump” as US president. Investors are focusing “on the potential benefits of stimulative tax cuts while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers”. In effect, “the stockmarket is behaving as if Trump will fulfil only the campaign promises it likes but conveniently break all those promises it doesn’t like”.
Yet Trump’s “erratic tendencies and over-confidence in his own wisdom and judgement” mean that “tail risk” has soared. “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation and global angst.” Still, Klarman isn’t confident enough to bet on a collapse. It’s “hard to develop an edge from such top-down viewpoints”. Instead, he plans to “focus on downside protection”, and wait “for bargains to arise”.