The stock market has been cruising this year, with the S&P 500 now up more than 19% and the Nasdaq Composite up nearly 38%. But trouble could lie ahead, warns billionaire investor Seth Klarman, who is also CEO of the Baupost Group.
On a recent podcast, Klarman said is concerned about the Federal Reserve's intense interest rate-hiking campaign over the past year and its potential impact on asset prices, particularly speculative assets, which took off in the ultra-low interest rate environment that occurred during the pandemic.
Image source: Getty Images.
The pandemic mania
A big concern of Klarman is that the bubble created during the zero-rate, easy-money days of the pandemic has not yet burst and could still have a long way to go.
"You had a bubble, it was really a credit bubble, that became an everything bubble," Klarman said during his recent appearance on the podcast Capital Allocators with Ted Seides. "Super-low interest rates, at times zero rates, made capital easily available and incredibly cheap... That led to start-up manias and SPACs and meme stocks and crypto, all kinds of speculative activity. I'm not convinced that we've even begun to sort out that bubble."
Interestingly, Bloomberg reported recently that there is more than $590 billion of corporate debt trading at distressed levels, including more than $168 billion tied to real estate. Also, despite what looks to be a solid showing so far for bank earnings, Klarman also worries that stress in the sector is not done just yet.
"I'm not convinced we know where all the bodies are buried," the 66-year-old said, referring to banks. "I don't know anything, but I'd be nervous because markets cause behaviors, and when people have to put money to work ... they're going to do something with the money."
Klarman cites past crisis periods, whether it was from 1998 to 2001 during the dot-com bubble or the Great Recession, which had a lot of hiccups through the stressed time period. He added that people shouldn't assume the U.S. government will continue to bail out the banks.
How to think about Klarman's warning
I'm not sure if I agree with everything Klarman said, particularly about the banks. While there are still some banks facing issues, I don't necessarily envision any more big bank failures like we witnessed earlier this year. That said, banks are still dealing with a challenging near-term environment, as well as higher funding costs that could continue to rise, which could be problematic.
But I do think Klarman makes some good points about asset prices becoming inflated during the pandemic, and I do think it remains to be seen whether there is more stress in the markets. The big thing I wonder about is whether markets are placing too much weight on a soft landing for the economy.
Interest rates have not risen this much, this quickly in decades, and coupled with quantitative tightening, which is essentially pulling liquidity out of the economy, I think it's too early to say that we are out of the woods just yet. If this is true, the market remains vulnerable to at least a correction, so investors do need to be cautious and assess their portfolios carefully before going in too heavy after a big run already this year.
As always, continue to take a long-term approach, and try to buy stocks at reasonable valuations.
