Thursday, May 14, 2009

Seth Klarman in OID

Here’s an excerpt from Seth Klarman’s remarks at last October’s Graham & Dodd Breakfast from the March Issue of Outstanding Investor Digest.

Sometimes, being too early is the same as being wrong….

Seth Klarman: For years, when someone asked me what my biggest fear was as an investor in managing my portfolio, my answer was that it was buying too soon on the way down from often very overvalued levels. I knew a market collapse was possible. And sometimes, I imagined that I was back in 1930 after the market had peaked the year before, and then dropped 30%. Surely, there would’ve been some tempting bargains then. And just as surely, you’d have been crushed by the market’s subsequent plunge over the next three years — down to below 20% of 1929 levels. A fall from 70 to 20, and from 100 to 20, would feel almost exactly the same by the time you hit 20. Sometimes being too early becomes indistinguishable from being wrong.

After a 30% drop, who knows how much further it might go?

Klarman: Of course, getting in too soon as the market falls involves great risk for all investors, including value investors. Certainly, when a few securities start to get cheap even as the bull market continues, a value-starved investor will step up and buy them. Soon enough, many of these prove to be no bargain at all, as the flaws that caused them to be rejected by the bulls become more glaringly apparent when the world gets worse. After a stock market has dropped 30%, there’s no way to tell how much further it might have to go. It’d be silly to expect every bear market to turn into the Great Depression. But it would be equally wrong to expect that a fall from overvalued to more fairly valued couldn’t badly overshoot on the downside.

We’re bombarded by apparent opportunity….

Klarman: So when individual stocks reach levels where they are truly undervalued, what are value investors supposed to do other than to buy them? Anything else is market timing. Investors live in real time — not in several year intervals, but in months, days, hours and even minutes. Because we cannot know the future — and cannot see in the middle of the cycle its end, and not even necessarily its beginning — we will be bombarded by apparent opportunity as the market descends. We will see tempting bargains and value imposters, false rallies and legitimate recoveries, smart bottom fishers and mindless buy-the-dippers — and we will never know until after the fact how low things might go. We can become macro forecasters, predicting 10 of the next two recessions, or we can ignore the macro economy, buying bargains that cease to look cheap as the economy deteriorates and credit contracts and the tide goes out on all marketable securities.


Related link: James Grant, Bruce Greenwald, and Seth Klarman at the Annual Graham & Dodd Breakfast