I am not a value investor, but I appreciate hard-earned market wisdom from any source. See below an extract from Seth Klarman’s investors letters for the period of 1995 to 2001, generously provided by Market Folly
Here are some of my favorite quotes from the letters:
The prevailing casino atmosphere must certainly put a damper on trips to Las Vegas or Atlantic City, where there are more losers than winners. In Internet- land, there have been no real losers as of yet; the illusion of a positive-sum casino is an attractive lure for the gambler. Recent exuberance notwithstanding, at today’s valuations it is clear that Wall Street is certain to continue issuing shares of new Internet companies until the supply of shares overwhelms the resources of the buyers…
Sentiment, existing only in the minds of investors, is subject to change quickly and without notice…
The financial markets have been so strong for so long that fear of market risk has mostly evaporated. People who used to hold bank certificates of deposit now maintain a portfolio of growth stocks. It is not really within human nature to comprehend that you may not know everything you think you know, and, further, that what you believe in could change on a dime…
Unprecedented gains in large capitalization growth stocks continue to generate a mistaken faith among individual investors in the safety of owning stocks, as well as an erroneous impression of the potential future returns from equity ownership. Success begets additional success as investors project future results from the rear view mirror. One particularly irksome development is that fundamental research is today a significant impediment to good short-term results, as the most overvalued securities have steadily been the best performers and the most undervalued the worst. 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…
Very few professional investors are willing to give up the joy ride of a roaring U.S. bull market to stand virtually alone against the crowd, selling overvalued securities without reinvesting the proceeds in something also overvalued. The pressures are to remain fully invested in whatever is working, the comfort of consensus serving as the ultimate life preserver for anyone inclined to worry about the downside. As small comfort as it may be, the fact that almost everyone will get clobbered in a market reversal makes remaining fully invested an easy relative performance decision…
Our concern is that we cannot know when the current love affair with large capitalization growth stocks will end, and what sort of havoc this will wreak on smaller stocks, however inexpensive. As we have explained before, the only logical way to hedge against this risk is to protect an investment in these undervalued smaller stocks with a put option on or short sale of more expensive stocks. We have ruled out short selling for a number of reasons, including the unlimited downside risk that short selling poses. With puts, at least, your cost is limited to the up-front premium. Such a hedge, however, is historically quite expensive and, as we learned last year, far from perfect…
The gravitational force of the Internet and technology stock bubble is exerting a strong pull on the assets of investors. Money is draining from other sectors of the market into these strongly performing ones, causing share prices of more mundane companies not merely to underperform but actually to decline…
The Investment challenge of providing liquidity to out-of-favor asset classes is more complex than simply identifying areas that others are avoiding. First, it is important to never be blindly contrarian, betting that whatever is out of favor will be restored. Often, investments are disfavored for good reason, and investors must consider the possibility that recovery may not occur. Second, it is important to gauge the psychology of other investors. How far along is the current trend, what are the forces driving it, and how much further may it have to go? Being extremely early is tantamount to being wrong, so contrarians are well advised to develop an understanding of the psychology of the sellers. Finally, valuation is extremely important in reducing risk. Investors must never mistake aninvestment that is down in price for one that is bargain-priced; undervaluation is determined only by
a security’s price compared to its underlying value…A great many value investors suffered terribly during the Internet stock mania of 1999 and early 2000. In a market dominated by money flows, the stocks of mundane companies were abandoned for those that offered growth, the more explosive the better. These value managers experienced poor performance, resulting in investor outflows, which necessitated additional selling. Although value managers have recently outperformed growth managers, they have only started to narrow the performance gap of the last several years.
In today’s environment, money flows rule, trumping all other factors in determining security prices. From any starting point, money flowing into one category and away from another can wreak havoc with accustomed levels of valuation and can cause egregious mispricings, both too high and too low…
Seth-Klarman-Baupost-Group-Letters
