That Baupost Group founder Seth Klarman doesn’t think that President Trump is going to make hedge funds—or anything else—Great Again shouldn’t surprise. The somewhat reclusive, famously press-shy hedge funder in August stepped out from the shadows back in August to endorse Hillary Clinton, pronouncing it “simply unthinkable that Donald Trump could become our president.” He was, of course, right: It is unthinkable, and gets more so with each passing hour, regardless of the fact that it is also our reality. Now, Klarman’s not the only hedgie who would have preferred someone—anyone—other than the current occupant of the Oval Office be sitting in the White House right now. Bill Ackman and Paul Singer come to mind. But while Ackman has turned cheerleader and Singer has made accommodations, Klarman doesn’t buy the Trump rally or that anything good could come from the next 1,443 days.
“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.
Contra the fairly widespread notion that Trump’s impulsiveness, combined with the ongoing regulatory bonfire, will bring about the market volatility that hedge funds crave, Klarman says to be careful of what you wish for.
“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”
Oh yea, and those things he is “planning”? They’re not going to work. In fact, they’re probably going to be a disaster.
“President Trump may be able to temporarily hold off the sweep of automation and globalization by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces,” he continued. “While they might be popular, the reason the U.S. long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off….”
“The Trump tax cuts could drive government deficits considerably higher,” Mr. Klarman wrote. “The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels….”
“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.”
With that off his chest, Klarman acknowledges that Trumponomics isn’t the only problem, or rather that it is just a manifestation of a larger problem, which is to say: us. Klarman’s not going to pretend that hedge funds have been worth 2 and 20 recently, but what do you expect when tons of dumb money chase returns from 15 years ago? Luckily for the savvy, dumb money goes both ways.
“When money flows into an index fund or index-related E.T.F., the manager generally buys into the securities in an index in proportion to their current market capitalization (often to the capitalization of only their public float, which interestingly adds a layer of distortion, disfavoring companies with large insider, strategic, or state ownership),” he wrote. “Thus today’s high-multiple companies are likely to also be tomorrow’s, regardless of merit, with less capital in the hands of active managers to potentially correct any mispricings….”
“This should give long-term value investors a distinct advantage,” he wrote. “The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.”
Now we, and—as Andrew Ross Sorkin makes clear—everyone else would love to see the Oracle of Boston’s words in full, but ARS isn’t sharing. If you’ve been graced by the Great Man’s missive, perhaps you’ll be less selfish. Send it along to firstname.lastname@example.org and we’ll share with the whole class.