Wednesday, 29 April 2015

How to analyze real estate developers***

Real estate stocks make up a significant number of companies in Asian stock exchanges and many of them are among the the most volatile stocks. Whether the real estate developer is listed or not, they are influenced by a host of cyclical factors ranging from government policies, interest rates, unemployment rates, affordability, etc. Hence, it is important to understand how real estate companies can be analyzed.

Profit Model

Real estate industry can be separated into the following sub-industries or types of real estate developers:
  • Residential real estate developers
  • Commercial and mixed use real estate developers
  • Industrial real estate developers

Profit model of residential real estate developers

Residential real estate developers are more dependent on economies of scale than ever because of increasing land prices and declining rate of increase in residential property prices. In many developing countries, developers used to be able to acquire land at cheap prices and hope for rapid increase in home prices to make huge profits. In developed countries, land prices are higher, and price increases are more muted. Hence, brands and good management are playing an increasingly important role.

Profit model of commercial real estate developers

As prime real estate for commercial developments become more scare, commercial real estate developers tend to prefer to have rental incomes rather than selling units so that they can have consistent income and manage the properties. These developers are also more likely to sell their commercial properties to real estate investment trusts to free up capital and many are REITs that also develop properties.

Profit model of industrial real estate developers

Industrial real estate developers operate more like commercial real estate developers as they seek to have stable rental incomes and also sometimes selling their properties. Some industrial estate developers might even have a fund to invest in promising industrial companies so as to achieve higher profits.

Factors that Affect Value

  • Land bank - the value of a real estate developer is directly influenced by its land bank. As the larger the land bank, usually means the developer can make more profits from developing the land banks later. Hence, the land bank that a real estate company has is always disclosed in detail in the listed companies' reports.
  • Inventories - Real estate inventories an be separated into a few categories. Usually increasing values of construction-in-progress and land held for development will translate to higher future earningswill translate to higher future earnings for the company:
    • Completed developments - properties whose construction has been completed
    • Construction-in-progress - means the value of properties under construction.
    • Land held for development - value of land help for future developments.
    • Investment properties - properties held for rent or sale
  • Customers deposits - for residential projects, it is often that developers will collect customers deposits or even prepayments of entire houses prior to completion of the units. As these properties are pre-sold and their profit and loss have yet to be recognized in the income statement, growing customer deposits could signal increasing revenue and most likely profits in the coming years ahead.
  • Housing prices - the profits from real estate developers that primarily sell their developments come from selling the units at above costs. Hence, the moving of housing prices have direct impact on the profitability of residential real estate developers. Usually the stock price of real estate developers have high correlation with the anticipated housing price direction.
  • Rental rates - Rental rates are especially important for commercial and industrial real estate developers as most of them do not sell all the units that they developed but they keep these units for rental returns. Rental rates have direct bearing on stock prices of such developers and REITs.
  • Industry consolidation -  as economic difficulties mount and economies of scale becomes more important, mergers and acquisition activities will also drive prices of real estate companies as the merged entities might be more efficient given a larger land bank.
  • Macro economic factors - government policies play a huge role in controlling property prices as the following factors will determine the direction of property prices. We have listed
FactorMovementLikely Effects
Interest ratesUpNegative
Land supplyDownPositive on short term price but will affect future profitability if land bank dries up
Loan QuantumUpPositive
Reserve ratioUpNegative


Valuing Real Estate Developers

A common method to value real estate developers is using the Revalued Net Asset Value ("RNAV") approach which basically determines the net asset value of a real estate developer by adding up the change in value of the investment properties held by the company, the surplus value of properties held for development using Discounted Cash Flow method and the net asset value of the company with any other adjustments that are deemed necessary.
Usually a discount or premium percentage is multiplied with the RNAV base on the developers other qualities such as management capabiltiies, branding, track record, etc. A smaller developer with poor record of continuously generating consistent income is usually given a significant discount to its RNAV.
Using the RNAV approach only takes into account of what the developer can earn with the assets that it has in its books at the time of the valuation. If properly applied, it is usually more conservative than the market approach such as P/E multiples.
However, to use this method, it requires a lot of work in revaluing the properties held by the developer, making it difficult to implement by most people as information needed to determine RNAV needs some skill in obtaining.
The price earnings ratio method could also be useful to cross check the RNAV method.


Friday, 24 April 2015

Future of the Ringgit

The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio’s real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange rates play an important role in the rate of return on their investments.

There are positive factors that still support the ringgit: decent economic growth expected for 2015, low Government external debt and a credible monetary authority that has led to relatively low inflation over the years,’’ said Zahidi.

From a yield perspective in 2015, the US dollar will continue to sustain its appeal as the Federal Reserve is preparing to normalise the prolonged ultra low interest rates, albeit in baby steps in the months ahead.

“While the ringgit is expected to stabilise once negative sentiment towards it fades, investors will be focusing on Malaysia’s medium-term growth prospects and also assess whether the ringgit will continue to provide attractive returns from both a yield and appreciation standpoint in the face of higher US interest rates, going forward.

In another report, CIMB Investment Bank did a study in March 2004 when the ringgit was still pegged to the US dollar and at that time, found the ringgit to be undervalued by around five per cent.

‘’Since then, Malaysia’s fundamentals have strengthened further. As such, I would think that the ringgit deserves a much higher value from current levels,’’ said CIMB Investment Bank director/regional economist Julia Goh.

Negative perception and sentiment can really damage the value of a currency, which would cause concern among businesses and investors.

While those businesses that receive their payment in US dollars may celebrate, the net effect may not be that great as there could be high import costs of components and raw materials.

The current depreciation of the ringgit should remain for a year. However due to low debt to GDP ratios and high saving rates the immediate effects are on exports and inflation.

For a country with a depreciated currency, exports will increase in relation to imports as exports become cheaper and imports become more expensive.

Fortunately Malaysia’s trade surplus is RM2.86 billion and it is going to increase due to currency depreciation. The depreciation of the ringgit might increase the inflation rate and raise the cost of living somewhat, but the good news is that Malaysia has been maintaining a ‘safe-side inflation level’ of below two per cent for quite some time.

The exchange rate, whether appreciating or depreciating, was not the issue but volatility of the currency which rendered conduct of business extremely difficult and affected the capital market and the banking sector when it came to mortgages and shares.

Read more:

Why Shanghai and Hong Kong are the world's cheapest sharemarket 'bubbles'

A 25 per cent surge in Hong Kong-listed shares has investors worried the market is running too hot.
A 25 per cent surge in Hong Kong-listed shares has investors worried the market is running too hot. Photo: Bloomberg
When the price of any market doubles in the space of 12 months (like the Shanghai Stock Exchange's benchmark index), or jumps by almost a quarter in a matter of weeks (like its Hong Kong equivalent), the temptation is to write them off in one word: "bubble".
But can a sharemarket trading on a price-to-earnings ratio of 10 be considered to be in a bubble? That's the Hong Kong-listed stocks in both the Hang Seng Index and the Hong Kong China Enterprises index.
If the answer is "yes", then Mammon help local investors who are ploughing money into the Australian sharemarket, which trades on a nose-bleeding forward P/E of 16.
Ah yes, you say, but look at the mainland Chinese sharemarkets. That's where the full weight of irrational exuberance is on display. The Shanghai Composite Index now trades at 18 times estimated earnings for this calendar year, on Bloomberg data. Once again, the move has been dramatic, but the resulting valuation less so. The Shanghai index is about the same as the S&P 500 index, but well below the multiple of 28 investors are paying for the US Russell 2000 index.
"On an absolute basis, the valuations of these markets are not expensive, nor are they if you benchmark their P/Es against the US, Japan, Australia, or even Europe," Joseph Lai, who manages Platinum Investment Management's Asia Fund, says.
HSBC's head of Asia ex-Japan equity strategy Herald van der Linde doesn't see a bubble in Chinese shares, also pointing to valuations that have expanded fast but from very low levels. He remains "overweight" China, although he does add that some air might come out of the stocks that have run particularly hard.
"We like the financials sectors, banks and property companies, on the back of the lower interest rates we see in China," van der Linde says. "We also see infrastructure projects, such as those happening on the old silk road, benefiting infrastructure companies in China."

New money 

What has been particularly exercising pundits is the fact that the surges on the Shanghai and Shenzhen exchanges, and more recently in Hong Kong, are the result of a wave of new money from individual Chinese investors who look to be punting on a government-sanctioned boom in share prices, and often doing so on borrowed money.
"In our summer last year we started seeing in the Chinese media almost educational pieces encouraging mainland investors to get back into the sharemarket," Catherine Yeung, a Hong-Kong based investment director at Fidelity Worldwide Investment, says.
But this also needs to be put in context. After years of losing money, "mum and dad" investors in China had largely abandoned the sharemarket, often in favour of the property market. Exchanges in Shanghai, Shenzhen and Hong Kong essentially stagnated from late 2011 to 2014, as the chart shows.
Then in November the Chinese government announced reforms that made it easier for foreigners to invest in the Shanghai exchange and for mainlanders to buy Hong Kong-listed mainland businesses.
About the same time, policymakers began stepping up measures designed to stimulate a flagging economy. Chinese mums and dads began starting to take notice of the sharemarket, which was showing signs of life for the first time in years. They began to pile in.
The crescendo looks to have been reached in March, when retail Chinese investors opened about 4.2 million brokerage accounts, triple the number in February and taking the total number of new accounts this year to about 8 million. That's more than were opened in 2012 and 2013 combined, Fidelity's Yeung says.
A change of rules around Easter that gave Chinese mainland fund managers more access to Hong Kong-listed shares sparked a buying frenzy, as southbound money poured into the island's sharemarket and local investors jumped in to front-run the flow of money.

Daily turnover

The average daily turnover on the Hong Kong stock exchange tripled in short order, from an average of $HK87 billion ($14.47 billion) to $HK231 billion between April 8 and April 21.
More recently, regulators announced measures to rein in margin lending, which has been taken up enthusiastically by mainland investors.
"The ultimate aim of the government is to create a slow bull market rally," Yeung says. "It's very hard to change the behaviour of an investor who is set to go two ways – either a strong rally or sharp correction. That is the conundrum."
Lai says there has been some particular exuberance among Chinese small caps, but the larger names remain good value.
He points to a name like SAIC Motor Corporation, a joint venture between Volkswagen and General Motors and "a big company that sell millions of cars in China". The Hong Kong-listed stock is up 86 per cent over the past year, but trades on a P/E of 9.5. Or the giant China Mobile, which is the dominant mobile telco provider in China, with more than 800 million subscribers. It trades on eight times cash flow, Lai says, and that's after having jumped 65 per cent over the past 12 months.
A bet on China is also a bet that the government can continue to reform and rebalance the country's economy and steer it towards a more sustainable future.
"If economic reforms can continue to progress towards a more equitable and ecologically sound outcome, and the country can allocate capital better, then I think the market today is very cheap," Lai says. But he warns: "If the reform stalls, then we would have to reassess the market and our investment".

Tuesday, 21 April 2015

Inflation through the ages. Loss of purchasing power of your cash.

It is about value, not price

Monday, April 20, 2015

QAF Limited: $1.14 a share is cheaper than 93c a share?

One year ago, when QAF Limited's stock was trading at 93c a share, I observed that the PE ratio was 16.6x and I said that to buy in at that price would be making an assumption that earnings could improve dramatically in the future. There were pertinent concerns such as rising costs of doing business as well as the weak Australian Dollar and how these could continue to weigh down performance.

Well, for the full year 2014, QAF Limited has exceeded expectations as earnings per share (EPS) improved 46.4% from 5.6c to 8.2c, year on year. With the Australian Dollar having weakened further against the Singapore Dollar, how did this happen?

There was a one off contribution by Oxdale Dairy through the sale of its dairy business. Group operating profit, thus, received a boost of $1.6m. This will not be repeated, of course. However, considering the fact that Group profit improved some $15.7m (before tax), not having this one off contribution in the current year would still mean that QAF Limited would do very well, everything else remaining equal.

All business segments did well but the lion share of the improvement came from Rivalea, an Australian business segment. Operating profits improved threefold although revenue stayed flat because of higher selling prices, better product mix, productivity gains and lower raw material costs.

Lower finance costs also helped QAF Limited to do better in 2014 as borrowings were pared down. Interest expense decreased $0.9m from $4.1m to $3.2m last year.

Today, QAF Limited's stock closed at $1.14 a share and based on an EPS of 8.2c, we are looking at a PE ratio of some 14x. Even if we remove the one off divestment gain by Oxdale Dairy, we would be looking at a PE ratio of 14.5x, thereabouts.

So, although QAF Limited's stock is priced higher now, compared to buying at 93c a share a year ago, it is actually cheaper at $1.14 a share. This is what I meant when I said that a stock could actually be cheaper although its price could be higher. It is about value, not price.

Read more here:


1.  Price is different from value.  At price of 93 c a share, its PE was 16.6x.  At $1.14 a share, its PE was 14x.  Thus, though the price per share is higher, you are actually paying a lower multiple for its earnings.

2.  For the same reason, a $25 per share company maybe a cheaper buy than a 25 c per share company.  Compare their PEs.

Sunday, 19 April 2015

Should You Hold On To Your Wallet Now?

September 15, 2013 

As I am writing this article, the S&P 500 has advanced 3.37% so far in September, bringing total year-to-date price return to 18.36% and year-to-date total return to 20.18%. It seems like investors are having a good year with the index is only a little more than 1% away from all time high. The question is, where are we going next?

We have seemingly compelling arguments from both the bulls and the bears. I'll not waste the readers' time in listing out the arguments out there. Instead of picking a side based upon what various market experts masterfully opined on CNBC, I'd rather follow the wisdom of one of my favorite investors-Howard Marks:

"We may never know where we're going, but we'd better have a good idea where we are."

The Most Important Thing Is... Having a Sense for Where We Stand

Although this is not a macro forecast, it is by no means easy to figure out where we stand in terms of the cycle and act accordingly. Fortunately, Howard provides us with "The Poor Man's Guide to Market Assessment", which I shall use in an attempt to take the temperature of the market. The purpose of the assessment is to come to an objective conclusion with regards to the position of the pendulum. This assessment include a list that can be found in Chapter 15 of Howard's book "The Most Important Thing." Essentially this list contains pairs of market characteristics and for each pair, we will check the one that we think is applicable to today's market. At the end of this exercise, we should be able to have a sense of where we stand. Below is a brief summary of my analysis of the list:

  • Economy: The U.S economy is still "muddling through" with unemployment still at 7.3% (August) and estimated growth of GDP at merely 1.6%. I think it is neither vibrant nor sluggish.
  • Outlook: This is a market characterized by plenty of uncertainty mingled with cautious optimism. Therefore, a neutral rating seems appropriate.
  • Lenders: If we use Thomson Reuters' PayNet Small Business Lending Index as a proxy, it looks like lenders are becoming more eager as the index is at a level just around 115, much higher what it was at the bottom of the recent crisis (65) and not far from what it was prior to the crisis (130).
  • Capital Market: Using the Total Credit Market Borrowing and Lending data available from the Federal Reserve as a proxy, I think we are neither tight nor loose. Credit market borrowing and lending has picked up considerably since 2009 (negative $539 billion) to about $1.5 trillion at the end of 2012 (last full year data available). However, compared to the pre-crisis level of $4.5 trillion, I think we are still at a neutral stage, but probably not for too long.
  • Terms: Here we can talk about the terms of mortgage, corporate long term debt and etc. In terms of mortgage, it is pretty clear that lenders are very selective when initiating mortgages. Banks have been very strict in the arrangement of corporate debt covenants. Therefore, it seems to me that the loan terms are closer to the restrictive side.
  • Interest rates and spreads: Low. Not much explanation needed.
  • Investors: American Association of Individual Investors publishes survey result of individual investors on a regular basis on its website ( The latest result shows that 45.5% of investors are bullish, 29.9% are neutral and 24.6 % are bearish. Overall, individual investors are bullish.
  • Equity Owners: The Fed has forced equity owners to hold their equity positions.
  • Equity Sellers: With no better places to go, I would argue that the number of equity sellers are relatively few.
  • Markets: Using the trading volume of the S&P 500 as a rough proxy, the market is neither too crowded nor starving for attention at August's average trading volume of 3,069,868,600. During panic months such as March 2009 and October 2008, average trading volume were above 7,000,000,000.
  • Funds: According to Hedge Fund Research, "total hedge fund launches in the trailing 4 quarters ending 2Q 2013 totaled 1144, the highest total since nearly 1200 funds launched in the trailing 4 quarters ending 1Q08."
  • Recent performance: Strong.
  • Assets prices, respective returns, and risk: Both the Shiller P/E and the total market capitalization as % of GDP imply a high equity price and low implied returns, and hence, relatively high risk. You can find the relevant information using gurufocus' market valuation tools.
  • Popular qualities: Consumer discretionary and financial sectors have been leading the way in the market advance so far this year. Although the technology sector (which usually is perceived to be a sector for aggressive investors) has been a laggard year to date, many investors (of course not value investors) are paying a lot attention to and a hefty premium for stocks with promising futures such as Salesforce,Tesla, Linkedin, Stratesys, and 3D Printing. This indicates aggressiveness.
Now that we have finished the market temperature exercise, I thought it might be useful to quantify this checklist. In doing so, I tweaked Howard's method a little by adding a neutral characteristic in between and assigned a score of 1, 3, 5 for each category. A score of 1 indicates characteristics of a potentially overvalued market; a score of 3 indicates characteristics of a fairly valued market; a score of 5 indicates characteristics of a potentially undervalued market. Below is the summary table based on the above analysis: 

Economy: Vibrant Neutral Sluggish

Outlook: Positive Neutral Negative

LendersEager Neutral Reticent

Capital markets: Loose Neutral Tight

Terms: Easy Neutral Restrictive 

Interest RatesLow Moderate High 

SpreadsNarrow Moderate Wide

InvestorsOptimistic Neutral Pessimistic

Equity OwnersHappy to hold Neutral Rushing for the exits

Equity SellersFew Moderate Many

Markets: Crowded Neutral Starved for attention

FundsNew Ones Daily Neutral Only the best can raise money

Recent Performance: Strong Moderate Weak

Equity Prices: High Moderate Low

Respective Returns: Low Moderate High

Risk: High Moderate Low

Popular Qualities: Aggressiveness Neutral Caution and discipline

Total Counts: Score of One: 12; Score of Three: 4; Score of Five: 1

Score: 12*1+4*3+1*5=29

Maximum Score: 85

Score %: 29/85= 34%

Obviously 34% is just an estimate, we can easily shift some categories from score 1 to 3. However, as value investors, we would rather err on the side of caution. Hence, for the items that I am not entirely sure of, I chose the more conservative characteristic. 

When interpreting the result, the lower the percentage score is, the more cautious a prudent investor should be. At the peak of the crisis, I think we are not too far from the maximum score. Things have improved dramatically since then. To me, 34% implies that this is a time for us to take a more defensive stand and this is consistent with Howard's recent observation that "the race to the bottom isn't on, but we are getting closer." Of course the future of the stock market is unknowable but there are many things that I think we can comfortably say knowable, just to name a few. 

(1). Interest rates are going to rise and we all know how it will impact the price of all assets classes. 

(2). Corporate profits as % of GDP is unlikely to stay above 10% for a sustained period of time. 

(3). Both the Schiller P/E and Total Market Cap as % of GDP indicate potential overvaluation and reduced implied returns for equity investors. 

(4). The U.S's debt problem is still looming and has not gotten any better. 

None of the above knowables bodes well for the equity market. However, that doesn't mean we will have a so-called correction. It means we need to apply a higher level of prudence when managing our money, or other people's money given what we know. 

I want to end this discussion with the last paragraph of Chapter 15 of "The Most Important Thing." Here, Howard shrewdly observes:

"Markets move cyclically, rising and falling. The pendulum oscillates, rarely pausing at the "happy medium," the midpoint of its arc. Is this a source of danger or of opportunity? And what are investors to do about if? My response is simple: Try to figure out what's going on around us, and use that to guide our actions.

Finance Tips from the Rich

Everyone loves the thought of having a lot of money; or at the very least, having the financial freedom to give up working 9-5 to pursue their passions. Whilst we dream; these few already have it all. But why have they been able to make it big and the rest of us struggle?

We sought to find out the ultimate money lessons the world's rich and elite impart to see if they really know something we don't. Could these nuggets of wisdom be the missing link to monetary success for everyone? You be the judge.

1. Warren Buffett

Warren Buffett is one of the world's most renowned investment gurus with a fortune of about $71.5 billion to his name. He started investing at the age of 11 when he purchased six shares of Cities Service.

So what advice does Mr Buffett have for mere mortals like us? Some of his famous quotes are:

On Earning: "Never depend on single income. Make investments to create a second source."
On Spending: "If you buy things you do no need, soon you will have to sell things you need."
On Savings: "Do not save what is left after spending, but spend what is left after saving."

All 3 of the advice above come from readily established money-saving best practices: the creation of multiple sources of income, only spending on things you need and to make savings your priority.

But can you really make millions by adhering to these 3 simple steps? It seems a little far-fetched but doing the above anyway certainly doesn't hurt!

2. Bill Gates

He’s the Microsoft guy, the richest person of 2015 with a net worth of $78.8 billion.

Although, he is a dropout; Bill Gates' love for tech saw him create life-changing computer software and systems. According to some reports, when he was just 17 years old when he sold his first computer programme (a scheduling software) to his high school at the price tag of $4,200. Here is Bill Gates' favourite money quote:

“If you’re born poor, it’s not your mistake. But, if you die poor, it’s your mistake.”

Bill Gates isn't saying much. But you can't argue with the fact that hard work is integral to success - and is completely up to you. You can only blame others (your parents, your teachers, etc) for your financial circumstances for so long!

3. Sir Richard Branson.

The founder of Virgin Group and owner of more than 400 companies; Sir Richard Branson is no stranger to limelight. According to Forbes, his net worth in 2015 stands at $4.8 billion, making him not only famous but comfortably well-off too.

Born with dyslexia, which made school particularly hard, it was no wonder he dropped out at the age of 16. This was integral to the the start of his business career and the foundation of Virgin Records. His advice is no surprise:

“Don’t feel ashamed of your failure. Learn from it and start again.”

Getting up and trying again often means the difference between being a failure and finally succeeding. We can't argue with this truism either!

4. Tan Sri Syed Mokhtar Albukhary

Listed as one of the richest men in Malaysia with a total fortune of $2.8 billion, he is well-known both locally as well as overseas.

He has a lot of influence in wide variety of businesses including transportation and logistics; real state development; military; and power generation and engineering. But what's his advice to billionaire wannabes?

"Education does not guarantee success in life, its hard work.”

Yup, sounds about right to us.

So, What is the Moral of All These Stories?

We're sorry to break this to you folks, but right out of the mouths of the money-makers themselves, there seems to be no quick-fix magic pill one can take to get rich quick. In fact, every one of these business magnates and all round rich-ies seem to say exactly what personal finance sites have been telling you all along:

Work hard;
Keep trying;
Save money;
Only buy what you need;
Have as many sources of income as you can.

If you've tried all of these and have yet to make the Forbes rich list then perhaps the one thing these guys forgot to mention - was a good helping of intelligence and good luck! That said, it doesn't hurt to keep trying the above!

Net worth quoted above is based on Forbes' Real-Time Net Worth as at 3.8.2015.

Seth Klarman: Investors Downplaying Risk “Never Turns Out Well.” Markets don't exist simply to enrich people.

Posted By: Mark Melin

Seth Klarman Baupost Group
Noting that stock markets have risk and are not guaranteed investments may seem like an obvious notation, but against today’s backdrop of never before witnessed manipulated markets Seth Klarman sagely notes “Someday, financial markets will again decline. Someday, rising stock and bond markets will no longer be government policy. Someday, QE will end and money won’t be free. Someday, corporate failure will be permitted. Someday, the economy will turn down again, and someday, somewhere, somehow, investors will lose money and once again come to favor capital preservation over speculation. Someday, interest rates will be higher, bond prices lower, and the prospective return from owning fixed-income instruments will again be roughly commensurate with the risk.”
When will this happen? “Maybe not today or tomorrow, but someday,” he writes, then starts to consider what a collapse might look like.  “When the markets reverse, everything investors thought they knew will be turned upside down and inside out. ‘Buy the dips’ will be replaced with ‘what was I thinking?’ Just when investors become convinced that it can’t get any worse, it will. They will be painfully reminded of why it’s always a good time to be risk-averse, and that the pain of investment loss is considerably more unpleasant than the pleasure from any gain. They will be reminded that it’s easier to buy than to sell, and that in bear markets, all to many investments turn into roach motels: ‘You can get in but you can’t get out.’ Correlations of otherwise uncorrelated investments will temporarily be extremely high. Investors in bear markets are always tested and retested. Anyone who is poorly positioned and ill-prepared will find there’s a long way to fall. Few, if any, will escape unscathed.”

Seth Klarman’s focus on Fed

Seth Klarman then once again turned his sharp rhetorical knife to the academics that run the US Federal Reserve who seem to think that controlling free markets is a matter of communications policy.
“The Fed, in its ongoing attempt to tamp down market volatility as much as possible decided in 2013 that its real problem was communication,” Seth Klarman dryly wrote. “If only it could find a way to communicate to the financial markets the clarity and predictability of policy actions, it could be even more effective in its machinations. No longer would markets react abruptly to Fed pronouncements. Investors and markets would be tamed.”  The Fed has been harshly criticized by professional traders for its lack of understanding of real world market mechanics.
given that the Fed is taking the economy into uncharted territory with unprecedented stimulus.  “As experienced travelers who watch the markets and the Fed with considerable skepticism (and occasional amusement), we can assure you that the Fed’s itinerary is bound to be exceptional, each stop more exciting than the one before,” Seth Klarman wrote, sounding a common theme among professional market watchers. “Weather can suddenly turn foul, the navigation faulty, and the deckhands hard to understand. In short, the Fed captain and crew are proficient in theory but lack real world experience. This is an adventure into unexplored terrain, to parts unknown; the Fed has no map, because no one has ever been here before. Most such journeys end badly.”
While the mainstream media is loaded with flattering articles of the Fed’s brilliance in quantitative easing and its stimulus program, the real beneficiaries of such a policy are the largest banks.  Here Seth Klarman notes they have placed the economy at great risk without achieving much reward.  “Before 2009, the Fed had never bought a single mortgage bond in its nearly 100-year history,” Seth Klarman writes of the key component of the Fed’s policy that took risky assets off the bank’s balance sheets.  “By 2013, the Fed was by far the largest holder of those bonds, holding over $4 trillion and counting. For that hefty sum, GDP was apparently raised as little as 25 basis points in the aggregate. In other words, the policy has been a near-total failure. Bernanke is left arguing that some action was better than none. QE in effect, had become Wall Street’s new ‘too big to fail’ policy.”

Seth Klarman: What do economists know?

There has been considerable discussion that the academic side of the economics profession has little clue how markets really work.  Economic academics, who now make up the majority of the Fed governors, often look at the world from the standpoint of a game of chess, where one can explore different options and there is now a “right” or “wrong” approach to market manipulation.
“The 2013 Nobel Memorial Prize in economics was shared by three academics: two were proponents of the efficient market hypothesis and the third was a behavioral economist, who believes in market inefficiency,” Seth Klarman wrote. “We suppose that could be considered a hedged position for the awards committee, one that would never occur in the hard sciences such as physics and chemistry, where a prize shared among three with divergent views would be an embarrassing mistake or a bad joke. While a Nobel Prize might well be the culmination of a life’s work, shouldn’t the work accurately describe the real world?”
Another interesting insight on the topic was to come from David Rosenberg, Chief Economist and Strategist atGluskinSheff, who recently wondered “[A]m I the only one to find some humour, if not irony, in the fact that the three U.S. economists who won the Nobel Prize for Economics did so because they ‘laid the foundation for the current understanding of asset prices’ at the same time that these asset prices are being determined less today by market-determined forces but rather by the distorting effects of the unprecedented central bank manipulation?”