A Value Investor's View on Rates

My equity strategist friends continue to predict strong GDP growth in the back half of the year and into next year. The Fed continues to see no reason to raise rates, despite the private sector's optimistic forecasts. Meanwhile, it is beginning to appear that European inter-bank lending will impose some disciplines on the weaker players, despite the most dovish pronouncements. All of this continues to make me uneasy---it's the sense of complacency.

Seth Klarman, who worked for Max Heine at Mutual Shares (my first mutual fund and a seminal value investor), gave an interesting talk to the CFA Society in Boston. The site Market Folly has a fine set of notes on his talk. I think his perspective is really spot on. Rahm Emanuel is reported to have said, "A good crisis is not worth wasting." So, the global financial system is saved as it circles the drain, and this gets us financial regulation, consumer protection, TARP, Cash for Clunkers, and universal health care insurance.

Klarman points out that, unlike the Great Depression, we didn't get anything lasting out of our recent crisis. The post-Depression mentality--skepticism, frugality, a savings mindset--influenced parenting for generations and helped to fuel a sustained prosperity. For us, Klarman says the current crisis has been "a few bad weeks." That's certainly what it seems like reading the Fed Governors comments and private forecasters.

Add to that the fact that the Fed has insisted on keeping rates near zero, which Klarman says has forced market participants to take on more risk in the inevitable search for higher return. The government he says is feeding the public a "Hostess Twinkie" market--eye catching, delicious with no nutritional value. Everyone is seduced into going long so that confidence can be restored. The results, like eating the Twinkie, will not satisfy, as they seem not to be now.

Have a look at Klarman's talk--definitely nutritive value for the mind there. You may retune your asset allocation as a result also!