#Seth Klarman likens investors to frogs slowly boiling in a pot

If you start to feel warm — with a sudden urge to hop out of the stock market — there might be a reason for that.

A prominent hedge-fund tycoon said investors are like frogs who are getting slowly boiled in a pot as he warned of the risks of easy money from the US government to offset economic damage from the pandemic.

Billionaire Seth Klarman — whose letters to clients of his Boston-based fund Baupost Group are closely read on Wall Street — said the Fed’s pandemic-fueled policies of keeping rates close to zero have not stimulated the economy but instead sent the market flying beyond reason and made investors recklessly unafraid of risk. 

“Trying to figure out if the economy is in recession is like trying to assess if you had a fever after you just took a large dose of aspirin,” Klarman wrote, according to a report by the Financial Times (paywall). “But as with frogs in water that is slowly being heated to a boil, investors are being conditioned not to recognize the danger.” 

The warning from 63-year-old Klarman — considered by some to be the most respected value investor besides Warren Buffett — comes days after Janet Yellen testified in her confirmation hearing as Treasury Secretary that the US government needs to “go big” as she backed rock-bottom interest rates and President Biden’s $1.9 trillion stimulus package.

Since bottoming out in mid-March during the early days of the pandemic, the S&P 500 has surged back up by almost 73 percent, hedge fund returns for 2020 are coming in as high as 95 percent and megabanks are offsetting poor years in commercial banking with huge profits from their trading desks.

On Wednesday, all three major indices set record highs. On Thursday, the latest jobs showed that 900,000 Americans filed for unemployment in the second week of January.

“The fortunes of those already at the top bounding swiftly upward,” wrote Klarman, whose fund reportedly underperformed the market in 2020. “While those at the bottom remain on a downslope without end.”

In his letter, Klarman calls the Fed an “800-pound gorilla” has sent stocks to artificially high levels by replacing the private sector in providing liquidity when companies need it most.

Using Tesla as an example, Klarman points out that Elon Musk’s electric car company is “barely profitable” yet its stock price is up more than 670 percent in one year.

To Klarman, this is clearly a result of the Fed fostering an “exceptionally benign market conditions” where almost every stock is a winner based on projected cash flows as opposed to the less exciting reality of current results.

Or as Klarman told his possibly disappointed investors, “The market’s usual role in price discovery has effectively been suspended.”