Big names at CFA confab see little to celebrate in the stock market

Some of the highest-profile investors speaking at the CFA Institute's annual conference this week have found more to worry about than celebrate in the stock market's government-engineered resurgence of the past 14 months.

Seth A. Klarman, president of Boston-based Baupost Group, a hedge fund manager with more than $20 billion in client assets, told the conference's roughly 1,600 attendees in Boston Tuesday that he's more worried now “than I've ever been in my career.”

“Virtually everything is being manipulated by the government,” with the apparent goal of muddling through rather than tackling serious problems, argued Mr. Klarman. “Every can is being kicked down the road,” he said.

Addressing the same crowd on Monday, GMO Chairman Jeremy Grantham likewise struck a skeptical tone. Under the Federal Reserve's current near-zero interest rate policy, the country's major banks would be awash in profits even if they were led by grade-school children, he said.

Meanwhile, the country's retirees, unable to earn enough on their savings, are being pressured to plow money into riskier assets such as stocks, which at current market levels don't offer obvious value, Mr. Grantham said.

In fact, a little over a year after a range of equity and fixed-income pockets were offering compelling values, bargains today seem few and far between.

“The rally has been indiscriminant,” with risks “starting to be priced close to perfection again,” as they were before markets began crumbling during the second half of 2007, noted Mr. Klarman.

“We may be going right back” to an environment where the spreads between risky and less risky assets become unusually narrow, Seth D. Alexander, president of the Cambridge, Mass.-based Massachusetts Institute of Technology Investment Management Co., said in a separate talk Tuesday.

Even so, Mr. Alexander, who oversees the investment of MIT's $8 billion endowment, defended the endowment model against recent critiques, arguing that incremental changes could alleviate the vulnerabilities that the model's focus on less liquid asset classes exposed it to during the market's recent volatility.

MITIMCo. has been working on those incremental changes. For example, the investment office has worked to ensure contractual access to liquidity for a greater portion of its illiquid investments and coordinate better with the budgeting side of the university, he said.

Mr. Alexander said the rush of money into alternative strategies such as hedge funds and private equity funds in the years leading up to the financial crisis put downward pressure on potential returns — with cheap leverage benefiting managers rather than investors. That flood has subsided somewhat, and the opportunities in those alternatives segments for investors could well be more attractive for the coming three or four years, he said.

Messrs. Klarman and Grantham were less optimistic about the outlook for portfolio returns now. The value of financial assets at the point of entry “really matters,” noted Mr. Klarman, who said at current market levels it's not out of the question that investors coming in now could suffer another decade with no returns.

The “depression mentality” following the Great Depression more than 70 years ago led to some behavioral modifications that served investors and the country well, but today “we've developed a ‘really bad couple of weeks'” mentality, and for the most part the lessons that should have been learned haven't been, said Mr. Klarman. With “almost everybody drinking the Kool-Aid again,” the market could face another serious collapse and people still wouldn't be prepared for it, he said.

Some investors cited high-quality U.S. stocks, which have lagged their more speculative counterparts during the market's rally, as a relatively safe haven should things turn sour again.

Stocks with high, stable returns and low debt, such as Coca-Cola Co. and Johnson & Johnson, offer some of the best value around now, said Mr. Grantham.

High quality stocks — companies that can outperform their competitors — can serve as both a deflationary hedge and an inflationary hedge, noted Mr. Alexander, who said he's perfectly willing to sacrifice short-term gains during speculative rallies for the longer-term benefits.