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Klarman warns of impending asset price bubble

Miles Johnson

One of the world's most respected investors has raised the alarm over a looming asset price bubble, calling out "nosebleed valuations" in technology shares like Netflix and Tesla Motors and warning of the potential for a brutal correction across financial markets.

Seth Klarman, the publicity shy head of the $27 billion Baupost Group whose investment opinions have attracted a near cult-like following, said that investors were underplaying risk and were not prepared for an end to central banks reversing a five-year experiment in ultra-loose money.

(Read more: Candy Crush?WhatsApp? Sure looks like a bubble)

Seth Klarman, founder of the Baupost Group.
Daniel Acker | Bloomberg | Getty Images

While noting that he could not predict exactly when a significant market correction would occur, Mr Klarman wrote in a private letter to clients: "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?' . . .  Anyone who is poorly positioned and ill-prepared will find there's a long way to fall. Few, if any, will escape unscathed.

Baupost, which is closed to new investment, returned $4bn to clients last year.

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The warning by Mr Klarman, who has won a devoted audience for his highly cautious, value-driven approach, and whose out-of-print book on investment sells second-hand for as much as $2,900 on Amazon, comes after US shares surged by almost a third last year. Many well known technology companies, such as Facebook, more than doubled.

Robert Shiller: We have a bubble
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"Any year in which the S&P 500 jumps 32 percent and the Nasdaq 40 percent while corporate earnings barely increase should be a cause for concern, not for further exuberance," Mr Klarman wrote.

"On almost any metric, the US equity market is historically quite expensive. A sceptic would have to be blind not to see bubbles inflating in junk bond issuance, credit quality, and yields, not to mention the nosebleed stock market valuations of fashionable companies like Netflix and Tesla Motors," he wrote. The Baupost Group declined to comment.

Since central banks slashed interest rates to record lows and began a policy of buying up government bonds after the 2008 market crash, the S&P 500 has rallied by more than 150 percent to new all-time highs. Bond yields have fallen sharply and many other assets, from fine art to property in Singapore and London, have leapt in value.

(Read more: Cramer: Has marketgotten too hot to handle?)

Mr Klarman is exceptional among hedge fund managers for often holding the bulk of his portfolio in cash, yet still generating annualized returns of 18 percent since 1983 using often highly concentrated investments.

The Boston-based investor was recently ranked as the fourth best performing hedge fund manager of all time for generating $21.5bn in returns over its history, coming behind George Soros, Ray Dalio and John Paulson.

By The Financial Times