Howard Marks (Trades, Portfolio) is a billionaire investor and co-founder of Oaktree Capital Management, an investment firm with $163 billion in assets under management. He is also known for his popular investing memos, which are even read by the great Warren Buffett (Trades, Portfolio).
Earlier this week, Marks made an appearance on BNN Blooomberg. During the interview, he discussed his outlook for the economy and the investment landscape. To follow is a discussion of some of the major points made.
Inflation and interest rates
The current macroeconomic situation of high inflation and rising interest rates needs to taken into consideration with this discussion.
Overall inflation is still well above the Federal Reserve’s 2% target and Fed Chairman Jerome Powell plans to keep hiking interest rates until it is fully dealt with. The current interest rate peaked at 4.25% before dropping to 3.5%. This is at the same level as 2008, just after the global financial crisis and a stimulus injection.
In 2020, Marks noted, interest rates were extremely low, which meant cash was “cheap” and government bonds returned minimal rates. This subsequently sent stock prices higher due to the T.I.N.A effect, which means "there is no alternative.” However, we are now seeing the opposite effect, with higher interest rates compressing stock valuations. In addition, higher interest rates increase borrowing costs and squeeze the profit margins of both businesses and the everyday consumer.
The positive is we know the Fed is purposely trying to slow down the economy to drive down inflation. However, this could be slightly more complicated due to the phenomenon of “expected inflation.” If business owners believe costs will go up, then many will put their prices up beforehand, which ironically creates more inflation.
Further, Marks believes the Fed will hold rates high for a long period to ensure inflation is dealt with effectively.
Low rates are not coming back
One of the biggest questions on investor’s minds is whether interest rates will drop down to around the 1% level, like in 2020, as inflation falls. As he noted in a recent memo, Marks believes we are due for a “sea change” from a low interest rate environment to a high interest one. The guru mentioned that in 2008, the Fed lowered rates “close to zero” to stimulate the economy. He believes this was the right thing to do as an “emergency measure,” but added they held rates low for too long (approximately seven years).
Marks compares lowering interest rates to a “shot of adrenaline," which is used if someone has a heart attack to bring them back to life. However, that does not mean we should take a shot of adrenaline every morning. In the 1980s, the investors mentioned that he took out a loan at a massive 20% rate. Therefore, the fact most people tend to think a 1% to 2% rate is “normal” is not necessarily correct.
Former Fed Chairman Alan Greenspan previously compared the “free money” conditions to a punch bowl scenario, where capitalists were getting “drunk” off the “cheap money” situation. However, Marks now believes the sea change will result in a mindset shift away from this irrational optimism.
A low interest rate environment is also effectively a “low return” world and, therefore, to get returns during this period, you have to take more risk. This is one reason why we saw a massive boom in speculative stocks, growth assets, special purpose acquisition companies and even meme stocks in 2020. Marks said crypto could also potentially be put into this category as a byproduct of investors seeking higher returns.
When economic times are seen as “tougher,” the investor noted, a “fear of bankruptcy” can actually instill better behavior from business owners. Marks previously criticized the “zombie companies” of 2020, which were kept alive despite having poor business models or management who were effectively gambling.
Should you try to time the market?
Marks is famous for not believing in the accuracy of economic forecasts. In the past, he has said there are two types of forecasters, “the ones who don’t know and the ones who don’t know they don’t know.” During the interview, he quoted Mark Twain, who famously said, "It ain't so much the things that people don't know that makes trouble in this world, as it is the things that people know that ain't so."
This is an extremely concise and true piece of wisdom that is relevant when investing. If you are extremely certain a stock will go up in price, you will likely put more capital into that investment and take more risk. However, if you have a blind spot and missed a piece of vital information, you could be wrong. Alternatively, if you admit initially that you don’t know, it actually leads to more prudent and effective investing. Admitting you are not knowledgable about something can actually be very cleansing when making decisions, rather than trying to “know the unknowable.” Buffett uses a similar process in which he looks to invest in “simple businesses” that are easy to understand.
The best way to act when dealing with the unknowable is to understand multiple scenarios and the best and worst case for each. Marks uses the simple example of buying a house, which the average person can relate to. Some people will try to time the economy or market by aiming to "buy a house” or even invest in stocks when the market is good. However, often when the market is good, it is harder to get a good deal as prices tend to be highly valued. With regards to a property, Marks believes it is a good idea to assess the location, cash flows and whether you can still afford a property if your financial situation changes. This is simple financial planning, but most people do not do this.
Marks believes investors should “prepare for bad times” and mitigate the downside risk, then let the “good times” be a nice bonus or surprise. Most people do the opposite in that they make an investment thinking purely about how much they can make as opposed to what they can lose and the odds of each scenario. Ideally, you are looking for a “symmetric” risk-reward ratio, which is a low-risk, high-return opportunity. Further, the investors said to be aware of the man who was six-foot tall and drowned crossing a stream that was “five-feet deep on average.” We tend to instinctively know the average case, but few people assess the best and worst case. According to Marks, it is not good enough to survive on “average;” we have to survive the “tough times.”
Bottom-up investing
In regard to his investment strategy, Marks said his firm focuses on bottom-up investing, which is not dependent entirely on macroeconomic forecasts. He reiterates his value investing approach as the best way to identify great companies for the long term.
Final thoughts
Marks is considered one of the greatest investors of all time. Despite being in his 70s, his insights on the market are relevant and well supported.
The "sea change" discussed during the interview and in his memo is defined as a “complete transformation” as opposed to just a “cyclical fluctuation” that will have many effects on the average investor. As such, it makes sense to be grounded on what the investing landscape is like currently as opposed to what we hope it should be like. Ironically, 2020 was considered as the “good times” due to low interest rates and a huge amount of stimulus. However, it was actually an extremely dangerous time to invest, as stock market valuations skyrocketed toward the fourth quarter of the year.
In 2023, inflation appears to be on a downward trend and although interest rates are still high, stock valuations are low. This means many stocks are trading “cheap” and, therefore, for long-term investments, this actually seems like a good time to buy. Of course, volatility is expected this year due to a forecasted recession, but I expect by 2024 we will start to see a positive uplift in both the economy and the stock market.
