New memo from Howard Marks, founder of Oaktree Capital Group LLC (NYSE:OAK) on the Wealth and Confidence effect.
Memo to: Oaktree Clients
From: Howard Marks
Re: The Role of Confidence
Confidence is generally defined as belief in one’s ability to choose a course of action and execute on it. Although it’s not part of the definitions I’ve consulted, I think confidence also connotes optimism (at least it does among investors). Finally, there’s an element of certainty: beyond an optimistic view of the future, there’s conviction that view is correct. Taken together, the ingredients I see in confidence – belief, optimism and certainty – combine to create a feeling of well-being. Confident investors are sure big returns lie ahead
The Confidence Effect
The so-called “wealth effect” plays an important and well recognized part in the functioning of an economy. In short, when assets appreciate in value, the owners of those assets translate their increased wealth into increased spending. While at first glance this is unsurprising, it should be noted that this is true even if the appreciation is unrealized, and thus the increased wealth exists solely on paper. The relationship can be simply stated as follows: the richer people feel, the more they spend.
Changes in confidence have an impact on behavior similar to the wealth effect. That’s what this memo is about.
I have long been impressed by the role of confidence in an economy. In fact, I’ve written in the past – exaggerating only slightly – that sometimes I think confidence is all that matters. I consider its impact to be significant, pervasive, self-reinforcing and self-fulfilling. The primary impact of confidence on the economy is simple. If people think the economic future will be good, they’ll spend and invest . . . thus things will be good.
? Consumers’ optimism will translate into incremental demand for goods, adding to GDP.
? Consumer buying will convince businesses to invest in expanded facilities and additional workers in order to keep up with growing demand.
? Businesses’ investment in plant and workers will add to GDP.
? Newly hired workers will have money to spend, and their buying will add further to the
? The reports of confidence-fueled increases in GDP and other positive mentions of the economy in the media will reinforce this virtuous circle of optimism: back to step one. So, just like the wealth effect, increased confidence makes people and businesses spend more, and this in turn cycles back into the economy.