Below is a new interview with Howard Marks, published in today’s issue of the Swiss Business newspaper Finanz und Wirtschaft by editor Christoph Gisiger. Excerpts from the interview re-printed with permission
What kind of deals are you thinking of?
Well, look at deals like Argentina being able to sell 100-year debt at a yield of 8%. Netflix can sell debt at 3,625% and Softbank is raising a private equity fund worth $100 billion. These deals are all indicative of the mindless shouldering of risk that arises when investors are eager to put money to work. They do it because the alternative, cash, is so unattractive. In Switzerland for instance, you have negative interest rates – so investors feel forced to put their money to work. But, you see, it is not necessarily the worst thing to hold cash at negative interest rates. There are things that are worse, like buying securities at prices which are highly inflated and then seeing their prices decline substantially.
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When we look at stock market valuations, they are very rich. In the case of the S&P 500 they were only higher in 1929 and in 1999-2000.
Yes, but that does not necessarily mean the valuations can’t go higher. In early 2000, the P/E ratio of the US stock market was significantly higher than today. Also, interest rates are much lower today, which justifies high P/E ratios. Even Warren Buffett says equity valuations are not so high – if you believe interest rates will stay low. The big question of course is whether that will be the case.
What do you think? Will interest rates stay low?
The Fed says it will raise rates. But it seems to have a hard time doing so, because it’s concerned that rate hikes will choke off the little bit of economic growth we have today.
So we have high valuations, deals that shouldn’t get done, and other indications that we’re in the late state of the cycle. Are we even in another bubble?
No. You know, people make sloppy use of terminology. A bubble is not just a highly valued market. A bubble is ridiculously high. Don’t get me wrong, I think the valuation of the U.S. stock market is very high, but it’s not ridiculously high. In a bubble, people say that there is «no price too high,» and they say «only good things can happen.» I don’t see that today. Most of the people I talk to say things like: «We know this thing can’t go on forever, but we just don’t see what could derail the market anytime soon.» At least they’re conscious that there are limitations.
So it’s the euphoria that’s missing to call this a bubble?
Exactly. People are not euphoric today, nobody is ecstatic. The bullish people acknowledge that stocks are expensive, but they want to let them go a bit higher. In such an environment, prices can go up further, even though they’re expensive. Of course, a value guy would say if stocks are expensive, you should not own them. I would state it like this: You should not own as much of them as you did when they were cheap. But again, I don’t see people coming up with explanations why stocks should be considered cheap because «it’s different this time.» Nobody says valuations don’t matter anymore. Thus the situation today is not as dangerous as it was in past bubbles.
Isn’t it a case of «This time is different» when people say interest rates are going to stay low forever and hence fair valuations should be much higher?
It would be a dangerous bet to say interest rates are going to stay low forever, but I don’t see many people taking that bet. And you see, even if interest rates were to stay where they are, that would argue for P/E ratios to stay where they are. And if they do, then stocks will only appreciate at the same rate as earnings, which is not really fast; there would be no multiple expansion. This market is not built on some euphoric view of the future, but mainly on the unwillingness to accept zero or negative returns on cash and safe instruments. It’s based on the view that there is no alternative: people are afraid to be out of the market. But then again, a perceived lack of alternatives is not a good argument for chasing yield and taking big risks. That’s why I think this is the time to turn cautious.
So people understand that the market is highly valued but they think it will continue to burble up. Isn’t that built on everyone’s assumption that they will be able to get out in time?
Yes, indeed. It’s not smart, but people think that’s what they have to do now. You remember Chuck Prince, the CEO of Citigroup, who in July of 2007 said «when the liquidity dries up, this will end badly, but as long as the music is playing, you have to dance?» What does that even mean? People always say they’ll stay in the market, thinking it has further to go, but if it starts to turn down they will get out. Maybe that’s what people are thinking in today’s stock market: «It will continue to go up, but I will get out in time.» People overestimate their ability to get out in time. Who will be there to buy when everyone wants to sell? That’s wishful thinking.
So you see a lot of complacency today?
Yes. The VIX, the volatility index, is at its all-time low set in 1993. That was a time when Bill Clinton took office, the Cold War had ended and people were expecting a peaceful world. Should investors really be as complacent now as they were then? I don’t think they should. But the VIX does not say what volatility will be in the future. It tells us more about people’s mood today than it does about the events of tomorrow.
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