Howard Marks spoke at Barclays Global Financial Services today. Below are his comments from a transcript obtained by ValueWalk.
Howard Marks: Thanks very much, Skip. Thank you for joining me this morning, everybody. And one of the most important jobs that I perform at Oaktree Capital Group LLC (NYSE:OAK) is to figure out the micro environment and the setting in which we all perform. We don’t consider ourselves market timers. We don’t raise in lower cash and our clients don’t expect us to do that, not doing so has always been an important part of our investment philosophy. But on the other hand, we think it’s very, very important to have a handle on the macro environment and to determine how aggressive or defensive to be and how much money to raise. I always say that – people ask me, what scares me, that’s the second question after what happens after you go under the buzz. And I will say, well, there are two things that scares me; one is raising too much money and the other is raising too little money. And it’s very hard to get that exactly right, but certainly to do that, we have to have a handle on the environment.
Many of the most well-known hedge fund managers in the world engage in philanthropy, and in doing so, they often reveal their favorite hedge funds through a review of their foundation's public filings. Bill Ackman's Pershing Square Foundation invested in several hedge funds during the fiscal years that ended in September 2019 and September 2020.
Howard Marks on macro forecasters
And before I go on with my remarks, let me just say that we also don’t consider ourselves macro forecasters and we don’t have an economist on staff and the things we do are not based on forecasts of the economy, but one of my sayings is that we may not know where we’re going, but we ought to know where we are. And so, a lot of what I talk about this morning will be about the current environment and what it implies for how we should behave.
I think that to put it simply, the world is much more uncertain than it used to be. This is the biggest change in last five years. Most people are aware of the uncertainties that exist in the environment, nevertheless many markets are raising and it’s important to know why.
When I say that the world is more uncertain, if you think back, I was reminded this morning that we’re within a week of the fifth anniversary of the Lehman filing, which is a good marker for all of us, but if you think back six years or seven years to the world as it existed at that time, how you would you describe it? Well, here is what I would say. I would say that people were 100%. People who would have been filling these seats in this room were 100% certain that they understood what made the world tick. What it would look like five years from then, and how anything could get fixed, if it went wrong. And I think the biggest single change in the world is nobody thinks those things anymore. Everybody realized that the world looks very different from what they would have said six years or seven years ago, what they would have said it would look like today. And clearly it’s been demonstrated the Fed etcetera cannot just push buttons and fix things. If you watch TV there is no easy button with regard to the economy. And I think that this change to the consciousness of uncertainty is a very big change.
Howard Marks: Central banks liquidity
But let’s talk about the current environment. What has been driving the markets for the last few years: Number one, of course, the central banks understood Bernanke as the scholar of depression, understood perhaps better than not any that it was the absence of liquidity, the withdrawing of liquidity that exacerbated the depression to the extent that it was bad.
And it’s us, the central banks to varying degrees created a lot of liquidity and particular of course reduced interest rates to zero. Now when we saw them reducing interest rates five years, six years ago what did we think? We said, aha, this is great because it will stimulate the economy and it will get – it will reduce the cost of doing business [ph] with current people to buy things, take on inventories, build plans et cetera, that’s great.
Number two, this is terrific because this will recapitalize the banks. And if you lend banks money at zero, which they can lend out at 5% it’s like you gave them $5 times the capital, and that’s great. What most people didn’t catch on, I must admit that I didn’t catch on to the current extent is that when you reduce the interest rates on treasury to zero you force people at the risk curve because it pulls down the whole risk curve, and so if you want to get the returns like you used to get before it happens, you must go further out the risk curve to make that money. And, that’s been the story over the last few years in the capital markets.
So, money was created, it had to go some place. The central banks lowered the return on treasuries and other safe investments and this caused people to look elsewhere for the risky markets they create. Before the crisis, you used to be able to get 6%, 7% on intermediate term treasury notes and now of course, you can’t even get that from high yield. So, you go to high yield or you go beyond, if you need 6% or 7%. You can’t stick around the treasuries.
Howard Marks: Low bond yields
Now, in addition to what the central banks did, there have been certain factors which reinforced these trends; number one, the returns on risky assets have been very good over the last few years, and so people are encouraged to do more of it; number two, the default experience among high yield bonds, for example, has been unusually low since 2010.
And when people – when defaults don’t occur, people tend to get sloppy and say well, I think we’re living in a low default world, I think we’re living in a safe world; and then number three, psychology becomes more positive as markets rise. So you take those factors together, good experience, low defaults and rising psychology and that’s why I say that even though people are not thinking bullish, they are concerned about the uncertainties, they are acting bullish, their behavior and not only they’re buying riskier securities, but they are buying them at lower returns and they are buying it with weaker features. The covenant is disappearing. It’s easy to do a dividend recap, a CCC issue or something like that in the high yield bond market. So, if you take it all together, what do you have, today, the price for pursuing safety appears very high in terms of opportunity cost, and the price for accepting risk appears very low, mainly because risky securities have been performing so well, and of course, this is the combination of factors that very much encourages risk taking, and that has been the story of the world in the last few years.
So the question is, for us to decide how to behave today? How to position our business, our portfolios? So, obviously, there are factors on both sides, and there are always are and that’s a healthy debate. And today, the fact is arguing for us to move forward and take action or and invest or the number one, the U.S. economy is recovering; number two, psychology is muted; number three, prices of most assets are moderate, stocks are selling at a fairly normal PE ratios, high yield bonds are selling at actually generous yield spreads related to treasuries, and finally, safety is priced too high to pursue, it’s with the exclusion of risk taking. If you say, I want safety today, I don’t want to worry about losing money, then you get a pittance in terms of return. So these factors argue for forward movement, but there are also factors that argue for the application of caution.
Number one, the level of uncertainty is very high in the world as I discussed. Number two, the economy is – can only be described as sluggish. We continue to see two steps forward, one step back, which I guess is better than other places where you see one step forward and one step back. There is the possibility of highly significant negative developments.
Howard Marks: Black swans
You know, what you might call black swans. I mean, there are things out there which have a low probability of happening, but could have substantial consequences. Examples would be some problem with the euro and the euro – and Europe don’t feel the me like they are out of the woods organizationally. Another would be hyper inflation brought on by too much money printing and other would be deflation and it Japan experience and I point those two out to just show you that the fact that people worry today about both inflation and deflation shows you what a confusing world we live in today. And then finally, the providers of capital are providing risk tolerant behavior and all four of those factors in my opinion add for – argue for restraint.
So I’ve devised over