Howard Marks: The Risks Today Are Substantial

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Mr. Marks, we’re at an interesting point in time. For the first time since the financial crisis the Federal Reserve has raised the interest rate. How does the world look like from your perspective at this historical moment?
We’re in a very strange market. Most people are doing a good job of thinking and the consensus is not necessarily wrong today. On one side, the world is a very uncertain place and I think the average investor understands that. Most people are sober and sensitive to all the uncertainty. You don’t see many people who are massively bullish. Nobody is saying stocks are going to the moon. Back in 1999 there was a book published with the title “Dow 36’000” predicting that the Dow Jones (Dow Jones 17528.27 -0.14%) Industrial would almost triple. Well, that book is not being re-published today.

And on the other side?
Security prices are not low. I wouldn’t say high, but full. So people are thinking cautiously but they’re acting bullish and they’re behaving in a pro-risk fashion. While investor behavior hasn’t sunk to the depths seen just before the crisis, in many ways I feel it has entered the zone of imprudence.

How do you explain this juxtaposition?
The answer is that they are forced to be buyers by the central banks. The rate on money markets is close to zero and treasuries yield between one and two percent or even negative in Europe. Most investors can’t live with that. They have to move out the risk curve in order to try to get five, six or seven percent. That has induced or forced risky behavior. To me, this is the most important thing that’s been going on over the last few years, and it still is here at the end of 2015.

There are a lot of risks lurking out there: Monetary policy divergence between the US and Europe, a high degree of stress in the emerging markets and the specter of further terrorist attacks. What’s the most important risk for investors?
Academics say risk equals volatility and the nice thing about volatility is that it gives them a number they can manipulate and use in their formulas. But I don’t worry about volatility and I don’t think most investors are worried about volatility. We know prices will go up and down. But if something is going to be worth a lot more in the future than it is today we’re going to buy it regardless. So people don’t worry about volatility. What they worry about is the potential of losing money.

You wrote extensively about risk in one of your recent memos. What does risk mean to you?
Most people think that there is a positive relationship between risk and return: If you make riskier investments you can expect a higher return. That’s total nonsense! Because if riskier assets could be counted on for higher returns than they wouldn’t be riskier. The reality is that if you make riskier investments you have to perceive that there will be a higher return or else you have no motivation to make that investment. But it doesn’t have to happen: If you increase the riskiness of your investments the expected return rises. But at the same time the range of outcomes becomes greater and the bad outcomes become worse. That’s risk and that’s what people have to think about.


Where do you see potential for bad outcomes?
Investors are not doing what they want to do. They’re doing what they have to do. They are like “handcuff volunteers”. Today, if you want to make a decent return you have to take risks. And most people have been willing to do that. And because of that money has flown into high yield bonds and leveraged loans. For example, at one time there were ninety-five straight weeks of inflows into leveraged loans mutual funds.

Now, credit markets have become quite nervous. What goes through your mind when you look at the rising spreads on high yield bonds?
That’s a good thing. If you’re a buyer you would rather buy at a high risk premium than on a low one, everything else being equal. Maybe the onrush of money was too strong, maybe the attitudes were too optimistic. Now people are a little more worried, especially since they already had a little bad experience in Ukraine, in Greece and in China over the summer.

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