Update on 9 April 2020
Within a week of his previous memo to clients, Howard Marks has revised his position. As he admits, he has set a personal record by issuing four updates in a month "in the total absence of guidance from analogies to the past."
He now believes the risks are a little better understood, although great uncertainty remains, and price declines have created opportunities. He says:
"Given these new conditions, I no longer feel defense should be favored. Yes, the fundamentals have deteriorated and may deteriorate further, and the disease makes for risk (remember, I’m the one who leans toward the negative case). But there’s a big difference between a market where no one can find a flaw and one where people have given up on risk-taking. And there’s a big difference between one that’s priced for perfection and one that allows for bad outcomes.”
He writes about 'cautious positioning' serving its purpose, that those with defensive positions have posted smaller losses this year and there are bargains available.
“Thus, I feel it’s a time when previously cautious investors can reduce their overemphasis on defense and begin to move toward a more neutral position or even toward offense (depending on how sure they want to be of grasping early opportunities). I’m not saying the outlook is positive. I’m saying conditions have changed such that caution is no longer as imperative.”
He is not calling the bottom of the market, as it is impossible to pick that moment.
“The bottom line for me is that I’m not at all troubled saying (a) markets may well be considerably lower sometime in the coming months and (b) we’re buying today when we find good value. I don’t find these statements inconsistent.”
Marks’ full memo called 'Calibrating' is here.
Back to the article published here last week
Howard Marks wrote his previous memo to clients of Oaktree Capital on 19 March 2020, and on Wednesday this week, he issued another one. It's a sign of how quickly the market is changing as he usually writes only once every couple of months.
In the space of 11 days, he seems far more worried. Previously, he wrote:
"Given the price drops and selling we've seen so far, I believe this is a good time to invest, although of course it may prove not (to) have been the best time. No one can argue that you should spend all your money today ... but equally, no one can argue that you shouldn't spend any. The more you want to garner potential gains and don't mind mark-to-market losses, the more you should invest here."
What's his latest view?
In his latest memo, he describes the 'quickest meltdown' in US stock market history, a fall of 34% in little over a month. It was followed by a gain of 17%, the best three-day rise since the 1930s. Amid the turmoil, 106 companies issued an unbelievable $213 bllion of investment grade bonds in a month, another record.
After his decades in the business, Marks is as well placed as anyone to assess the outlook. In his latest views, he catalogues the optimistic and pessimistic views, and reaches a vital conclusion. He starts with:
"It’s important to take time out for a serious discussion of possible scenarios. Are this past week’s remedies certain to work? Are the prior week’s negatives really erased? Which will win in the short and intermediate term: the disease, economic ramifications or Fed/Treasury actions?"
He then divides the arguments into the positive and negative cases.
Positive outlook
1. The virus will be brought under control within three months or so. He says every forecast makes the assumption that isolation, immunity, warmer weather, treatments and a vaccine will flatten and turn down the curve.
2. The negative impact of the disease on the economy will be sharp but brief. The V-shaped recovery assumes a big hit to earnings initially but an even stronger recovery within a short time, probably as little as three months.
3. The government will provide life support to the economy during a lockdown-induced coma and then bring the patient out of the coma after the cure has been effected. Recovery will be helped by improving news on the disease.
Negative outlook
Marks admits he's more of a worrier than a dreamer, with his personal defensive tendencies leading him to find more negatives than positives.
1. He is very worried about the outlook for the disease, especially in the U.S, and believes the headlines on infections and deaths will become much worse.
"The success of other countries in slowing the disease has been a function of widespread social distancing, testing and temperature-taking to identify those who are infected, and quarantining them from everyone else. The U.S. is behind in all these regards. Testing is rarely available, mass temperature-taking is non-existent, and people wonder whether large-scale quarantining is legal."
2. The economy will contract at a record rate, millions will be out of work, company earnings will collapse, and there may even be food shortages. He questions how realistic the V-shape recovery argument is.
"I believe we’re likely to see defaults on the part of leveraged entities, based on price markdowns, ratings downgrades and perhaps defaults on their portfolio assets; increased 'haircuts' on the part of lenders (i.e., reduced amounts loaned against a dollar of collateral); and margin calls, portfolio liquidations and forced selling."
3. It will be challenging to resolve the conflict between social isolation and economic recovery. He repeats the point made by President Trump in asking whether the disease merits the severity of the cure. The longer lockdowns continue, the harder it be for the economy to recover. If a decline in new coronavirus cases leads to a resumption of activity, a second wave of infection could hit.
4. In addition to the disease and its economic repercussions, there is a specific impact of the low oil prices on energy companies.
"Due to a confluence of reduced consumption and a price war between Saudi Arabia and Russia, the price of oil has fallen from $61 per barrel at year-end to $19 today."
He then adds negative psychology, fear of more problems and the negative wealth effects to his list of worries. He is even concerned whether enough businesses will continue operating during a lockdown:
"The Treasury can make up for people’s lost wages, but people need the things wages buy. So replacing lost wages and revenues will not be enough for long: the economy has to produce goods and services."
Summing up
He makes an important conclusion, saying if it's not too late, investors should increase defensiveness in their portfolios. He says:
"In the Global Financial Crisis, I worried about a downward cascade of financial news, and about the implications for the economy of serial bankruptcies among financial institutions. But everyday life was unchanged from what it had been, and there was no obvious threat to life and limb.
Today the range of negative outcomes seems much wider, as described above. Social isolation, disease and death, economic contraction, enormous reliance on government action, and uncertainty about the long-term effects are all with us, and the main questions surround how far they will go.
Nevertheless, the market prices of assets have responded to the events and outlook (in a very micro sense, I feel last week’s bounce reflected too much optimism, but that’s me). I would say assets were priced fairly on Friday for the optimistic case but didn’t give enough scope for the possibility of worsening news. Thus my reaction to all the above is to expect asset prices to decline. You may or may not feel there’s still time to increase defensiveness ahead of potentially negative developments. But the most important thing is to be ready to respond to and take advantage of declines."
Howard Marks is Co-founder and Co-chairman of Oaktree Capital Management, the largest investor in distressed securities worldwide. This article is general information and does not consider the circumstances of all investors.
A full copy of his latest client memo is linked here.