Regular readers of Cuffelinks know we are fans of Howard Marks, Founder and Co-Chair of the $100 billion fund manager, Oaktree Capital. Financial markets are at a fascinating junction where most analysts expect favourable global growth, but a shadow is cast by massive government debts, rising interest rates and growing tensions between major countries (this week, The Economist identifies conflicts between the US, North Korea, China, the UK and Russia).
The latest Marks memo to his clients focusses on this contrast of market optimism versus fear.
The positives
Marks starts by clarifying he would never tell investors ‘it’s time’ to ‘get out’. The market rarely gives such clear signals. To counter the perception that he is overly cautious, he lists a number of positives, including:
- The sustained US recovery from 2009 is now joined by other economies, delivering worldwide growth. There has been no boom and when a recession eventually occurs, there will probably not be a severe bust. The pro-business President Trump is encouraging capital spending, and tax cuts will help company profits.
- US unemployment is down to 4.1%, the lowest in 60 years, which should gradually translate into wages growth and increasing consumer demand.
- At the moment, inflation remains low and any rise in interest rates should be gradual and limited.
- Overall, investors have not been behaving euphorically, reducing the catalysts for a downturn.
The negatives
He warns that this favourable macro environment comes with high prices for most asset classes, and the threat of rising inflation and interest rates and an uneasy quiet in markets:
- Many valuation measures (such as Buffett’s ratio of market capitalisation to GDP, the VIX, bond yields, the Shiller cycle-adjusted P/E ratio) are at or close to all-time highs, which in the past have signalled a downturn.
- Investors are taking risks to compensate for low returns, leaving prudent investors sidelined:
“How healthy can it be when investors think an asset or market is rich but they’re holding anyway because they think it might go up some more? Fear of missing out (or “FOMO”) is one of the more powerful reasons for investor aggressiveness, and also one of the most dangerous.”
- The easy money has been made, prospective returns are well below normal for almost every asset class and risky investor behaviour prevails. He argues for defensiveness rather than squeezing the last drop of return from the market.
Marks' summary of conditions
Marks does not try to satisfy the demand for a definitive position. Asset prices are worrisome but investor psychology is unpredictable. He will continue to invest on the basis of value relative to price, based on his mantra of “move forward but with caution”. His summary is:
“For me the key points regarding the general market outlook are as follows:
- The absence of widespread euphoria certainly is an important flaw in any near-term bearish view.
- Thus there’s no reason for confidence in the existence of a soon-to-burst bubble.
- Investor psychology continues to grow more confident, however.
- Asset prices are already unusually high.
- Future events remain unpredictable, but today’s high prices mean the odds are against a significant long-term upward move from here.
- No one can say what’s going to happen in the short term.”
And in response to the argument that a more aggressive stance would have produced higher returns, he says that could not have been justified by logical reasoning in the past. He muses:
“Is an incorrect decision one that didn’t work out well, or one that was wrong at the time it was made? I insist it’s the latter.”
We should all recognise this when we have remorse about missing out on a surging tech stock with little revenues, negative bond rates and Bitcoin going above $20,000.
Graham Hand is Managing Editor of Cuffelinks. The article is general information and does not consider the circumstances of any investor.
Howard Marks’s latest memo to his clients, which also discusses his reaction to the latest US tax cuts, is linked here: Latest Thinking.
CNBC Video: Billionaire investor Howard Marks: I wouldn't call this market euphoria