Why Howard Marks Says A V-Shaped Recovery Is Too Much To Hope For

One of the world’s biggest distressed-debt investors said a V-shaped recovery belief has too positive a connotation at a time governments across the world offered massive fiscal stimulus and central banks lowered interest rates to near-zero to revive economies that came to a standstill after the coronavirus outbreak.

Usually, a ‘normal’ upcycle occurs because things are going well in the economy, causing decision-making and psychology to become increasingly optimistic and eventually euphoric. Corporates expand and stock prices rise. Eventually, productive capacity exceed what is needed and stock prices exceed underlying value, Howard Marks, co-chairman at Oaktree Capital Management, which has a $19.2-billion portfolio linked to distressed debt worldwide, said in his latest memo. When these trends outstrip the fundamentals and became unsustainable, he said, the result is a downturn. Often, a recession triggers a market correction.

But this time, it’s different. This correction, according to Marks, was caused by an “exogenous, non-economic development”, the Covid-19 pandemic. The recession, rather than being the cause, was the result.

“This downcycle can’t be fully cured merely through application of economic stimulus. Rather, the root cause has to be repaired, and that means the disease has to be brought under control,” Marks said.

And even with the disease controlled, an economic stimulus is unlikely to reverse all the damage, he said. That’s because large firms will continue to automate and streamline. A large number of smaller businesses, such as restaurants, bars and ships, will never re-open, implying millions of people will not be rehired into the jobs they formerly held, Marks said. “For this reason, the expectations with regard to economic recovery have to be realistic.” So, the “V-shape”, according to him, has too positive a connotation.

Stimulus Measures

The U.S. economy, according to Marks, is in need of a continuous support. And while early on, the treasury supported the economy, differences between two parties meant a lack of measures closer to the election.

The economic recovery that everyone is counting on is dependent on continuation of the fiscal expenditures, he said, adding that the outlook for action in this regard is not good.

Interest Rates

Marks attributed the uptick in equity indices to interest rates. The stimulative effect of low interest rates, increase in discounted present value of future cash flows and lowering of demanded returns across the capital market line all led to the effect of higher equity returns, he said.

The lower the Fed funds rate is, the lower the bond yields will be, according to Marks. And lower yields on bonds means they offer less competition to stocks, so that stocks don’t have to be cheap to attract buying, he said.

Most decisions in investing, according to him, are relative decisions. And this theory of relativity is leading to buying in stocks. Lower demanded returns lead to higher valuations, and low interest rates and the resultant low prospective returns encourage risk tolerance and reaching for returns, Marks said.