Market Defying Logic, But Not In A Bubble Yet, Says Oaktree’s Howard Marks
This is not the time to be aggressive, cautions Howard Marks.
Most assets are trading above their intrinsic value, but the market isn’t in bubble territory yet, according to Howard Marks.
“I don’t think we are in a bubble and I don’t think the conditions are crazy, but I do think that we are in the advanced stages of a very positive cycle,” Marks, co-chairman of distressed debt investor Oaktree Capital, said at Bloomberg’s Year Ahead Summit in New York.
This is the time to have less risk than normal in your portfolio. This is not the time to be aggressive.Howard Marks, Co-Chairman, Oaktree Capital
Biggest Risk, And Biggest Challenge
Marks cautioned that investors are clamouring to get into risky investments. “The biggest risk is that you and others are taking an excessive risk because you feel you have to, herd behaviour.”
The capital has flowed to the alternative markets and you’ve heard me before describe people doing it as handcuff volunteers. They have done something because they think they have to.Howard Marks, Co-Chairman, Oaktree Capital
According to Marks, the biggest challenge that investors will face in 2020 isn’t from politics, but from deciding how to get “a decent return in a low-return world without taking an inordinate risk.”
Watch the full interview with Howard Marks here:
Here are the edited excerpts from the interview:
This has been the longest bull market in history. Everybody knows it can’t last forever. You have studied market cycles and you have identified patterns in investor behaviour at various stages of risk-taking. From indiscriminate buying to sell-everything panics. Where are we now?
After 10 or 11 years of economic or market gains, you can’t say we’re at the beginning. You can’t say that we have bargain-priced assets that are languishing. The truth is, especially with low-interest rates, institutional investors who need significant returns are pursuing risk assets aggressively and alternative assets. They have to. I think most assets have been bid up to and are selling at prices above their intrinsic values. Most markets are full of capital and somewhat crowded.
I don’t think we are in a bubble and I don’t think the conditions are crazy but I do think that we are in the advanced stages of a very positive cycle.
It is hard to spot a bubble, isn’t it?
I don’t think it is terribly hard to spot a bubble. There are certain forms of behaviour which characterise bubbles. If you correctly say we are in a bubble today, that doesn’t mean it’s going to be punctured tomorrow because things can inflate further.
I have been doing this for 50 years and I have lived through some bubbles and I believe I have seen some bubble-behavior. For example, almost every bubble, I guess, is characterised by people saying about a certain asset class: ‘There’s no price too high.’ I saw it 50 years ago and I saw it in tech 20 years ago. For an XYZ (stock), the merit is so strong that no price is high. And clearly, that is irrational.
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Isn’t that’s what is going on today with negative yield and debt?
I don’t hear anybody saying the ‘there’s no price is too high’. When people buy bonds at prices that guarantee losses over the holding period, it’s debateable if that is rational behaviour.
You really think that’s debatable?
I put out a memo on that topic a month ago called ‘Mysterious’ because I do think it is mysterious and there are explanations. For example, in a low-return environment like today, where most assets are inflated, you could argue that in a bond where you only lose a half percent a year is the least worst outcome. I don’t argue that but that’s one line of thinking. Some people buy bonds that yield ‘negative half’ because they think interest rates are going down so a year from now a bond that has a terrific yield of only ‘negative half’ will be very much in demand. So, there are explanations. The only question is whether you buy them.
Who, if anyone, should be a buyer of negative-yielding debt?
The negative yield is a storage fee. What you’re saying is, I am willing to pay the government (most of this is sovereign) of Germany 0.5 percent a year to store my money because I am afraid (of losing my money), (and) I like the idea that end of every year I still have 99.5 cents left for certain because I trust Germany. And I am afraid if I do anything else, I will subject myself to greater losses.
How is it that we can live in a world where on the very same day some people (not a small number) are paying the government of Germany or Switzerland however many basis points to store their money and the same time, the stock market is trading at a record high?
My mother used to say, to each his own said the woman as she kissed the cow. I mean, different people have different opinions. For one thing on the debt side, there are people who, (A) have to buy debt and don’t have an option of buying stocks and (B) in many cases have to buy their own country’s debt - the national institutions for example. The German institution might have to buy sovereign debt regardless of the price. Markets equilibrate when the capital has the ability to go back and forth. In some cases, they don’t. But certainly, what you are describing is largely irrational.
Irrational markets. They have been irrational before.
Yes.
On the subject of bubble-like characteristics, if negative-yielding bonds, in and of themselves aren’t necessarily an indicator of some kind of bubble-like behaviour, what about some of the other things that people have observed? Particularly in the credit markets. Leveraged buyouts being done at 12 times Ebitda and more. No covenant loans, mushrooming of the triple B market.
Buying Argentine debt- 100-year bonds. Things can be elevated and imprudent without being bubble. The term bubble is used broadly.
Some people think a bubble is any time assets are overpriced. I think a bubble is a special word that should be reserved for special occasions.
True euphoria?
Crazy euphoria! A willing suspension of disbelief. A belief that this asset is so good that regardless of the price I buy it at, I will make money. And that just defies logic. You and I were talking about the logic of markets. It defies logic. The price you pay does not matter because regardless of the price you pay there will be some greater fool who will pay you more—that defies logic.
The last cycle—the one that ended in 2008-2009, was the biggest economic collapse since the Great Depression. How do you think this cycle will end, what will it look like and feel like?
First of all, the subject of today’s conference notwithstanding, I don’t consider myself a forecaster as you know. We talk about the fact that this economic expansion is the longest on record. There hasn’t been one in 10 years and now, of course, there is. And of course, the bull market as well, the longest in history. So, everybody fixates on that.
But the length of the economic expansion notwithstanding, this is the slowest economic expansion on record.
If you look at a chart of economic growth over the last ten economic expansions, and this is zero (gestures), they look like... (gesticulates arms in different directions to indicate fluctuations) they are all over the place and this one is down here in terms of rate of growth. So, I believe that one of the reasons we have cycles of up and down is that, we have excesses and corrections around the trend line. I believe that of course the excess is the period when the economy grows much faster than the trend line and it reverts to and through the trend line. I don’t think they are (there) in the real economy.
I don’t think there have been a lot of excesses in this particular cycle or in this recovery. You haven’t seen, for example, a lot of factory building ahead of demand and so forth.
What about balance sheet excesses? There is an awful lot of corporate debt.
That is different. As I said, it’s in the real economy and you are talking about finance. In finance, I think that the ultra-low interest rates, the rates of zero and below have warped a lot of calculations. So, in the small picture sense, it makes sense that companies have taken on more debt because it is so cheap.
You can borrow money and it almost costs nothing per year, why wouldn’t you? The answer is, the more debt you have, the less likely you are to get through a period of economic difficulty.
In the meantime, yes, there has been a lot of levering up at all levels.
Where do you see evidence of warped calculations?
For example, the pension fund which needs to return to seven-and-a-half, and can’t use cash, or even get what it thinks it needs from stocks and bonds, pushes out to alternative investments: private debt, private equity, venture capital and things like that. (This has been great) for our peers, that’s right. When we started Oaktree, my colleagues and I left the firm where we were managing $7 billion and our hope was, we’d get back to $7 billion.
Now, as you said, we are at $120 billion. So that gives you the idea that of course, when we started Oaktree, the word ‘alternative investment’ didn’t exist and now, it is extremely important. I think that’s an area of excess.
The capital has flowed to the alternative markets and you’ve heard me before describe people doing it as handcuff volunteers. They have done something because they think they have to.
Do you worry Howard, because of the fact that we have negative interest rates for example because we’ve had and still have quantitative easing; that the old rules of the game don’t apply any longer and if they don’t, what do you do?
Now, that is one of the most important questions. I wrote a memo two months ago called ‘This Time is Different’ and historically, ‘This Time is Different’ is used by people to rationalise bullishness that didn’t work out in the past and violations of the norms that prevailed in the past like valuations and that kind of thing. John Templeton said, 20 percent of the time, it really is different and nowadays, you have the sense that it is going to be more than 20 percent. So, you can’t say that the old rules apply, and you can’t say that in the absence of the old rules, you know how exactly this is going to come out. We are in a difficult period.
Everyone should be looking for red flags, certainly anyone whose money is at risk in the market. Eventually, the prudent investor will stop putting money to work and he/she will wait for prices to correct. What signals or red flags if you will, Howard, are you looking for to know that the moment has arrived? What should we see?
You have to watch all these trends and particularly, you have to watch what I call a pro-risk behaviour. People who are putting assets into risky asset classes because they feel they have to. If that’s the warning sign, then we are already there. So, that cannot be the warning sign or that warning sign can be exceeded which is really true. The answer is, you cannot say it’s time to get out.
What you have to say is, today, given the totality of everything we’ve been discussing and all the one-hand and the other-hand stuff, should you have more risk or less for you? I hope that every investor has a sense of what his/her normal risk posture should be, and the question is, today should you have more risk or less risk and I would say, less. That is different from saying, ‘it’s time to get out, it’s time to sell’ but I don’t think we’ll ever know that we are there or not, that ‘this is the time to sell’. Anybody who says it is probably talking to his hat and is unlikely that he’ll be right.
President Trump is a self-styled fan of low rates. He says that the Fed should cut rates further; why? Because there is no inflation and furthermore, the European rates as we have established several times in this conversation, are negative. As a result, he said that Germany has an unfair advantage, the U.S. dollar is too strong, and that’s running exports. Why shouldn’t the Fed keep cutting rates?
Well, number one, the proper rate has something to do with the rate of economic growth and our economic growth is better than the rest of the world so we should have higher interest rates than the rest of the world.
Number two, in that memo, I listed a dozen possible negative effects of having rates too low including the fact that I think it sends a very negative message to people and so in Europe, for example, where they have negative rates and you don’t get anything on your savings, they have a very much above-average savings rate because I think people are afraid and one of the reasons that they are afraid is, that the central banks are telling that they are really rough out there and that’s why the rates are negative.
The other thing is, of course, you want to have firepower as a central bank so that you can lower rates if the economy slows. Our economy is growing.
This is not the time to stimulate the economy in my opinion. It’s not the Fed’s job to prevent recessions and keep the market going up but if it’s true that you want to have firepower so that you can cut rates if things slow, then how much lower can you go than one-and-a-half percent?
It’s really an interesting question if you think about it. Historically, for example, in the global financial crisis, they cut the rates from 5 to 0. If we are at 2 percent, can you cut rates to 5? (Anchor: only if you go negative) There are some people who will say you can (go negative) but if you look at Europe and Japan, it’s hard to argue that it is working. They have negative rates and not a lot of economic vigour.
The people sitting in your seat this morning Howard, have asked what’s the biggest challenge in the year ahead? Is politics the biggest in the year ahead?
For investors, politics is one thing that contributes, I wouldn’t think it’s the biggest challenge.
What is the biggest risk then?
What could change the herd is hard to say. Last year, at this time we had one of the worst fourth quarters and one of the worst ‘Decembers’ in history. It’s hard to say exactly why but the herd is subject to turning. In 2000, the tech bubble burst and if you go back and watch the videotape from 2000, it’s hard to find a reason. It just did-maybe prices were unsupportably high, maybe people who were very bullish for some reason changed their mind en masse. I don’t think we can predict what is going to cause the next correction, but I believe we will have one.
The key is to watch the herd and be careful?
I don’t think so. I was on your show on Feb. 16 and you and your co-host were saying that markets are going down, down, down; isn’t that the sell signal? I don’t think the market knows anything. I ran back from your show to my office and wrote a memo titled ‘What does the market know?’
And I don’t think the market knows anything. I think you can’t take large instructions from the market; the market is not smarter than us.
You can watch for increases in unemployment, that would be a very negative sign and you should watch for reductions in earning expectations. Those two things together would give you a pause.
But there are a lot of people who believe that as long as the Fed supports, the market will go up and they could be right. So, the investment markets are not something like physics, where there is a schematic that always works, and we don’t know how this thing is going to work. The only thing we can know in point time, in my opinion, is whether we should have more risk than usual or less.