Howard Marks, Co-Chairman of Oaktree Capital, cautions that we don't know what the real economic impact of the coronavirus outbreak will be. The legendary value investor points out how important it is to be humble and explains why stocks look like a much better bet than long-term Treasury bonds.
When Howard Marks speaks, investors around the globe listen carefully. That’s especially the case right now, after the stock market suffered a severe setback and ten-year US Treasury Notes are yielding less than 1% for the first time in history.
Yet, anyone who thinks the founder of the US investment boutique Oaktree Capital is going to tell you where financial markets are heading next will be disappointed. In contrast to most «experts» in the investment world, Marks doesn't need to pretend that he knows the future.
«We know the market declined by 13%,» he writes in his new memo to Oaktree clients. «There can be absolutely no basis on which to conclude that stocks will lose another 13% in the weeks ahead – or that they’ll rise by a like amount – since the answer will be determined largely by changes in investor psychology.»
In an in-depth talk with The Market, Howard Marks shares his view on how he is navigating today’s challenging environment - and where he spots opportunities for investments.
Mr. Marks, in your new memo to Oaktree clients, you discuss the coronavirus outbreak and the uncertainties surrounding the impact on the global economy. What’s your advice for investors in this volatile market environment?
The great American author Mark Twain once said: «It ain’t what you don’t know that gets you into trouble. It’s what you know for certain that just ain’t so.» In our business as investors, there is no room to be certain about anything, and especially not today. Nobody knows what’s going to happen with the new coronavirus or what the implications are. But if you’re sure you know the answers and you bet heavily on it and it’s wrong, then you lose a lot.
What does this mean for investment decisions?
In our industry, a sentence that starts with «I may be wrong, but ...», or «I don’t know, but...» is unlikely to get you into trouble. You have to know what you know, and you have to know what you don’t know. If you think you know and you really do know, then your investment decisions are going to be very profitable. But if you think you know and you really don’t know, then it’s very dangerous. You have to know the difference, but too many people have too high an opinion of their opinion.
Then again, is there really nothing we can say about the economic impact of the new coronavirus at this stage?
No, too many things are currently unknown and unknowable. So clearly, there can be no such thing as a reliable statement regarding the implications of the virus. We don’t know how long this outbreak will last. We don’t know how many people will be affected. We don’t know how many will die. So how can we possibly estimate the impact on the economy? Yet, many brokerage firms come out and say GDP growth for the US economy will be 1.5%, for instance. There are as many forecasts as there are forecasters. They tell you what’s going to happen in the second, third and fourth quarter. But how the hell do they know? They may feel an obligation to make an estimate, and it may be their best guess. But there’s a big difference between «this is my best guess» and «this is correct».
So how are you personally dealing with uncertain times like today?
I don’t feel I have to make an estimate. I’ve been very successful in my career by telling people «I don’t know» when I don’t. I’m about to give a presentation next month, and I will start off by saying: «Nobody knows the future much better than anybody else. Still, some people feel that to be a success in this business they have to act as if they know the future.» I’m terribly opposed to that. For example, did you ever hear an economist or a strategist say: «I estimate that next quarter market is going to be up 2.2%, and over the last forty quarters I have been correct 41% of the time»? They never publish their batting record. If you would consider hiring me as an investor, you would want to know my record. But in the case of an economist, nobody is ever asking about the record. In fact, at the beginning of my career, they used to say that «an economist is a portfolio manager who never marks to market.»
In the last two weeks, financial markets have been extremely volatile. What does this say about the current mentality of investors?
In the real world, things generally fluctuate between «pretty good» and «not so hot.» But in the world of investing, perception often swings from «flawless» to «hopeless». When the market is optimistic, we don’t know where it’s going to go. It could become more optimistic or less optimistic. But we know the gains from increasing optimism may not justify the potential risk when the market swings from optimistic to pessimistic. There could be a big decline and people feel disillusioned and panic. This tells me that we should make an effort to understand how investors are feeling. For example, if investors are very optimistic, that’s dangerous. We use the expression «priced for perfection». But perfection is rarely achieved, and it doesn’t last forever. So I would consider such a market environment risk prone. In contrast, if people think that only bad things can happen and it’s going get worse forever, then that's opportunity prone. It’s essential to know the difference.
And what about the situation today?
I have thought that the market was high for a few years, and it didn’t go down. So there’s no formula for surefire success. Three, five, ten, and even eighteen months ago, everybody said: «Things are looking great, the US economy is the best in the world, and people have no alternative than to buy stocks because they can’t buy bonds with negative returns.» Most people thought the macro outlook was uniformly favorable, and they had trouble thinking of a possible negative catalyst with a serious likelihood of materializing. But when optimism is ruling the market in that way, if the sentiment swings from optimism to pessimism, you get events like the ones we’ve had in the last two weeks. So the catalyst for a recession or correction isn’t always foreseeable. It can seemingly appear out of thin air, as this virus seems to have done: The unimaginable catalyst is here and terrifying.
In early 2000, you wrote a remarkably timely memo titled «bubble.com», warning of extended valuations in the stock market. Are there parallels or similarities when you compare the internet mania with the market sentiment before this recent correction?
Back then, people also thought the future was perfect, and that for Internet stocks there was not such thing as a price too high. It’s a dangerous thought. I’ve never thought the environment in the last several years was as dangerous as it was in early 2000. That time was crazy, and 2007 was crazy, too. Looking at this cycle, the last eleven bullish years, I wouldn’t describe the market as crazy. The stock market was cheap from 2009 to 2012, and then it became fairly priced from 2012 to 2016. So maybe from 2016 until now it has been a little expensive. But I don’t think it has been crazy.
And what about the bond market? For the first time, 10-year Treasury Notes are yielding less than 1%. Isn’t that an indication of exaggeration?
Rates that low in the US are analogous to the negative rates in Europe or Japan. There’s not much difference between a 1% yield and a negative yield. Why would you buy such securities? The answer is that there has to be an extreme amount of fear. Naive people may say: «The great thing about Treasuries yielding 1% per year is that I can’t lose money. If I buy $100 worth of Treasuries today, then ten years from now I have $110.» But if you buy some good stocks with that money, what’s the probability that you will have less than $110 ten years from now? Today, the dividend yield for the S&P 500 is around 2%, and these companies have growth potential. That’s why I will bet on the S&P 500 vs 10-year Treasury Notes all day long.
Yet, there’s also a risk that the stock market will tank further when the coronavirus outbreak gets worse and the economy goes into recession.
There are two real possibilities. Number one: We bounce back and everything is back to normal in which case most stocks will do okay. Or, number two: The world is fundamentally changed and people alter their behavior and, for example, stop going to stores. This would be good for a company like Amazon featuring e-tail orders and at-home deliveries. Yet, the stock of Amazon is down over the last two weeks. To me, Amazon is a better bet than 10-year Treasuries. I’m not saying stocks are not going to go lower. I don't know what the stock market is going to do in a day, a week, a month or a year. Anybody who claims he does has to get his brain examined. But I would bet you that ten years from now, stocks like Amazon and Google will be worth more than they are today.
How can you tell when it’s a good time to buy?
What really matters is whether the price is proportional to the fundamentals. There is nothing that provides reliable help in the short-term. But I have no doubt that assessing price relative to value remains the most reliable way to invest successfully for the long run. If you invest for a profit in the short-term, all you’re doing is trading and guessing. But if you’re a long-term investor then you have a chance of success. You will be going through ups and downs, but that’s okay if you don’t panic and sell at the lows.
How attractively are stocks valued right now?
Valuations are a little higher than usual in terms of the P/E ratio. You could argue that maybe the quality of earnings isn’t so great these days, but because rates are low, you could also argue that higher valuations are justified. Before this slide started, the P/E ratio on the S&P 500 was 19. Today it’s 17, and the post war average is 15 to 16. That means valuations are a little high. But if you go back to 2000, the P/E ratio was 32. So this is not a crazy bubble. If you buy stocks when they are a little high, they may fall and they will have ups and downs. But if you buy good companies, chances are that in ten years from now, you will come out ahead. We can’t say that much about the 10-year Treasury Note. So my answer is: This is probably a decent time to buy a little. But if they go down, you have to keep your nerves, resist selling, and hopefully buy some more. No one can tell you that stocks aren’t going to go down: now or ever.
In June 2019, you wrote another important memo titled «This Time It’s Different», sharing your thoughts on the limits of monetary policy. What do you make of the emergency interest rate cut by the Federal Reserve?
In the last twenty years, the Fed has become too activist for my taste. It has been trying to solve or prevent too many problems. As a consequence, investors rely too much on monetary policy to do so. In order to try to prevent every recession, the Fed has cut rates lower and lower, and it has failed to take advantage of opportunities to raise rates. So today, there is very little room to cut rates meaningfully as in previous cycles. I think that’s very dangerous. We have near-zero interest rates and trillion-dollar deficits in times of prosperity. No one wants recessions, but using up our ammunition to fight them may not have been smart.
So how should prudent investors calibrate their portfolio accordingly?
You have to ask yourself how the riskiness of your portfolio today compares to its normal riskiness? That’s the key question. I have been saying for a couple of years that now is the time when you should have less risk than usual. So if you have less risk than usual, then you are okay. But if you have more risk than usual, I don’t think that’s right for this environment.