Howard Marks has received plaudits over the years as a skilled and savvy investor capable of looking beyond the day-to-day bustle of markets.
Now 72, Marks has stepped back from his daily duties at the credit-focused Oaktree Capital Management (OAK), which oversees nearly $124 billion in high-yield debt, distressed debt, convertible securities, and other assets. But he helps the firm he co-founded form its macro view, and he does a lot of public speaking and traveling.
Marks has also charted a parallel career as a financial writer. His memos to clients, which he began penning in 1990, remain popular on Wall Street. His latest book, Mastering the Market Cycle (Houghton Mifflin Harcourt), had just been published when Marks stopped by Barron's offices in early October. We spoke with him again last week to get his assessment of the recent market upheaval.
Q: There's been a lot of market turmoil since we spoke on Oct. 1, with the S&P 500 (.SPX) down about 9%. At that time, you said we were still in an optimistic phase of the market. Does that still hold?
A: No. The interesting thing is really how quickly things have changed. It illustrates something I mentioned in the book. I refer to a cartoon whose caption is: "Everything that was good for the market yesterday is no good for it today." I wrote that "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.'" Nobody can say why this happens or why the tipping point was reached. But the psychology of the market is so irrational and excessive in its swings.
In the beginning of 2016, the market was crashing because, among other things, people thought rates were going up and oil was going down. First of all, is it bad if oil goes down? It is bad for the oil companies, but it is good for a lot of others. The increases in interest rates should have been foreseeable, and the situation is kind of similar this time.
Q: In what way?
A: When the stock market sold off on Oct. 4, it was attributed to the rise in the 10-year Treasury yield. But that shouldn't have come as a surprise. We've been in a rising interest-rate regime for about three years.... For some reason, because of the way investor psychology works, people switch from only seeing the good to seeing only the bad. So what I said nearly a month ago about the market being in an optimistic mode turned out to be very fragile.
Q: Does this recent volatility impact where we are in the market cycle?
A: You can't really tell. It could be a start of a down market for a while or it could be just another wobble on the way up, and we've seen this before. In this bull market, we've had periods of weakness, one in early 2016. You can't tell what these things mean at the time they are happening, and you can't really intelligently bet on it.
Q: When we sat down a month ago, you thought most assets were expensive, including debt and equities. Is that still the case?
A: You could call the stock market a little rich, but I don't think it's highly overvalued. However, you just can't think of the market as this machine. There is no schematic for how it works. It just picks funny things to obsess about on the positive side for a while and then the negative side. This could be the beginning of a down leg or not—but you just can't attach too much intelligence to the market's daily fluctuations.
Q: In your book, you write about how it's crucial to calibrate between being aggressive and defensive. What should investors do now?
A: To me, the main question is: Is it time for offense or defense? And I still think it is time for defense, predominantly. It's not 100%, but at this point, I would worry more about losing money than I would about missing opportunities, and it is time for caution. [Although he didn't cite specific examples, he made it clear that besides holding cash and shunning leverage, one way to play it safe is to find mutual funds that have outperformed in down markets.]
Q: What are the key themes in your most recent book?
A: Managing risk and understanding where you are in the cycle are really the two most important things for an investor, and they are interrelated. That's because where we stand in the cycle is a main determinant of risk.
Q: Do a lot of people overlook that?
A: They probably get it intuitively, but they don't think about it rigorously. In the book, there are graphs that relate the cycle to the probability of return distributions.
Q: What do those graphs show?
A: As we rise in the cycle, which means that prices are higher relative to values in general, the probability distribution of future returns shifts to the left, which is to say it gets harder to make money and easier to lose money, and the expected return declines. On the other hand, if you can buy when we are low in the cycle, the probability is that price is low, relative to intrinsic value, and the probability distribution of future returns shifts to the right—that is, it is harder to lose money and easier to make money, and the expected return is higher. That all sounds very academic, but it is the difference between buying in, let's say, early 2007 versus late 2008.
Q: What are some important considerations to keep in mind in assessing where we are in the cycle?
A: For most of us, over a two- to three- to five-year time frame, hitting the right mark in terms of the mix of offense versus defense in a portfolio is the most important single decision. If you get the offense versus the defense right, it doesn't matter really what you pick, what stocks you bought, or whether you did stocks versus bonds or whether you did U.S. versus foreign or whether you did small-cap versus large- or growth versus value. If you get it wrong as far as calibrating your portfolio between being defensive and more aggressive, all that other stuff isn't going to save you. But if you get it right, you will be heading in the right direction.
Q: Is it more important than valuation?
A: I think so, and it is a lot more important than stock-picking. If you could have turned cautious in 2005, 2006, and aggressive in late 2008 and early 2009, it didn't matter what you did. It didn't matter which asset classes you chose. Look at late 2008. All you needed for success was money to invest and the conviction to invest it. The source of that conviction would have been an understanding of what was going on in the environment. I call this taking the temperature of the market.
People can learn to take the temperature if they look at the right things. How, for example, is the news? How is the news being treated? Are people obsessing on the positives and ignoring the negatives or vice versa? Are new deals being bought up or they going begging? Are funds filling up right away? If somebody like me goes to a cocktail party, are there people who actually want to hear what I have to say, or do I get shunted off to a corner?
Q: Do they want to hear what you have to say?
A: Today, they do.
Q: Glad to hear that. Please continue.
A: If you take all these things and interpret them—and if you draw the proper inferences—you can reach a judgment about whether investing is popular or unpopular. If you can combine that with quantitative measures, such as price/earnings ratios and bond yields and capitalization rates for property, you reach a conclusion about whether the cycle is in the propitious part or the precarious part.
Q: Can anybody really assess where we are in the market cycle?
A: The truth is: Investing is not easy; making money isn't easy. How can it be easy? Everybody wants to make money. It is a very competitive activity. But if you are disciplined, if you study, and if you can keep your emotions under control, then you can do these things. But one of the real keys is to keep your emotions under control. Everything in the environment conspires to make us do the wrong thing, to buy when things are going well and prices are high—and to sell when things are going poorly and prices are lower, which is the exact opposite of what we should do. But it all comes from emotion. We have to resist.
Q: What are the best environments for good investing opportunities?
A: When things are undiscovered or intimidating, that's when you find bargains. But when they are popular, nobody can see a flaw in them, they have been performing well, and the capital is flooding in, that's not the environment in which you find bargains. In the book, I cite Mark Twain, who is reputed to have said that history doesn't repeat itself, but that it does rhyme. But what is it that rhymes?
When you look at market cycles, the duration, the speed of the fluctuations, the severity, the causes, and the effects all vary. What rhymes are the root causes—too much optimism, not enough risk aversion, and too much money. Just about every boom that I have seen has been marked by those things, and these are the kinds of things that readers can look for to assess the market environment.
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