He opened his remarks to the BOP by saying, “I think it’s important to think. I’m not telling you what to think but illustrating the way I think.” Then Marks embarked on his presentation to the BOP board of directors gathered for their June meeting in Philadelphia.
Marks said, “The world seems more uncertain today than at any time in my experience. I’ve been doing this for 45 years, so that says a lot.”
He later quipped that he sees part of his job as worrying for his investors, admitting that he tends toward skepticism and conservatism in terms of investing.
According to Marks, those uncertainties include the sluggish U.S. economy, the dearth of leadership in the U.S. and globally.
U.S. economic recovery?
Marks noted that “the U.S. economy is sluggish, slow, unsteady and not dynamic — and no one is seeing a robust return to prosperity.” When asked why, the answer included an over-reliance individually and governmentally on credit, consumer confidence and a bevy of long-term problems now in view.
Marks said that “Credit is one of the drivers because people buy things they cannot afford. The last 40-50 years has been dominated by the use of credit at all levels — not just college kids but cities and states and countries. That has been a stimulus to the economy, but it was not all good. Spending has grown faster than incomes. Borrowing to spend is not sustainable, and we have done it to excess.”
He continued that “confidence is down and that is a major contributor to economic growth. Confidence is also self-fulfilling. If the people in this room conclude that the future will be good then they will go out and spend and create the outcome they now forecast.” But right now, he noted that although “consumer confidence is moderate, business is hesitant to expand because of uncertainty related to healthcare costs and Washington is failing to provide a predictable or reliable setting related to tax codes and business regulations.”
The “long term problems” to which Marks eluded include Europe, whose future is impossible to discern, U. S. fiscal problems which he described as “less immediate but not much less significant” and the reality that the U.S. government has made a lot of promises without funding them.
Other factors driving uncertainty
Marks observed that “elected officials around the globe appear unable to produce solution.” He noted that it’s “hard to find a Churchill today.”
He predicts that “there is a hard landing coming for the Chinese. It is a highly credit stimulated economy and they want to taper off — but a hard landing is more likely. This will affect all economies in Asia.”
Turning back to the United States, he observed that “the economy is highly reliant on stimulus, which will have to end some day,” “the U.S. infrastructure is deteriorating,” “income inequality is a growing problem,” and “there are geopolitical problems worldwide.”
Not desiring to over-emphasize the negative, Marks noted that “asset valuation metrics appear reasonable, equity pie ratios are in line with the average, high yield bond spreads are adequate, real estate prices are down from crisis highs, and investor psychology is moderate.”
Investor psychology: sufficient risk consciousness can render a risky world less risky
Marks said, “The riskiest thing in the investment world is to believe that there is no risk.” But Marks thinks that although “conservatism and skepticism will help you make better investments,” today’s lack of investor euphoria may be cause for concern.
He observed that “much of the risk in investing comes from the behavior of the participants and the riskiest thing is the belief that there’s no risk.” Although that was a major contributor to the U.S. financial crisis, “no one feels the way today — everyone is aware of the litany of the negatives,” Marks said.
Today, “low yields are forcing even wary investors into pro-risk behavior. People are moving up the risk curve in order to get the return they used to get in less risky investments.” Marks continued, “So, even though people were not thinking bullish, they were acting bullish which makes the world a risky place even in the absence of risky psychology.”
Strategic investing today (2-4-year horizon)
Marks reminded the directors that “strategic is not tactical. Strategic investing is neither short term nor is it forever. Ask the question, ‘Strategically, how do you want to be positioned for the next 2-4 years?'”
He said that “Eighty percent of setting strategy is answering the question, ‘Do you want to be offensive or defensive?’ If you get this wrong, if you are positioned aggressively when you should be positioned defensively it doesn’t matter who is managing the Titanic you’re on.”
He outlined a series of questions that should be asked, including:
- Do you expect prosperity or not? If your answer is yes, then you want to be invested in equities, growth, cyclicals, risk, leverage – because in good times it’s good to take risks. Marks admitted that he answers the question “no.” That drives investments into debt (bonds), value, stability, safety and less leverage, “because in risky times you reduce risks anticipating that the world is not going to comply with your greatest hopes,” he said.
- Which risk should you worry about more? Do you worry more about the risk of losing money or the risk of missing opportunity? Marks said that either of those risks can be reduced or even eliminated, but not both. He said that the two are balanced by taking a position in the middle, “varying your position as the world changes, when people become euphoric, become a contrarian to the herd and become less aggressive; when people become depressed, add risk and become more aggressive,” Marks said.
- Which attributes should you emphasize? Marks said that aggressiveness and risk bearing are appropriate when the world is worried. “You need money and nerve when the whole world is worried, but you need caution, conservatism, discipline and risk control when the world is euphoric.”
Marks’ “prescription for an uncertain world” included six points:
- Make sure your expectations are moderate.
- Emphasize corporate investments because they can adapt to an uncertain world.
- Commit to active decision making verses passivity.
- The reasons for caution are not imaginary — there are real unpredictable risks out there today; the improbable disaster isn’t impossible.
- Balance the many pros and cons — it’s not supposed to be easy, and it isn’t easy.
- Move forward, but with caution.
Howard Marks, CFA, CIC is Chairman, Oaktree Capital Management, L.P. Since the formation of Oaktree in 1995, Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy, communicating closely with clients concerning products and strategies, and managing the firm.
Read more of Carmen’s coverage of the BOP meeting: