Back in July, Howard Marks caused a stir in capital markets when his letter “There They Go Again… Again ” laid out a bubble checklist which seemed to confirm that the current environment was just that. Since then, Marks has been dogged by an aura of bearishness, as he himself admits in his latest letter in which he writes that readers of his last few letters “perceived my stance as ultra-bearish. This was epitomized by the TV commentator who reported, “Howard Marks says it’s time to get out.”
Of course, Marks – always the diplomat – would never be so black and white, and he repeats, again, that “there are two things I would never say (since they require far more certainty than I consider attainable): “get out” and “it’s time.” It’s rare for the market pendulum to reach such an extreme that views can properly be black-or-white. Most markets are far too uncertain and nuanced to permit such unequivocal, sweeping statements.”
Which brings us to Howard Marks’ latest memo – after a surprisingly lengthy delay of 4 since his most recent, September memo – called Latest Thinking, in which we get more of the same, middle-of-the-road lukewarm caution that has, well… marked all of Marks’ recent letters. It is also why Marks’ observations on the market this time are only 5 pages, with the rest dedicated to his observations on tax law.
In his discussion of markets, Marks notes that “most people (and certainly the media) want definite answers: in or out? buy or sell? risk-on or risk-off? But it’s rare for answers that simple to be correct” which is also why he thinks that most investors are never either “maximum aggressive” (100% invested in high-beta, high-risk assets, or maybe more than 100% through the use of leverage),or maximum defensive (100% cash, or perhaps being net short)… although based on recent surveys one can make the argument that investors have never been more bullish.
In this context, the Oaktree investor says that he wouldn’t want to be on either extreme:
I’d be someplace in between. That’s easy to say. But where? Closer to the bullish end of the spectrum or the bearish end? Or balancing the two equally? My answer today, as readers know, is that I would favor the defensive or cautious part of the spectrum. In my view, the macro uncertainties, high valuations and risky investor behavior rule out aggressiveness and render defensiveness more sensible.
So where “is” he? Confused, because with the S&P at a clearly bubbly 2,850, the “easy money has been made“:
For one thing, I’m convinced the easy money has been made. For example, the S&P 500 has roughly quadrupled, including income, from its low in 2009. It was certainly easier for the p/e ratio to go from the low teens in 2011-12 to 25 today than it would be for it to double again from here. Thus the one thing we can say for sure is that the current prospects for making money in U.S. equities aren’t what they were half a dozen years ago. And if that’s the case, isn’t it appropriate to take less risk in equities than one took six years ago?
Additionally, current meltup aside – and it may well end in a crash – future returns will be far lower, if not negative.
Prospective returns are well below normal for virtually every asset class. Thus I don’t see a reason to be aggressive. Some investors may adopt an aggressive stance to be in the riskiest (and thus hopefully the highest-returning) assets; to squeeze out the last drop of return as the markets continue to rise (under the assumption they’ll be able to get out at the top, something that’s present in every strongly rising market); or to achieve a high return in this low-return world. I don’t view any of those as good ideas.
And while Marks’ repeats not to get out, he is rather close to urging just that. In his own words:
So I didn’t say, “Get out now,” and I still wouldn’t. But I think this continues to be a time to incorporate a good helping of defensiveness in portfolio management. Being fully invested in a cautious portfolio has been an appropriate stance over the last few years. It gave Oaktree performance that in general was respectable or better. Aggressiveness would have produced higher returns, of course, but I don’t think it could have been justified a priori. (Is an incorrect decision one that didn’t work out well, or one that was wrong at the time it was made? I insist it’s the latter, as you know.)
And today? What has changed?
To the four descriptors of the investment environment listed above, I would add three more:
- the economy is strengthening, not slowing, and Washington is supporting its progress,
- prices are even higher and valuation metrics have moved up,
- and, as I said, the easy money has been made.
Thus the current environment is still mixed – better fundamentally and worse price-wise. The positive near-term economic outlook, lowness of interest rates, need of most investors for return and moderate psychology all seem to suggest it would be a mistake to get out. On the other hand, the extremely high asset prices, macro-fragility and risky behavior going on all around us argue for considerable caution.
How does the current market melt-up figure in Marks’ thoughts:
Today there’s beginning to be talk of a possible late-bull-market melt-up, making investors more money but perhaps fulfilling the requirements for a full-fledged bubble. (This may be part of the usual pattern of capitulation that occurs when those who haven’t fully participated lose the will to keep abstaining after years of market gains.)
The basic themes supporting the “melt-up” theory include (a) the existence of the fundamental positives listed above and (b) the arrival of euphoric psychology, which has been absent to date.
For me the key points regarding the general market outlook are as follows:
- The absence of widespread euphoria certainly is an important flaw in any near-term bearish view.
- Thus there’s no reason for confidence in the existence of a soon-to-burst bubble.
- Investor psychology continues to grow more confident, however.
- Asset prices are already unusually high.
- Future events remain unpredictable, but today’s high prices mean the odds are against a significant long-term upward move from here.
- No one can say what’s going to happen in the short term.
Asset prices and valuation metrics are certainly worrisome, but psychology and its implications – as well as timing – are unpredictable. I think that’s about all we can know.
Thus Oaktree will continue to invest on the basis of value and its relationship to price, and to refrain from trying to time markets based on predictions regarding economies, markets or psychology. The “melt-up” school says securities that already are highly priced may become more so. We’d never bet on whether they will or won’t.
He concludes as he started: unsure what happens next, yet invested… warning of a potential move lower, yet long:
“It’s impossible to say the negatives will win the tug-of-war anytime soon, but that doesn’t mean caution should be discarded . . . especially now.”
His full note can be read here.
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