Howard Marks, Oaktree Capital — 2020-10-13
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Memos from Howard Marks 2020-10-13T07:00:00.0000000Z" pubdate title="Time posted: >10/13/2020 7:00:00 AM (UTC)">Oct 13, 2020
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Roughly two months have passed since my last memo, Time for Thinking , and still not much has changed in the economy or the markets. The toll from Covid-19 continues to rise, the economic outlook is largely the same, vaccines remain some time off, and the S&P 500 is back where it was in early August. So I'll repeat what I said then: it's mainly been time for thinking. Fortunately, the more I've thought about the issues, the more things have come into focus for me. Thus, I'm going to use this memo to go into greater detail on a few topics.
The Prerequisite
In Time for Thinking I talked about the fact that I don't consider this year's developments to be cyclical. You could say, "Why not? The economy and the markets went down, and now they're recovering. Isn't that a cycle?" What I really mean is that this is very different from a normal cycle, and I've figured out a way to better explain that, borrowing a bit of what I said in my 2018 book, Mastering the Market Cycle.
Most of the up-cycles I've witnessed occurred because things were going well in the economy, causing psychology and decision-making to become increasingly optimistic and eventually euphoric. Corporations favored expansion, stock prices rose and financial innovation became possible, even encouraged. Eventually, productive capacity exceeded what was needed, stock prices exceeded underlying value, and shaky investment innovations were embraced. When these trends outstripped the fundamentals and became unsustainable, the result was a downturn. Often a recession triggered a market correction, and sometimes the impact of that recession was reinforced by negative exogenous events that further darkened the previously-blue skies.
A good example is the first non-investment grade debt crisis Bruce Karsh and I managed through, in 1990-91. There was a recession, exacerbated by the shock of going to war to help Kuwait repel an invasion by Iraq. The newly developed high yield bond market experienced its first major spate of defaults, the result of a recession and credit crunch and exacerbated by the prosecution of Michael Milken and the failure of Drexel Burnham, precluding remedial bond exchanges that otherwise might have helped companies stay alive. Stocks declined, but high yield bonds went into free-fall. Notably, many of the prominent LBOs of the 1980s – which had been financed with perhaps 95% or so of debt – went bankrupt. Investor psychology collapsed and bondholders headed for the exits.
A collapsing economy needs a good dose of stimulus to pull it out of its swoon, and that's what occurred. Usually that's enough. Eventually the economy recovers; consumers resume buying; investors regain their equilibrium – some even sense the bargains that have been made available; and the upswing takes the economy back toward good health . . . and the cyclical process continues.
So, most of the time, downturns stem primarily from economic weakness, and they are repaired with economic tools. But this episode is different. It was caused by an exogenous, non-economic development, the pandemic. The recession – rather than being the cause – was the result: a closure of business induced intentionally in order to minimize inter-personal contact and halt the spread of the disease.
Thus, this down-cycle cannot be fully cured merely through the application of economic stimulus. Rather, the root cause has to be repaired, and that means the disease has to be brought under control. An effective vaccine will do this – in time – but healthy behavior will be required in the meantime. Spikes like much of Europe is seeing represent something of a step backward in this regard.
And even with the disease controlled, economic stimulus is unlikely to reverse all the damage. The trauma has been deep, and the impact may not be easily shaken off. Large firms will continue to automate and streamline. Large numbers of smaller businesses – such as restaurants, bars and shops – will never re-open. Thus millions of people will not be rehired into the jobs they formerly held. For this reason, the expectations with regard to economic recovery have to be realistic. To me, as I've said, "V-shape" has too positive a connotation.
The Need for Further Assistance
One of the things weighing on the recovery is the matter of help from Washington. Whereas the Treasury was able to announce aggressive spending programs in the spring, there has been no new package here in the fall. Partisan differences have arisen regarding the size of a package and its contents. Further, we're so close to the upcoming election – less than a month away – that neither side wants to give the other anything that might be described as a victory.
But this is not an academic matter. The trillions of dollars paid out thus far were not stimulus payments, but support. They weren't made to get the recipients to spend so much as to keep them and the economy alive. In short, the amounts distributed – to the unemployed, families with incomes below $100,000, companies and institutions – were designed to replace lost income and maintain, rather than stimulate, the economy. Individuals got money so they could buy the necessities of life. Companies got money to replace lost revenues, so they could continue to employ people. These needs have not dried up, even as the disease has ground on and the supplemental unemployment benefits have expired.
As one of my Oaktree colleagues wrote me last week, "I was chatting today with the owner of a small movie theater chain. One wouldn't trade places. All of their theaters in California are closed; the ones out of state are operating with high costs and no patrons; and there is virtually no product to attract audiences. And the lenders and landlords are banging on the door."
Individuals have problems, too. According to Morning Brew on September 25:
With the economy still in the basement, people are straining to pay their mortgages. According to industry analyst Keith Jurow, "several million" people will have gone nine months without making a payment when the Federal Housing Finance Agency's foreclosure and eviction moratorium expires at the end of the year.
17% of FHA-insured mortgages were delinquent in July, per the Department of Housing and Urban Development. In NYC, 27.2% of mortgages were.
Another pressing need can be found at state and local governments. Their revenues have withered as the take from taxes and fees has declined. But their need to spend is unabated – they're not enjoying any savings in connection with the slower economy – and in fact it has grown. Police, firefighters and EMTs are no less essential, and the need for health care and family services has only increased. And yet, unlike the federal government, cities and states can't engage in unlimited deficit spending since they can't print money or issue seemingly unlimited amounts of debt. Like companies and individuals, they need significant aid.
On September 24, The Wall Street Journal reported on Fed officials' testimony to Congress:
The recovery would move along faster "if there is support coming both from Congress and from the Fed," Chairman Jerome Powell said during the second of three days of congressional testimony Wednesday.
Chicago Fed President Charles Evans told reporters that his projection that the unemployment rate would fall below 6%