Howard Marks, Oaktree Capital — 2023-07-10
-
Japanese
-
Korean
-
Simplified Chinese
-
Traditional Chinese
Memos from Howard Marks 2023-07-10T07:00:00.0000000Z" pubdate title="Time posted: >7/10/2023 7:00:00 AM (UTC)">Jul 10, 2023
- PDF (English)
- PDF (Translations)
- Listen to Memo
- Archived Memos
Subscribe
In preparation for my interview for "Lunch with the FT" last fall, I sent the reporter, Harriet Agnew, five memos I had written between 2000 and 2020 that contained market calls. How were they chosen? First, I felt the memos accurately conveyed my thinking at the key turning points in that 20-year period. And second, my calls turned out to be right.
Five Calls
I've written before about the time in 2017 when I was working on my book Mastering the Market Cycle and batting ideas back and forth with my son Andrew. I said, "You know, looking back, I think my market calls have been about right." His response was dead on target as usual: "Yeah, Dad, that's because you did it five times in 50 years." It struck me like an epiphany: He was 100% correct . In those five instances – around the publication of the respective memos – the markets were either crazily elevated or massively depressed, and as a result, I was able to recommend becoming more defensive or more aggressive with a good chance of being right. (Before I go further, let me make it clear that while hindsight shows that the logic behind those calls was correct, that doesn't mean I made them without great trepidation.)
To illustrate how one might approach making market calls, I'm going to briefly summarize what led me to make those five calls. (I'm not going to go into detail, since the contemporaneous memos I cite in each section will supply more than enough for those who're interested.) As you read the description of each event, look closely at how the forces that contributed to – and resulted from – each episode led to the next one. You'll be able to appreciate why I've long stressed the role of causality in market cycles.
January 2000
In the fall of 1999, against the backdrop of the massive gains being achieved in tech, media, and telecom stocks, I read Edward Chancellor's excellent book Devil Take the Hindmost . I was struck by the similarities between the TMT boom and the historical bubbles that are the subject of that book. The lure of easy profits, the willingness to leave one's day job to cash in, the ability to invest blithely in money-losing companies whose business models one can't explain – all these felt like themes that had rhymed over the course of financial history, leading to bubbles and their painful bursting. And all of them were visible in investor behavior as 1999 came to an end.
While I wasn't involved directly in equities and Oaktree's investments had little if any exposure to technology at the time, I observed many market narratives that I thought were too good to be true. Thus, I said so in the memo bubble.com , which was published as 2000 began. The memo described how tech investors were buying the stocks of young companies at astronomical prices set in many cases as a multiple of current revenues, as the companies often had no profits. In fact, many had no revenues, in which case the price was based on little more than a concept and hope. I define a bubble as an irrationally elevated opinion of an asset or sector, and the TMT craze of the late 1990s exemplified this definition. Thus, I wrote as follows:
In short, I find the evidence of an overheated, speculative market in technology, Internet and telecommunications stocks overwhelming, as are the similarities to past manias. . . .
To say technology, Internet and telecommunications stocks are too high and about to decline is comparable today to standing in front of a freight train. To say they have benefited from a boom of colossal proportions and should be examined very skeptically is something I feel I owe you.
In my opinion, the TMT bubble burst in early 2000 for no reason other than that stock prices had become unsustainably high. The Standard & Poor's 500 Index fell by 46% from its 2000 high to the low in 2002, and the tech-heavy NASDAQ Composite declined by 80% during this period. Many tech stocks lost much more, and many young companies in fields such as e-commerce ended up becoming worthless. And the word "bubble" became part of everyday speech for a new generation of investors.
Late 2004 to Mid-2007
The aftermath of the TMT bubble led to an environment in the mid-aughts that felt to me like a slow-developing trainwreck, with an emphasis on "slow-developing." I started complaining too soon . . . or maybe my timing was reasonable but the negative consequences just took longer to develop than they should have.
In summary, the Federal Reserve was engaging in accommodative monetary policy – taking the fed funds rate to new lows – to battle the potential ramifications of the TMT bubble's bursting. Thus, in my memo Risk and Return Today from late 2004, I observed that (a) prospective returns on most asset classes were unusually low and (b) risk-seeking on the part of investors looking to improve on those low returns had led them to embrace higher-risk and "alternative" investments.
I identified some of these alternatives in the memo There They Go Again (May 2005), spending most of my time discussing residential real estate, as that was where investors were embracing the most glaring fallacy: the belief that home prices only go up. I also discussed the tendency of investors to (a) ignore the lessons of past cycles, (b) fall for new developments, and (c) pile into risky investments, guided by time-honored platitudes such as "it's different this time," "higher risk means higher returns," or "if it stops working, I'll just get out." Many of these logical errors were being committed by investors in the housing market.
The driving force behind Oaktree's behavior in that period wasn't any of the above. Rather, it was the fact that my Oaktree co-founder Bruce Karsh and I were spending much of each day trudging to each other's offices to complain about the crazy deals – characterized by low returns, high risk for investors, and a lot of optionality for issuers – that were easily being brought to market. "If deals like this can get done," we agreed, "there's something wrong with the market." Few people, we thought, were demonstrating prudence, discipline, value consciousness, or the ability to resist the fear of missing out. Investors are supposed to act as disciplinarians, preventing undeserving securities from being issued, but in those days, they weren't performing that function. This signaled a worrisome state of affairs.
These observations – along with an awareness of the generally high prices and low prospective returns that prevailed at the time – convinced us to dramatically increase our usual emphasis on defensiveness. In response, we sold off large amounts of assets, liquidated large funds, organized small funds (or none at all in certain strategies), and significantly raised the bar against which potential new investments would be evaluated.
In July 2007, I published the memo It's All Good , in which I was more emphatic (and had better timing):
Where do we stand in the cycle? In my opinion, there's little mystery. I see low levels of skepticism, fear and risk aversion. Most people are willing to undertake risky investments, often because the promised returns from traditional, safe investments seem so meager. This is true even though the lack of interest in safe investments and the acceptance of risky investments have rendered the slope of the risk/return li