Howard Marks, Oaktree Capital — 2024-07-17
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Memos from Howard Marks 2024-07-17T07:00:00.0000000Z" pubdate title="Time posted: >7/17/2024 7:00:00 AM (UTC)">Jul 17, 2024
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The impetus for my memos can come from a wide variety of sources. This one was inspired by an article in The New York Times on Tuesday, July 9. What caught my eye were a few words in the sub-headline: "She doesn't have any doubt." The speaker was Ron Klain, a former Biden chief of staff. The subject was whether President Biden should continue to run for reelection. And the "she" was Jen O'Malley Dillon, Biden's campaign chair. The article went on to quote her as having said, "Joe Biden is going to win, period," in the days just before his June 27 debate against former President Donald Trump.
And, with that, I had the subject of this memo: not whether Biden will continue campaigning or drop out – or whether he'll win if he continues – but rather how anyone can be without doubt. It'll be another of my "shortie" memos given the uncertain shelf life of the Biden candidacy.
This choice of subject calls to mind another time I heard a highly credentialed person express absolute certainty. In that case, an acknowledged expert in foreign affairs told a group I was part of there was "a 100% probability that the Israelis would 'take out' Iran's nuclear capability before year-end." He seemed like a genuine insider, and I had no reason to doubt his word. Yet, that was 2015 or '16, and I'm still waiting for "before year-end" to come around (in his defense, he didn't say which year).
As I indicated in my memo The Illusion of Knowledge (September 2022), there's no way a macro-forecaster can produce a forecast that correctly incorporates all the many variables that we know will affect the future as well as the random influences about which little or nothing can be known. It's for this reason, as I've written in the past, that investors and others who are subject to the vagaries of the macro-future should avoid using terms such as "will," "won't," "has to," "can't," "always," and "never."
Politics
When the 2016 presidential election rolled around, there were two things about which almost everyone was certain: (a) Hillary Clinton would win but (b) if by some quirk of fate Donald Trump were to win, the stock market would collapse. The least certain pundits said Clinton was 80% likely to win, and the estimates of her probability of victory ranged upward from there.
And yet, Trump won, and the stock market rose more than 30% over the next 14 months. The response of most forecasters was to tweak their models and promise to do better next time. Mine was to say, "if that's not enough to convince you that (a) we don't know what's going to happen and (b) we don't know how the markets will react to what actually does happen, I don't know what is."
Even before the much-discussed presidential debate of three weeks ago, no one I know expressed much confidence regarding the outcome of the coming election. Today, Ms. O'Malley Dillon would likely soften her position regarding the certainty of a Biden victory, explaining that she was blindsided by the debate result. But that's the point! We don't know what's going to happen. Randomness exists.
Sometimes things go as people expected, and they conclude that they knew what was going to happen. And sometimes events diverge from people's expectations, and they say they would have been right if only some unexpected event hadn't transpired. But, in either case, the chance for the unexpected – and thus for forecasting error – was present. In the latter instance, the unexpected materialized, and in the former, it didn't. But that doesn't say anything about the likelihood of the unexpected taking place.
Macro Economics
In 2021, the U.S. Federal Reserve held the view that the bout of inflation then underway would prove "transitory," which it has subsequently defined as meaning temporary, not entrenched, and likely to self-correct. I think the Fed might have been proved right, given enough time. Inflation might have retreated of its own accord in three or four years, after (a) the Covid-19 relief funds that caused the surge in consumer spending were spent down and (b) the global supply chain returned to its normal operations. (However, not slowing the economy would have brought the risk that inflationary psychology might take hold in those 3-4 years, necessitating even stronger action.) But because the Fed's view wasn't borne out in 2021 and waiting longer was untenable, the Fed was forced to embark on one of the fastest programs of interest rate increases in history, with profound implications.
In mid-2022, there was near certainty that the Fed's rate increases would precipitate a recession. It made sense that the dramatic increase in interest rates would shock the economy. Further, history clearly showed that major central bank tightening has almost always led to economic contraction rather than a "soft landing." And yet, no recession has materialized.
Instead, late in 2022, the consensus among market observers shifted to the view that (a) inflation was easing, and this would permit the Fed to start cutting interest rates, and (b) rate cuts would enable the economy to avoid recession or ensure that any contraction would be mild and short-lived. This optimism ignited a stock market rally in late 2022 that persists today.
And yet, the anticipated rate reductions in 2023 that undergirded the rally didn't transpire. Then, in December 2023, when the "dot plot" of Fed officials' views called for three interest rate cuts in 2024, the optimists driving the market doubled down, pricing in an expectation of six. Inflation's stubbornness has precluded any rate cuts thus far, with 2024 more than half over. Now the consensus has coalesced around the idea of a first cut in September. And the stock market keeps hitting new highs.
The optimists today would likely say, "We were right. Look at those gains!" But, regarding interest rate cuts, they were simply wrong. For me, all this does is serve as another reminder that we don't know what's going to happen or how markets will react to what does happen.
Conrad DeQuadros of Brean Capital, my favorite economist (how's that for an oxymoron?), has supplied an interesting tidbit for this memo on the subject of economists' conclusions:
I use the Philly Fed's Anxious Index (the probability of a decline in real GDP in the upcoming quarter) as an indicator that a recession has ended. By the time more than 50% of the economists in the survey project a decline in real GDP in the coming quarter, the recession is over or close to being over. (Emphasis added)
In other words, the only thing worthy of certainty is the conclusion that economists shouldn't be expressing any of it.
Markets
The rare person who in October 2022 correctly predicted that the Fed wouldn't cut interest rates over the next 20 months was absolutely right . . . and if that prediction kept them out of the market, they've missed out on a gain of roughly 50% in the Standard & Poor's 500 index. The rate-cut optimist, on the other hand, was absolutely wrong about rates but is likely much richer today. So, yes, market behavior is very tough to gauge correctly. But I'm not going to take time here to catalog the errors of market savants.
Instead, I'd like to focus on why so many market forecasts fail. The performance of economies and companies might tend toward predictability given that the forces governing them are somewhat . .