Howard Marks, Oaktree Capital — 2021-07-29
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Memos from Howard Marks 2021-07-29T07:00:00.0000000Z" pubdate title="Time posted: >7/29/2021 7:00:00 AM (UTC)">Jul 29, 2021
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For a piece of information to be desirable, it has to satisfy two criteria: it has to be important, and it has to be knowable. – Warren Buffett
Regular readers of my memos know that Oaktree and I approach macro forecasts with a high degree of skepticism. In fact, one of the six tenets of Oaktree's investment philosophy states flatly that we don't base our investment decisions on macro forecasts. Oaktree doesn't employ any economists, and we rarely invite them to our offices to share their views.
The reason for this is simple: to use Buffett's terminology, we're convinced the macro future isn't knowable. Or, rather, macro forecasting is another area where – as with investing in general – it's easy to be as right as the consensus, but very hard to be more right. Consensus forecasts provide no advantage; it's only from being more right than others – from having a knowledge advantage – that investors can expect to dependably earn above average returns.
Many investors think their job requires them to develop a macro outlook and invest according to its dictates. Successful stock pickers or real estate buyers often make pronouncements regarding the macro outlook, even in the absence of evidence linking their investment success to accurate macro forecasts. Nonetheless, since macro developments are so influential, many people think it's downright irresponsible to ignore them when investing. Yet:
Most macro forecasts are likely to turn out to be either (a) unhelpful consensus expectations or (b) non-consensus forecasts that are rarely right.
I can count on one hand the investors I know who successfully base their decisions on macro forecasts. The rest invest from the bottom up, one investment at a time. They buy when they think they've found bargains and sell things they consider overpriced – mostly without reference to the macro outlook.
It may be hard to admit – to yourself or to others – that you don't know what the macro future holds, but in areas entailing great uncertainty, agnosticism is probably wiser than self-delusion.
But why take my word for it? How about these authoritative views?
It's frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what's going on. – Amos Tversky
It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. – Mark Twain
That brings me to the subject of forecasters' track records, or rather the lack thereof. Back in the 1970s, an elder told me, "an economist is a portfolio manager who never marks to market," and that description still seems highly appropriate. Have you ever heard an economist or macro strategist say, "I think there'll be a recession soon (and xx% of my recession predictions have turned out to be right within a year)"? Would anyone invest with an investment manager who didn't publish a track record? Why follow macro forecasters who don't disclose theirs?
Finally, I want to point out that the same comments apply to most investors. You rarely hear them say they have no idea what the macro future holds or beg off from expressing opinions. One of the most important requirements for success in investing is self-assessment. What are your strengths and weaknesses? If you invest on the basis of your macro views, how often have they helped? Is it something you should keep doing or discontinue?
Having gotten everything off my chest concerning the shortcomings of forecasts, I'm going to devote the rest of this memo to thinking about the future. Why? To invert the Buffett quote that began this memo, the macro future may not be knowable, but it certainly is important. When I think back to the years leading up to 2000, I picture a market that largely responded to events surrounding individual companies and stocks. Since the Tech Bubble burst in 2000, however, the market has appeared to think mostly about the economy, the Federal Reserve and Treasury, and world events. That's been even more true since the Global Financial Crisis in 2008. That's why I'm devoting a memo to a subject I largely disavow.
I'll try below to enumerate the macro issues that matter, discuss the outlook for them, and end with some advice regarding what to do about them. That reminds me to put forth my conviction that we all have views about the future, but as we say at Oaktree, "It's one thing to have an opinion, but something very different to assume it's right and bet heavily on it." That's what Oaktree doesn't do.
Inflation
As of this writing, macro considerations are certainly in the ascendency, centering on the subject of inflation. Over the last 16 months, the Fed, Treasury and Congress have used a firehose of money to support, subsidize and stimulate workers, businesses, state and local governments, the overall economy and the financial markets. This has resulted in (a) confidence in the prospects for a strong economic recovery, (b) skyrocketing asset prices, and (c) fear of rising inflation.
The policy measures described above traditionally would be expected to produce the following:
a stronger economy than would otherwise have been the case;
higher corporate profits;
tighter labor markets and thus higher wages;
more money chasing a limited supply of goods;
an increase in the rate at which the prices of goods rise (i.e., higher inflation); and, eventually,
a tightening of monetary policy to fight inflation, resulting in higher interest rates.
While the functioning of economies is highly variable and uncertain, economic orthodoxy considers the above process about as reliable as they come. However, I want to take a minute to highlight the uncertainty entailed in thinking about inflation.
Among the defining elements that marked my early years in investing was the 5-15% annual inflation that prevailed in the U.S. from the early 1970s through 1982. Dr. Doom and Dr. Gloom (chief economists Henry Kaufman of Salomon Brothers and Al Wojnilower of First Boston – I forget which was which) regularly admitted in their depressing speeches that they weren't sure what was causing the inflation or how to bring it down. No one was able to make progress combatting inflation until Fed Chair Paul Volcker solved the problem by raising interest rates dramatically, bringing on a significant double-dip recession in 1980-82.
What about the more recent experience? For years, central bankers in the U.S., Europe and Japan have targeted a healthy 2% rate of inflation, but none of them have been able to produce it. This despite continuous economic growth, significant budget deficits, rapid expansion of the money supply through quantitative easing, and low interest rates – all of which are supposed to be inflationary.
Finally, for roughly the last 60 years, economists have trusted the so-called Phillips Curve, which posits an inverse relationship between unemployment and inflation: the lower the unemployment rate, the tighter the labor market, the more negotiating power workers have, the more wages rise, and the greater the increase in the prices of consumer goods. But the U.S. unemployment rate fell throughout the last decade – ultimately hitting a 50-year low – and still there was no material increase in inflation.