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New Oaktree Capital Memo: The Race Is On

November 27, 2013 | About:
I absolutely love reading Howard Marks Memos and he has released a new one. Here is the opening paragraphs with a link to the rest. His website is littered with additional memos and is a great resource. Also check The 20 Most Important Things Proposed by Howard Marks (Part I Of IV) Memo to: Oaktree Clients.

By: Howard Marks

Title: The Race is On

I’ve written a lot of memos to clients over the last 24 years – well over a hundred. One I’m particularly proud of is The Race to the Bottom from February 2007. I think it provided a timely warning about the capital market behavior that ultimately led to the mortgage meltdown of 2007 and the crisis of 2008. I wasn’t aware and didn’t explicitly predict (in that memo or elsewhere) that the unwise lending practices that were exemplified in sub-prime mortgages would lead to a global financial crisis of multi-generational proportions. However, I did detect carelessness-induced behavior, and I considered it worrisome.

As readers of my memos know, I believe strongly that (a) most of the key phenomena in the investment world are inherently cyclical, (b) these cycles repeat, reflecting consistent patterns of behavior, and (c) the results of that behavior are predictable.

Of all the cycles I write about, I feel the capital market cycle is among the most volatile, prone to some of the greatest extremes. It is also one of the most impactful for investors. In short, sometimes the credit window is open to anyone in search of capital (meaning dumb deals get done), and sometimes it slams shut (meaning even deserving companies can’t raise money). This memo is about the cycle’s first half: the manic swing toward accommodativeness.

An aside: I recently engaged in an exchange with a reader who took issue with my use of the word “cycle.” In his view, something is a cycle only if it’s so regular that the timing and extent of its ups and downs can be predicted with certainty. The cycles I describe aren’t predictable as to timing or extent. However, their fluctuations absolutely can be counted on to recur, and that’s what matters to me. I think it’s also what Mark Twain had in mind when he said “History doesn’t repeat itself, but it does rhyme.” The details don’t repeat, but the rhyming patterns are extremely reliable.

Competing to Provide Capital

When the economy is doing well and companies’ profits are rising, people become increasingly comfortable making loans and investing in equity. As the environment becomes more salutary, lenders and investors enjoy gains. This makes them want to do more; gives them the capital to do it with; and makes them more aggressive. Since this happens to all of them at the same time, the competition to lend and invest becomes increasingly heated.

When investors and lenders want to make investments in greater quantity, I think it’s also inescapable that they become willing to accept lower quality. They don’t just provide more money on the same old terms; they also become willing – even eager – to do so on weaker terms. In fact, one way they strive to win the opportunity to put money to work is by doing increasingly dangerous things.

This behavior was the subject of The Race to the Bottom. In it I said to buy a painting in an auction, you have to be willing to pay the highest price. To buy a company, a share of stock or a building – or to make a loan – you also have to pay the highest price. And when the competition is heated, the bidding goes higher. This doesn’t always – or exclusively – result in a higher explicit price; for example, bonds rarely come to market at prices above par. Instead, paying the highest price may take the form of accepting…. Article Continued Here

About the author:

Tannor Pilatzke
I am a self taught investor through Warren Buffett, Charlie Munger, Ben Graham, Peter Lynch, Joel Greenblatt, David Einhorn, Seth Klarman, Howard Marks, Phillip Fisher and Thornton O'Glove. My focus is a bottoms up Value-GARP strategy with a mix of top down contrarianism.

"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain

Visit Tannor Pilatzke's Website


Rating: 4.5/5 (8 votes)

Comments

vgm
Vgm - 8 months ago
Thanks Tannor. I'm with you on HM's Memos. They're a treasure that merit thorough reading and re-reading to absorb the thinking and conclusions. I appreciate his generosity.

This latest Memo reiterates his views, with greater detail, from the recent Bloomberg interview - that valuations are quite full but not in bubble territory. Extraordinarily timely and appropriate - and helpful. I continue to "proceed with caution".

Thanks again - and thanks Howard too!
AlbertaSunwapta
AlbertaSunwapta - 8 months ago
On "doing increasingly dangerous things"...

Welcome Back, Leveraged Super Senior Synthetic CDOs - Bloomberg

http://www.bloomberg.com/news/2013-11-27/welcome-back-leveraged-super-senior-synthetic-cdos.html
TannorP
TannorP premium member - 8 months ago
No problem Vgm and I agree completely!

He has a very unconventional, unemotional appeal that draws me in. Howard is able to articulate complex ideas very simply with the purpose of educating, what more can you ask for?

Thanks for sharing Alberta, I will check out the article.

Cheers,
vgm
Vgm - 8 months ago
"Howard is able to articulate complex ideas very simply with the purpose of educating"

A really profound observation Tannor. It's only when a person gets to an exceptional level that he/she has sufficient breadth and depth of knowledge, as well as experience, to simplify complex phenomena for communication or educational purposes. It's true in many fields (Richard Feynman in physics, for example).

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