Howard Marks (Trades, Portfolio) of Oaktree Capital was just interviewed at the 2018 Delivering Alpha conference. Marks (Trades, Portfolio) is the author of :The Most Important Thing" and the upcoming "Mastering the Market Cycle." He has been the chairman of Oaktree Capital Management LP since the inception of Oaktree in 1995. His public memos are famous in the investing world and Warren Buffett famously said they are the first thing he reads when he finds them in the mail.
I read everything Marks puts out and try to listen closely when he speaks somewhere. There are a few key takeaways from this appearance although his message remains nuanced.
Marks estimates we are late cycle
Marks believes we are in the eighth inning, but there could be extra innings. Extended bull markets are usually greeted with four words: "It's different this time."
It seems to me there is some of this dynamic going on. Retail is an industry that's been proclaimed dead. We've gotten used to the current super low interest rates which have favored certain business models relying on future cash flows (that may or may not appear) and highly levered ones. Interestingly, both tend to be avoided by value investors.
In the 50 years Marks has followed markets he observed that people tend to come up in the later stages with rationalizations why cyclicality no longer applies. According to Marks the current key question is: Do you want to push your chips out or do you want to take a few off?
What to expect from the market
Marks said eight months ago before the tax bill passed that the market was actually less attractive. The forward price-earnings ratios went down from meaningfully overpriced to about average. Even though earnings projections have risen by double digits, the market is only up a few percent. Meanwhile there are a lot of potential negatives out there, Europe and trade wars for example.
The most important thing, he said, is, "People who haven’t been around very long tend to think good news means more appreciation. But that’s not necessarily true."
Investors underestimate the discounting mechanism of the markets and expect that when things are good (as they currently are) that means the market will run up.
What cracks the bull market?
The earnings-per-share growth we are experiencing is a bump due to the tax bill. It is not due to continuing earnings-per-share growth. Next year it may not be there. Specifially asked to guess what will crack the bull market, Marks offered four suggestions:
- $100 dollar oil.
- Rising interest rates.
- Strong dollar.
- Something else.
He says his money is always on the fourth.
If he can’t bet on a surprise, rising interest rates seem most threatening.
We have artificial low rates and have had them for nine or 10 years. It is unclear how the unwind will go. The yield curve is something people are talking about already. That's the curve you'll observe if you draw a line through treasury interest rates at various maturities, two-year, five-year, 10 year, and so forth. Usually the interest rate rises as you go further out in maturity. When it doesn't and interest rates on the two-year and the 10-year are the same, you have a flat yield curve. This happpened before almost every recession. However, it signals false positives as well.
Another worry of Marks is the national debt. We will add a trillion per year to the national debt. Is there a number that matters? People used to be prudent about national debt, but now there is no prudence, he said. If you want to take away the punchbowl you aren’t getting votes. The Republicans used to play this role, but they voted on the tax bill knowing what it would do.
Where are the best opportunities?
Move forward but with caution. Marks said Oaktree is already a cautious firm and currently more cautious than usual.
"The greatest achievement of Alpha is to generate almost the same return as the risk taker but without that much risk," he said. "There is a lack of scepticism and a lot of risk appetite. It is a mistake to try and match the best performance."
On a high level Marks suggests this isn't a great time to try and hit the ball out of the park. Which is something I wholeheartedly agree with.
Specific markets Marks likes are emerging market equities, private lending, real estate lending and infrastructure. He jolkingly calls everything with a CUSIP overpriced.
Disclosure: Author is long Oaktree Capital (OAK, Financial).
