(GuruFocus, January 25, 2010) Oaktree Capital Management Howard Marks recently published a letter to his investors, entitled “Tell me I’m Wrong”. In the letter, Marks treated a subject he usually avoids: the future of the US economy, and in particular, he focused on the negative elements and reminded the reader once again that he is a worrier. Here are the things that worry him:
The Near Term:
“One thing is indisputable: the rally in financial markets worldwide has outpaced the fundamentals”.
Reliance on Government Stimulus:
“I fall back on the analogy of a stalled car (the economy) being pulled by a tow truck (government stimulus). The tow truck will want to let the car down one of these days and go on its way. Will the car be able to move on its own? We can only wait and see. I think it’s more likely to sputter along than it is to move forward energetically. But at least we don’t have to worry any longer about the analogy of fifteen months ago: an airplane whose engine has flamed out. A powerless plane in mid-flight presents a far more troubling image than a stalled car.”
The Role of Interest Rates:
“Global considerations call for higher rates, but fighting domestic economic weakness relies on low rates. Resolving this dilemma won’t be easy . . . or painless.”
The Importance of Consumer Spending:
“Prudence dictates that people should have savings. But I hasten to point out that “should” isn’t the same as “will.” There’s a maxim that “No one ever went broke underestimating the intelligence of the American consumer.” I’d prefer to see consumers save rather than return to over-spending – it’s healthier for families and for the economy in the long run, providing reserves in case of emergency and capital for investment. But I won’t be shocked if they don’t.”
The Outlook for Real Estate:
“It seems inescapable that over the next few years:
· higher vacancy rates and lower rents will keep net operating income from returning to the peak levels of the last cycle,
· property buyers won’t go back to finding sufficient risk compensation in pre-crisis cap rates, and
· financial institutions aren’t going to lend the same high percentage of property purchase prices as they did 3-4 years ago. “
State and Local Governments:
“Will states and cities go bankrupt in coming years? What will be the effect on their bondholders, and on the municipal bond market as a whole? How will bankruptcy be reconciled with municipal bond issuers’ promises to dedicate their full faith and credit to paying interest and principal (and thus, implicitly, to raise taxes without limitation)? How will the federal government respond? If it opens its coffers to bail out profligate states, what will that say to states that were prudent enough to stay out of trouble? No answers here, but lots of trouble in sight.”
Our Dance with China:
Here are the facts:
· China has vast resources, human and otherwise.
· It produces goods cheaper than the developed countries.
· China’s likely undervalued currency aids its competitiveness as an exporter.
· The U.S. buys more from China than it sells to China.
· That means dollars keep piling up in China.
· The U.S. has to borrow back those dollars to fund its fiscal and trade deficits.
· We’d prefer low interest rates in order to minimize our interest payments, and a weak dollar so we can repay our debts (as if!) in devalued currency.
· China, with its reserves growing, has to invest large amounts of dollars.
· China wants high rates and a strong dollar in order to maximize the value of our future payments to them.
· China would probably like to diversify the investment of its reserves away from the dollar, but (a) it’s hard to figure out where to better invest them and (b) doing so would further weaken the dollar, of which China already owns so many.
Wherefore Jobs?
“In short, I worry that the growth in jobs in the recovery will be slow, and that unemployment and underemployment will remain stubbornly at higher levels than in the past. That doesn’t bode well for either the short-term cyclical recovery or the long-term outlook.”
Global Competitiveness:
“In order for U.S. goods to be competitive, our costs will have to come down, and with them our relative standard of living. Why should any country’s workers be able to command a higher standard of living if the goods they produce aren’t demonstrably superior?”
Inflation, Exchange Rates and Interest Rates:
“From today’s levels, I think rates are more likely to go up than down (there’s so little room for the latter).”
What to do about them? The list of possibilities is long:
· Buy TIPS.
· Buy floating rate debt.
· Buy gold (but only at the “right” price, and what’s that?)
· Buy real assets, such as commodities, oil and real estate (ditto).
· Buy foreign currencies.
· Make investments denominated in foreign currencies.
· Buy the securities of companies that will be able to pass on increased costs.
· Buy the securities of companies that own commodities, or that own assets denominated in foreign currencies.
· Buy the securities of companies that earn their profits outside the U.S.
· Hold cash (to invest once interest rates have risen).
· Sell long-term bonds (and possibly go short).
The Environment for Business:
“I worry about long-term problems that are being left untreated, such as our massive deficits and our under-funded Social Security, Medicare and education systems.
“I worry about the long-term impact of government involvement in business decisions.”
“Lastly, I worry about the rising tide of populism and anti-business sentiment.”
Read the complete 4Q09 Oaktree Capital Letter here.
The Near Term:
“One thing is indisputable: the rally in financial markets worldwide has outpaced the fundamentals”.
Reliance on Government Stimulus:
“I fall back on the analogy of a stalled car (the economy) being pulled by a tow truck (government stimulus). The tow truck will want to let the car down one of these days and go on its way. Will the car be able to move on its own? We can only wait and see. I think it’s more likely to sputter along than it is to move forward energetically. But at least we don’t have to worry any longer about the analogy of fifteen months ago: an airplane whose engine has flamed out. A powerless plane in mid-flight presents a far more troubling image than a stalled car.”
The Role of Interest Rates:
“Global considerations call for higher rates, but fighting domestic economic weakness relies on low rates. Resolving this dilemma won’t be easy . . . or painless.”
The Importance of Consumer Spending:
“Prudence dictates that people should have savings. But I hasten to point out that “should” isn’t the same as “will.” There’s a maxim that “No one ever went broke underestimating the intelligence of the American consumer.” I’d prefer to see consumers save rather than return to over-spending – it’s healthier for families and for the economy in the long run, providing reserves in case of emergency and capital for investment. But I won’t be shocked if they don’t.”
The Outlook for Real Estate:
“It seems inescapable that over the next few years:
· higher vacancy rates and lower rents will keep net operating income from returning to the peak levels of the last cycle,
· property buyers won’t go back to finding sufficient risk compensation in pre-crisis cap rates, and
· financial institutions aren’t going to lend the same high percentage of property purchase prices as they did 3-4 years ago. “
State and Local Governments:
“Will states and cities go bankrupt in coming years? What will be the effect on their bondholders, and on the municipal bond market as a whole? How will bankruptcy be reconciled with municipal bond issuers’ promises to dedicate their full faith and credit to paying interest and principal (and thus, implicitly, to raise taxes without limitation)? How will the federal government respond? If it opens its coffers to bail out profligate states, what will that say to states that were prudent enough to stay out of trouble? No answers here, but lots of trouble in sight.”
Our Dance with China:
Here are the facts:
· China has vast resources, human and otherwise.
· It produces goods cheaper than the developed countries.
· China’s likely undervalued currency aids its competitiveness as an exporter.
· The U.S. buys more from China than it sells to China.
· That means dollars keep piling up in China.
· The U.S. has to borrow back those dollars to fund its fiscal and trade deficits.
· We’d prefer low interest rates in order to minimize our interest payments, and a weak dollar so we can repay our debts (as if!) in devalued currency.
· China, with its reserves growing, has to invest large amounts of dollars.
· China wants high rates and a strong dollar in order to maximize the value of our future payments to them.
· China would probably like to diversify the investment of its reserves away from the dollar, but (a) it’s hard to figure out where to better invest them and (b) doing so would further weaken the dollar, of which China already owns so many.
Wherefore Jobs?
“In short, I worry that the growth in jobs in the recovery will be slow, and that unemployment and underemployment will remain stubbornly at higher levels than in the past. That doesn’t bode well for either the short-term cyclical recovery or the long-term outlook.”
Global Competitiveness:
“In order for U.S. goods to be competitive, our costs will have to come down, and with them our relative standard of living. Why should any country’s workers be able to command a higher standard of living if the goods they produce aren’t demonstrably superior?”
Inflation, Exchange Rates and Interest Rates:
“From today’s levels, I think rates are more likely to go up than down (there’s so little room for the latter).”
What to do about them? The list of possibilities is long:
· Buy TIPS.
· Buy floating rate debt.
· Buy gold (but only at the “right” price, and what’s that?)
· Buy real assets, such as commodities, oil and real estate (ditto).
· Buy foreign currencies.
· Make investments denominated in foreign currencies.
· Buy the securities of companies that will be able to pass on increased costs.
· Buy the securities of companies that own commodities, or that own assets denominated in foreign currencies.
· Buy the securities of companies that earn their profits outside the U.S.
· Hold cash (to invest once interest rates have risen).
· Sell long-term bonds (and possibly go short).
The Environment for Business:
“I worry about long-term problems that are being left untreated, such as our massive deficits and our under-funded Social Security, Medicare and education systems.
“I worry about the long-term impact of government involvement in business decisions.”
“Lastly, I worry about the rising tide of populism and anti-business sentiment.”
Read the complete 4Q09 Oaktree Capital Letter here.
