It’s a classic value investing adage that investors should be greedy when others are fearful. The problem with this pithy advice is that it is a lot easier said than done. It’s hard to buy stocks when prices are plummeting, because not even the most disciplined investor wants to sit on a rapidly growing loss.
This hasn’t stopped Howard Marks (Trades, Portfolio) from taking action. In an interview with Bloomberg last week, Marks said that his Oaktree Capital has been a big buyer in the month of March, and that while he doesn’t believe that last week’s bull rally will be a straight move upwards, he does think that investors who were wary of high valuations in the months leading up to the market crash can now afford to be a little bit more aggressive in buying.
However, what interested me most in his remarks were not his thoughts on whether stocks will go up or down, but rather his views on how the Federal Reserve is handling the economic downturn.
Moral hazard
Marks expressed surprise at the Federal Reserve’s recent actions in the distressed debt market, especially since he had been told personally by a Fed president a few months ago that the U.S. central bank would not dream of doing such a thing. The Fed has recently unveiled a broad purchasing program that will see it buying up low-rated bonds of American companies in an attempt to provide those businesses with liquidity.
Marks believes that this will introduce significant moral hazard to the market. Executives and boards who may have mismanaged their cash flows during the good times will be bailed out, while those who exercised prudence and saved cash for the rainy days will not be rewarded for their diligence. What message does this kind of activity send to future managers (and their shareholders)? Why should a company ever exercise restraint and build up a buffer when they know the government will ride to their rescue with newly printed dollars?
It’s entirely possible that if this continues, a scenario will emerge where diligent and conservative executive suites will find themselves out of work. Shareholders will say “I can’t believe you aren’t buying back our stock at all-time highs! Who cares if we run out of money, the Federal Reserve will help us out if push comes to shove.”
One only needs to look at a company like Boeing (BA, Financial), which engaged in extremely aggressive buybacks from 2016 right up until the second crash involving its 737-MAX aircraft. Trouble had already been brewing for the company even before last month’s market crash, and all of these problems were exacerbated by a lack of cash - money that had been spent on buybacks at extremely high valuations. Similarly, many airlines are now facing a cash crunch due to collapsing global demand for travel, despite recording record profits in the years prior. I believe policymakers should think very carefully about whether they want to encourage this kind of behaviour.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Seth Klarman: What Junk Bonds Can Tell Us About Value Investing
- A Brief History of Junk Bonds
- What Ordinary Investors Can Learn From a 1980s Wall Street Fad
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