Distressed credit investors like Howard Marks (Trades, Portfolio) care first and foremost about the ability of a company to pay its debts. If interest rates are low, as they have been for the last decade, more businesses will be able to service their debt, but this also means there will be fewer bargains available in the distressed credit space.
In a recent interview with Bloomberg, Marks talked about the long-term implications of recent government monetary policy.
Extraordinary measures for extraordinary times
Marks began by saying that the Federal Reserve and U.S. Treasury have obviously been enormously influential in its effects on the economy. The Fed has expanded its balance sheet from $4 trillion to $7 trillion, whereas the Treasury has grown the deficit to $4 trillion from $1 trillion - with the assumption that there will probably be more deficit spending ahead. How long can this continue? No one really knows, but it seems like policymakers have long passed the point of no return, and are fully committed to continuing to keep rates low, and to continue monetizing government and corporate debt.
With that being said, Marks does think that monetary and fiscal authorities had no choice but to act in these extraordinary circumstances:
“I believe that the injection of that kind of liquidity into the economy is likely to have some kind of long-term ramifications, and the most likely is some pickup in inflation. But that doesn’t mean that it was a mistake. The mere fact that you do something that has possible negative consequences doesn’t make it a mistake. They had to do it - if they hadn’t, we would be talking about a much more serious economic event - perhaps even a global depression.”
What other negative consequences could there be? It’s hard to predict future events, but it is possible to extrapolate trends that are already in motion. For instance, the growth in the number of zombie companies - companies who are unable to service their debt payments with their own cash flows - is likely to continue. The Federal Reserve’s corporate bond purchases have made it even easier for these zombies to continue shambling along.
These government backstops fundamentally distort the equation for investors. Typically, investors look for businesses that are going to outperform, and try to stay away from failing companies. But what happens when businesses that should fail don’t? How is it possible to invest on the basis of economic fundamentals like free cash flow if these things don’t matter any more?
Value investors wrestling with these questions may remind themselves that - historically - government backstops can only last for so long. From the last days of the Roman Empire to the British bull market of 1820, the bill has always come due when governments try to create too much money. When it does, value investing will have its day in the sun again.
Disclosure: The author owns no stocks mentioned.
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