It wasn’t long ago people worried that China might set off another global recession. In mid-January, headlines like, “U.S. stocks post worst 10-day start to a year in history,” and ”$1 trillion erased from stocks so far in 2016” showed up on financial websites across the internet. The S&P 500 (SPY, Financial) had lost 122 points and 6% in the first 10 days of 2016. Falling oil prices and slowing growth in China were on many investors’ minds.
In the same timeframe, Howard Marks (Trades, Portfolio) published a memo “On the Couch” where he came to the conclusion that the January swoon might be a buying opportunity.
“Now... investors’ optimism has deflated a bit, some negativity has come into the equation, and prices have moved lower," he wrote. "Depending importantly on which market we’re talking about and how it has fared in recent months, we consider it appropriate to move forward with a little less caution.”
“Before I close, I want to make it abundantly clear that when I call for caution in 2006-07 or active buying in late 2008 or renewed caution in 2012, or a somewhat more aggressive stance here in early 2016, I do it with considerable uncertainty. My conclusions are the result of my reasoning, applied with the benefit of my experience (and collaboration with my Oaktree colleagues), but I never consider them 100% likely to be correct or even 80%, I think they’re right, of course, but I always take my recommendations with trepidation.”
What made Marks cautiously optimistic?
Years of investing experience, exceptional skill and his knowledge of macroeconomics led Marks to conclude that the news stories were too negative. At the start of the year, the prevailing narrative implied that lower oil prices were here to stay and that was a bad thing. What the narrative completely ignored was the positive impacts of lower oil prices on the global economy. Lower oil prices can be positive because consumers have more disposable income and businesses have lower costs. Marks explains, “the one thing that’s beyond doubt is that the impact of the fall in the price of oil is far from all bad. In fact, I’d say that it’s positive on balance for the U.S. and an unmitigated boon for the UK, Europe and East Asia.”
A Financial Times article inferred that the fall in oil prices signaled slowing demand. Marks pointed out that world GDP is still growing. The Financial Times article discussed that the Fed’s likely decision to raise interest rates was another reason that markets fell. This was not new information and Marks writes, “there’s something wrong if an event that has been widely anticipated for years - and considered a near certainty for months - can be thought capable of significantly impacting the market when it becomes a fact.”
He also pointed out that analysts were worried that if the economy surprised on the upside that the Fed would be more likely to raise rates. Again, an improving economy is a positive development, yet the news publications focused solely on the negatives. Marks also talked about China. He recounted that during August 2015, there was another market scare attributed to China. The problems of China’s excessive investment in fixed assets and its inflated markets risk are risks that have been known for some time and the market gradually recovered by the beginning of November. From August to January, he didn’t see how the fundamentals in China changed only that investor sentiment swung wildly.
Final thoughts
I was fortunate to have read the “On the Couch” memo as events unfolded. I always make it a point to read Howard Marks (Trades, Portfolio)’ memos as they are released. What I appreciate most about his memos is that he’s not afraid to give opinions that are actionable. The S&P 500 has rebounded 10% from mid-January to the end of March.
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Marks is able to make projections about when to be offensive and defensive because his team studies macroeconomic data. There are differing opinions on how useful paying attention to macroeconomic conditions is in investing. I think it is extremely helpful because it gives me more peace of mind. Marks has another great quote, “It’s the job of investors to strike a proper balance between offense and defense, and between worrying about losing money and worrying about missing opportunity.” There’s risk on both the downside and missing out on the upside. Understanding basic macroeconomics principles gives insight into when the market is totally out of whack with the fundamentals.
Like most people, my investment portfolio took a big hit in 2008. The pain from that experience motivated me to do a lot of reading on central banking policy and monetary conditions around the world. It was time well spent. The knowledge will last a long time as many global conditions aren’t going to change any time soon i.e. global debt, aging demographics in developed countries, monetary policy, etc. Many of the bad actors from the past will re-emerge in the headlines. For instance, the whole drama about if Greece will exit the Eurozone will rear its ugly head again. When that time comes, people who understand the situation will have an advantage over the average investor. They will be able to assess whether to have an offensive, defensive or neutral investment stance.
Finally, with basic macroeconomic principles, investors can differentiate between market commentators who make well reasoned arguments like Howard Marks (Trades, Portfolio) versus the alarmists who are out for publicity. I would be interested in hearing other people’s perspectives on how they incorporate macroeconomics into their investing strategies. Please feel free to leave comments below.
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