Oaktree’s Howard Marks on Fed Support, Credit Market Distress, Virus Impact

[Music] Howard like the rest of us you've been trying to make sense of this pandemic and its implications for the economy and for companies what conclusions have you reached well you know the most important conclusion Eric is that as I put it we all have the same information about the present and the same ignorant about the future there are very few facts about the future and there are very few historical precedents or patterns to rely on that's true I'm not going to deny it but the question every investor is confronted with right now is how do you put capital at risk with any degree of confidence when the outlook is perhaps as you say more uncertain that at any time in modern history and that is of course the great dilemma because investing is only about positioning your capital to profit from future developments and yet I always say we don't know what the future holds more so today probably than any other time in my life I think the first thing you have to assume is that life will go on we will continue to have an economy we will return to shopping and working and eating in restaurants and children going to schools and people traveling and taking vacations and so forth but of course we also have to make allowances for the possibility that life will be different than it was in the past you know I always say that the four most dangerous words in the world are it's different this time because people use those words to rationalize breaks from the past well today we're living through a massive break from the past there will be differences this time and we have to try to imagine them and allow for the stability in our analysis what kinds of differences do you anticipate obviously many people have been somewhat productive working from home I feel I've been probably as productive as ever in the last two months and I say well now tell me again why I have an office and why I go there and so forth so that that could be a big difference we don't know but it would change a lot and the restaurants sports events hotels a business travel cruise ships shopping malls many of these things are are now in a state of flux but we have to make assumptions about them in order to be able to move forward well speaking of assumptions the market as it always does has divided itself into two camps there are those who are optimistic about controlling the pandemic and reviving growth and there are those who aren't which camp do you fall into well think that I think the real divide Eric is the ones who think it'll come easily and quickly and the ones who think it will come slowly and and ulting Lee and I'm in the latter category in that regard I don't see a immediate v-shaped recovery and people are talking about the possible recovery using different letters B u W my my partner Bruce Karsch talks about an l-shaped recovery some people talk about the Nike swoosh and I think that we'll we won't have a continuous uplift of good news we'll have good news live mixed with bad news we'll have a vaccine but it won't come this year and it won't come to everybody immediately you know we need seven billion doses for the whole world and it's going to take a long time to manufacture those and roll them out I will add one thing Eric there's another divide there's a divide between the people who think that stocks are fully too highly priced today given the economic outlook and there are people who think that's okay because the Fed will make sure that the whole economy and all the markets levitate and in many ways that's the more important divide today we all think that life will go on there will be return some part of the way to toward normalcy there will be a vaccine and so forth but the big divide is is the people who don't understand why stocks are where they are and the people who do understand it by interior izing the old motto you can't fight the Fed and and that is is I think an even bigger divide today what do you think can you fight the Fed I think that the Fed has great power but not forever and I think that first of all I don't think it really you know jpowel talked about the Fed having will not have the ability to run out of ammunition I don't know if the feds ammunition is really limitless I know that the Fed can cause markets to rise and stay up as long as it buys but I don't know if it can buy forever you know we're in we're in new territory here historically the Fed has never bought corporate securities this time around they included corporate securities and then they moved on to include non investment grade corporate securities and it's buying can make these things rise but only as long as it's buying I think of it as kind of you know we've seen these things where there's a there's kind of a column of water and then a ball sitting on top of the water and as long as the waters forced up the ball stays there water stops ball falls down to earth so obviously the Fed hopes that its buying will among other things inject confidence into people and that they'll take over in buying but that remains to be seen and it remains to be seen whether that buying will be at today's levels is there any reason Howard to expect that's going to happen let's just talk about the corporate bond market but use as an analogy the 10 years to follow the financial crisis we had QE 1 2 3 and every time the Fed tried to pull liquidity out of the market it seemed investors rebelled there was the taper tantrum there was the fourth quarter of 2018 and other instances are you suggesting that the moment the Fed tries to withdraw liquidity from a market that that really prices itself on solvency more than anything else the same things going to happen I think I think it has to happen to some extent I think well that you know this is the dilemma can the fled keep keep it up forever and if it doesn't keep it up forever will the prices weaken I mean those of us in the markets believe that stocks and bonds as well are selling at prices that they wouldn't sell at if the Fed were not the dominant force at prices that would be determined by just the outlook for the companies and so number one you know if the Fed were to receive look we would all take over as buyers but I don't think at these levels and you know you mentioned the difficulty of withdrawing the support I personally believe that there is too much concern with the downside of withdrawing the support and not enough concern with the downside of never withdrawing the support and I think that if it had been done earlier and gradually it could have been done and as you say there was a bit of a temper tantrum in the fourth quarter of 18 when the interest rate on the 10-year Treasury reached three and a quarter I think that was October fourth and the market started to go down from there so of course you know the kids like candy and investors like low rates but we have to have discipline also Howard a few days ago Royal Caribbean the cruise line sold more than three billion dollars of debt secured debt I should add at a yield of about 11% now I probably don't need to remind you but this is a company with zero revenue and very little hope of returning to its pre coronavirus state anytime in the near future yet the credit market is open to Royal Caribbean how do you make sense of that number one they'll get more back into business than everybody thinks because you know I think there's a knee-jerk reaction to say well you know the cruise ships were petri dishes for the infection we have this image of people floating around on cruise ships exchanging the disease with each other being refused entry to ports and so forth nobody will ever go back I understand Eric that bookings for cruise ships in 2021 are quite strong and that there there is a a coterie of fans for cruises and they want to demonstrate their support for their for their beloved pastime that's number one number two they're there the cruise lines for example do have great asset protection and if you can come in to a situation and if you can buy senior debt which will be paid ahead of all the other creditors and it's a small amount backed by a large amount of assets then you can feel okay about doing it business won't come back a hundred percent to what it used to be but if it comes back seventy five percent the people who buy that senior debt will do okay and then the other thing is that you know the Fed buying has caused high-grade bonds to drop in yield when people look at that they say man those high-yield bonds yield too much we're going to buy them that causes them to drop in yield there's people in the stock market look at that and they say well we can't get much yields from bonds anymore stocks look much more attractive we're going to buy those so those go up in price we don't talk in the stock market about down in yield so everything is relative to everything else and this wrong fed participation and and support of the markets has caused people to say oh you know a cruise line bond at 11:00 looks good to me you know non-energy high-yield bonds yield about seven four hundred extra basis points for taking the risk of a cruise line with good at asset protection we'll do that and so they get sold it's it's what happens in a market which is I would say artificially supported by fed buying so let's talk a little bit more about the artificiality of it in your opinion Howard wood Royal Caribbean be able to sell secured investment grade debt at all or just secured investment grade data to yield at eleven percent if the Fed weren't back stopping the market I don't know Royal Caribbean I don't even know if it's Caribbean or Caribbean but I don't know that company that well and I wouldn't I can't and I wouldn't comment on any one company but I think it's fair to say that there is a a yield at which they can sell well collateralized senior debt even if the Fed were not in operation but it probably wouldn't be eleven Howard you've made a career and I should add it's been a highly successful one out of understanding and explaining cycles and financial markets will this cycle look like past cycles first of all Eric this is not a cycle this is an episode not everything that goes on in the world is part of a cycle there are exogenous idiosyncratic events as well so you know a cycle and of course you're trying to plug my book mastering the market cycle and I greatly appreciate that but a cycle is kind of a I don't kind of a regular pattern of ups and downs there's a trend line let's say GDP the trend line of GDP in the US grows at 2% a year but sometimes faster and sometimes slower and sometimes it drinks in recession so there are excesses and Corrections and excesses and corrections fluctuations this occurs throughout history it occurs in economies in companies in psyches in in in civilizations in many things regular regular not in the sense of being consistent in length and and amplitude or even reasons or impact but regular in the fact that it tends to happen over time this is not that this is a meteor hitting the earth for reasons not having to do with the excesses or Corrections or people's activities this is what we call an exogenous impact and it hit the earth and it changed life as we know it for the last three months and it had economic impact but the nothing that's going on came from within the system within the economy within the companies etc and so I this this is not subject to cyclical analysis now we think there'll be a recovery and the recovery may look like the recovery from past cyclical declines and it is the speed and strength and duration of the recovery that that everybody wants to talk about and that will feel cyclical I I did actually have your book in mind believe it or not Howard there is a chapter in mastering the market cycle on distressed on the distress cycle and in it you talk about things that we've discussed many times before in which many people have in mind alright what precedes a turn in the cycle complacency perhaps some excess some would argue that we were there in January and February and that's that that's what you describe as stacking the logs in the fire for the next bonfire and then there's an igniting event that produces a recession we could talk about this as being an igniting event even if it's a meteor and it's in its scale you know and and and and and conflagration power and then some things are supposed to happen right companies are supposed to be locked out of it first of all corporate profits collapse and that's happened companies are supposed to be locked out of the credit market they're supposed to be defaults they're supposed to be bankruptcies and then risk capital is supposed to come in at the right price seeking outsized returns and help the economy to recover that's what I'm getting at is that going to happen this time some of those things seem to have occurred but we've also talked about things that appear to be different this time like for example the feds participation in the corporate credit market well Eric you did a great job of describing that you don't need me but yes there are things missing first of all the you talked about the credit window closing I forget what your words were but that's the common terminology but you get what's when when we get a recession and we get an adverse reaction in the markets we get a rising fear factor or you might say increasing risk aversion and the credit window slams shut and whereas three or six months ago anybody could borrow any amount of money for any reason or no reason now nobody can get any money and people who need money default go bankrupt etc and there's a cleansing out of the of the weak from the market and the strong comeback but this time in order to minimize damage minimize sounds like a ridiculous word in this context to limit the damage to the economy the Fed and the Treasury sprung into action not in months as they did in the global financial crisis but in weeks and started to inject large amounts of money into the economy and into the markets and so that tree that has limited the extent of the credit crunch there are still companies that are desperate for money in order to avoid default and and some that the Fed and Treasury actions are not reaching which will have problems and you know the the rating agencies are in the bank investment banks are predicting that somewhere between fifteen and twenty five percent of all the high-yield bond issuers for example will default in this cycle so the Fed has not eliminated the negative impact but it has limited us and you know the the cleansing out of the week and companies and especially the I would say punishing of risky practices that led to the down cycle cleaning them out contribute to the up cycle that has been four stalled at minimum as well if companies for example levered up when you take on more debt you lever or magnify the return on the equity but you also limit or reduce the company's ability to get through tough times and people who do it too much they there's a bankruptcy that occurs and the old owners are wiped out and the old creditors become the new owners and there's kind of a revival process and to the extent that the government take action and gets involved that that that obviates that Howard you quoted a most memorable line in one of your recent memos capitalism without bankruptcy is like Catholicism without hell it really is an incredible line and then I didn't make it up no no I'm aware you said it's been variously attributed I guess my question around that is if in fact there aren't as many bankruptcies this time around because of the fact that the Fed and I should add the treasure Department are doing everything they possibly can to support the economy and and if in fact there's less of what we might call a distressed cycle as a result of that what are the consequences first of all do you agree that that it appears as though there I'm not not a matter of agreeing does it appear to you is that there though there will be less of a distress cycle and if there is less of one what are the consequences well you didn't finish your sentence area because you said did you do you agree that there would be less of a distress cycle and you have to say less than what less than usual yes I suppose or less than there otherwise would have been you know you have to finish that right no no so so let's let's go with that as the premise yes less than they're less than normal less than there would have been less than the global financial crisis less than then whatever you choose well use as a comparison we are living through the worst economy that almost anybody alive has ever seen you have to be over 80 years old to go back to the 30s to to have seen worse and maybe we're even worse than that it's believed that the unemployment rate will hit a higher level than was achieved in the Great Depression I people are talking about second quarter GDP being down 30 to 40 percent as far as we know I mean there aren't good quarterly records but as far as we know there's never been a quarterly decline in GDP to that extent so we're in the worst economic environment let's say ever and you would think that that would bring on the greatest distress ever it may not happen because of the Fed and government action I think we'll still have a very substantial distress episode you know in 1991 and in Oh 100 to we had two years of 10% defaults in the high Oban universe we may have 20% defaults in high-yield bonds anyway and there are still lots of highly levered companies and highly levered investment entities that desperately need large amounts of cash to avoid a meltdown and you know some of them will not get what they need and some will meltdown the other thing I want to mention though is the the impact on society because there is a concept called moral hazard and moral hazard is when people who engage in risky behavior and bad things happen which could cause them to pay for their risky behavior are supported and sheltered from the risky behavior and that's the importance of the of the quote about Hell in order for business and investment to function as it should there has to be a fear factor I am afraid of losing money for my clients that causes me to be conservative and that has shaped my career and you know my oaktree colleagues bruise cars my partner we we both embody this conservatism and it has caused us to stay high in the capital structure and try to invest in companies which have better futures even if they are financially distressed when people are not afraid when when people believe that they can engage in risky financial practices and will be sheltered from the impact that creates a risk prone aspect of society which I believe is not desirable for economies and companies and markets Howard some people would say we were already there in the ten years that preceded this pandemic corporate borrowers were increasingly capable of levering up more and more and the stock market and for that matter the bond market in some cases rewarded them for doing so yes now you have a number of isolated examples that bring to mind what you just said the airline's for example mm-hmm which collectively US airlines use 96% of their free cash flow they generated between 2010 2019 the buy back stock obviously by borrowing a great deal to do so and now they're being bailed out by the government now that may be isolated to the airlines but it kind of addresses the point you're trying to make if that's where we are and if that's where we're going to be after the crisis of this pandemic is over Howard and financial markets in society and the economy return to something more akin to normal what does that mean if there is no punishment for bad behavior for recklessness where do we end up you know the answer if if there's no punishment for for the results of bad behavior than bad behavior we'll continue and increase the airlines did not I don't think the airlines did the stock buybacks in the expectation that that there that if there was an economic crash and their business went to almost zero the government would bail them out I mean they may think that in the bodies of minds but I don't think that was part of the plan the point is that there that the the up part of the cycle the economic expansion and the market rise went on too long and that tends to drive out caution and and prudence you know back in the early seventies somebody gave me the gift of telling me about the three stages of the bull market the first stage when only a few intelligent people believed there could be improvement the second stage when most people accept that improvement is taking place and the third stage when everybody and his brother thinks believes things can only get better forever so if you think if you go on long enough and you reach that start third stage and everybody forgets about the pain of the global financial crisis and everybody forgets about the possibility of a downturn and everybody think that good times will roll on forever then you would take on more leverage to stock buybacks engage in risky practices you look back you say well for the last five years the person who took the most risk made the most money I'm going to join that to this this brings on this type of behavior in and of itself and of course it's unhealthy and it eventually culminates in the reaching of a top and the turndown from the top I've been very cautious for the in recent years as you know my view of the market was that it would characterized by a high degree of uncertainty low prospective returns high asset prices and risky behavior on the part of people trying to get high returns in a low return world and those four things told me and told oaktree that we were in a risky world I said it for years and I was too early by the way another of the great adages in our business is that being too far ahead of your time is indistinguishable from being wrong we were too far ahead of our time we were conservative for a good many years but we believed that because of the conditions I enumerated the market was vulnerable to an exogenous influence a shock something that would make it decline now what people said to me is the people who are not crazy they were not euphoric and they weren't out of their minds people used to say to me I know the good times can't roll on forever but I can't think of anything that could make it stop and nobody could you know we didn't see the seeds for recession or inflation or any anything that would make it stop guess what something unimaginable to most of us arrived as an exogenous influence and did make the good times stop rolling on and that's what we have now but it was but the conditions in the market created a vulnerability to an exogenous shot which exacerbated the damage of the virus some people would say that the Fed has no choice but to step and do everything you possibly can our but by doing what it has done do you believe do you worry that it has set the stage for more recklessness in the future first of all Eric I am absolutely among the people who believe that the Fed had no choice thank God that it did what it did we were you know Bruce and I were go back to March 18th or 19th we were distracted ly discussing the possibility of a global depression of a multi-year very serious economic impact and the Fed and Treasury and other central bank actions have we believed prevented this and nobody's talking about global depression anymore so I'm absolutely among those people but it's very important to note that just because something has unforce evil negative consequences that doesn't mean it was a mistake I believe that there may be negative consequences from the from these actions but certainly that doesn't mean they shouldn't have been undertaken for now the Federal Reserve has drawn a line at fallen angels investment grade bonds that were downgraded to junk and we've talked about what that has done for the investment grade market and the Fed is also buying at the moment high-yield ETFs what if Howard the Fed goes further into junk territory what if it decides that it's okay to buy double B's or perhaps even lower rated debt well Eric there are also people who believe that one of these days the Fed may turn to buying common stocks so you know the buying of corporate bonds is a first and what they've demonstrated is that there are no tactics that they won't engage in there are people who believe by the way that it violates the rules under which the Fed acts but they're doing it anyway and they'll argue later about what it was okay so yes they're there they'll do anything their arsenal has been described as limitless I still believe that it will only work as long as it works and as long as they are actively doing it look Eric what if the feds said we're gonna be the buyer in every transaction every bond transaction every stock transaction we're gonna be the buyer the Fed has an unlimited checkbook you know the they our checks never clear so we we're gonna we're gonna buy forever you know they fed has increased its balance sheet up to 10 trillion there's no limit we'll buy more well in theory they could do that and in theory they if they bought aggressively they could make all the markets rise now everybody would know that that's a Potemkin market that it's a fake and the minute they stopped things would collapse and you know certainly the the Fed buying would drive out all private buying because we'd all know that the Fed is paying too much money the question is is there any reason why they couldn't do that I don't know and one of my memos I said why don't why doesn't the Fed just just send out a check or to a million dollar check to every American it would only cost three hundred and fifty trillion dollars and we'd all be rich and prosperity would return and so the question is facetious the question is is there a downside to things like that would there be negative ramifications I have to think so I don't know what they would be so will there be negative ramifications to the feds buying of fallen angels and high-yield ETFs I don't know would there be further ramifications if they bought single B's if they bought comes out I don't know I believe so you know here we are RG is 20 trillion and we have done securities purchases and and stimulus and support in many trillions in one two-month period are there limitations to what can be done and are there ramifications I believe so but you know this is not a science we'll see what they are Howard how do these considerations and concerns affect what oak tree is doing affect what oak tree is buying and when oak tree is buying sure well we were very active buyer in the public debt markets in mid-march and then on the twenty third or fourth of March the the government and fed started to talk about what their program would be and around the twenty six they announced it and that drove up prices in the public credit markets to the point where we're not buying as aggressively at this point in time so it you know it has it has changed the market from what it would have been if they hadn't gotten involved and that has had impact for us and I think that's inescapable do you think investment opportunities are likely to improve from this point forward where you will see the opportunity the the possibility of making elevated returns again or are we sort of here now and here for the time being well you tell me will the will that be polite to be the buyer on every transaction in which case prices don't ever have to go down in theory you know Yogi Berra said in theory there's no difference between theory and practice but in practice there is but let's let's talk about the future in a serious way so I mentioned that the rating agencies but even the investment banks that between 15 and 25 or so percent of the high-yield bonds outstanding will default that's roughly 400 billion dollars that's a lot to buy in April I believe there were 19 defaults or bankruptcies and I believe that's the greatest in history greatest single month in history and we're just getting going you know the defaults and bankruptcies largely occur when companies run out of cash and the fact that 19 occurred in the first full month of the crisis and that the crisis has months more to run tells me there'll be more defaults in bankruptcy and there as I mentioned before there are large highly levered companies and investment vehicles that the government and fed rescue program is not likely to reach and take care of so we believe there will be plenty and you know it it boggles the mind to think that we're going to have a crisis of the magnitude of this one and not have fallout and typically we have been able to profit from that fallout so is that to say that while oaktree was buying aggressively in march less so now it may yet become a more aggressive buyer in the months ahead absolutely I mean they you know like they say in a football game we take what they give us and the greater the the dislocation usually the greater the bargains which means the greater our buying we think that there's a substantial opportunity ahead Howard we know now that the federal bailouts and the stimulus programs that follow the financial crisis came at a social cost one of those costs was the widening gap between the rich and the poor you and I have talked about it you've written about it what do you think the costs of the pandemic bailouts and and stimulus programs will be at a social level well more the same I mean we've had a substantial rise in population in this country and around the world and I would describe populism as class resentment and the bailout from the global financial crisis was easy to characterize as a bailout of Wall Street not Main Street the banks were protected and brought back to life at the same time that many thousands of Americans lost their homes just to to put it in stark terms and so that gave rise to populism and a class resentment and I think that in this in this go-around number one the banks are not in the condition they were twelve years ago and so they do not have to be but rest in the same way and you know I think it's absolutely essential as I mentioned before that this economic support being gauged and but still people will be able to say look they gave 50 billion to the airlines and they gave this to that company and this to that company and they bailed out the fat cats and and 20 30 million Americans lost their jobs so I would imagine that that this episode will add further to that to that populism Howard I want to thank you very much well it's always a pleasure to be here with you Eric

Channel: Bloomberg Markets and Finance

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Keywords: Bloomberg, investing, coronavirus, top investor, money manager, stocks, pandemic, economy

Id: snZ_thb8F7Q

Length: 41min 4sec (2464 seconds)

Published: Mon May 18 2020