Oaktree's Howard Marks: Keep Calm and Invest On

his name is Howard Marks you know him as the co-founder and co-chairman of oaktree capital management it's a credit investment firm with a hundred billion dollars in assets I've had the pleasure of getting to know Howard quite well over the last few years and I think the opportunity to speak to him here is an even greater pleasure Howard please join us so by way of background if you read Howard's memos and you should you already know how insightful he can be Howard started on Wall Street in 1969 and he's been a professional investor since 1978 in 1990 he started documenting his thoughts theories and philosophies on investing and he has continued through as we'll all agree some of the most extraordinary and extraordinarily challenging times for financial markets we can go back to the great bond massacre of 94 we can talk about the Asian currency crisis the Russian default the dot-com bubble the financial crisis the European sovereign debt crisis the crises go on and on during that period as I mentioned he has built oak tree with some help into a firm overseeing a hundred billion dollars today I've asked Howard to contemplate a deliberately provocative question he hasn't yet covered in his memos and this is it is capitalism broken now I could run you through a long list of reasons why this may be the case and we'll probably get to some of them but I would rather begin by hearing from Howard and seeing where this conversation goes Howard his capital isn't broken well I think that the as with many things the the easy gains come in the beginning against little resistance and the greatest steps are taking in the beginning and then excesses developed you know one of my favorite sayings is that what the wise man does in the beginning the fool does in the end and and and and missteps come later and and so I don't think it's over but I think it's it's more complicated today than it was a hundred years ago well I mentioned that I have a long list yes so let's start going through the list because any one of these things in and of itself might not considered might not be considered a sign that capitalism is broken but collectively they raise some questions and I want to through them with you let's talk about monetary policy we know that financial markets are prisoners if you will to finance to monetary policy recognizing that markets are an essential tool for capitalism right price-setting mechanism how useful is the Japanese bond market as a price-setting mechanism that the central bank there isn't just running a negative interest rate policy for overnight rates but actively buying and selling to keep the 10-year yield at zero well and of course that's just symptomatic right of the extraordinary measures central banks have taken of yes because it's you know you shouldn't just be asking about Japan many places have set interest rates at zero and bought long-term bonds as well so I think that all I would say is that we believe in free markets we believe that the free market is the best allocator of resources in the long run and that's the essence of capitalism as the essence of success of the United States in large part although we do have regulated industries as well but we don't have a free market money all around the world and we haven't had four five six seven years and that's unfortunate and you know I kind of liked Keynes's approach which is that when when the market when the economy's in the soup you run a deficit you spend more than you bring in and that stimulates the economy it brings it back and then when the apana economy is running doing well you run a surplus and you spend less than you make and you pay off the debt and everybody's forgotten about that latter part and and now they think they can they can the Fed the central banks can manage their way to prosperity and I don't believe it I don't think that central banks can create growth and should be in the in the in long term and permanently in the business of controlling the money market thinking as a long-term investor which is what you do if the markets aren't free the thinking or the long-term thinking as a long-term investor yes which is what I think of you a thank you how do you invest confidently if it's not a free market well I think the answer is well first of all we are not our investments are not driven by the macro and we're not macro investors and and we're not fed watchers and we're not economists we are micro investors we invest one company at a time in companies where we feel we are well paid to take risk and and where we think the outcomes are predictable so in general Eric we don't make judgments about that the about the other the macro you know it's very easy to make those judgments it's hard to make them correctly and it's hard it's harder still to have the events you predict materialize on time and when they don't materialize on time you get into trouble and I think that you know you can name on on just a few fingers the people who are famous for getting macro right and I think of trying to guess at these things as an opportunity to make mistakes there are a lot of people who went to cash at the beginning of this year and thinking that there was a lot of uncertainty and low prospective returns and and that prices were high all of which was true and they missed a lot this year and so I think getting in getting out very very challenging not something we do here's a consequence of these low rates that maybe or maybe not raising some questions about capitalism returns don't reflect the risk of loss that says this is not the first time yeah that that's happened right no returns are extremely skimpy thanks primarily to the central banks lowering the the what we call the the capital market line with an origin of a risk-free rate close to zero and everything else proceeding from there so we have very very low prospective returns at the same time that we have great macro uncertainty that's not an attractive combination but the challenge is what do you do about it and I I reject the idea of getting out of the market among other things our clients need return and they can't say we'll take zero if you're a pension fund or an endowment you need return and similarly when they hire us to do a job we can say we're gonna keep it in cash and make zero for a few years waiting for better opportunities I mean we can do that but we'd better be right pretty soon or else we'll be out of business is there a moment when it's appropriate to get out of the market in your words and if so when might that point be well there is I think when there's a demonstrable bubble and when psychology is crazy bullish and and the risks are extremely high and valuations are extremely high implicitly I'm saying I don't think that's today I think things are elevated to the point where you have to proceed with with considerably more caution than usual but I do not think that we are in a dangerous bubble what does a dangerous what might the next dangerous bubble look like you know when did those valuations reach the nosebleed level that drives you out of the building well I mean for example we're not we don't manage that money in the mainstream stock markets but in in the SP you know the AB the p/e ratio is about 19 today versus the post-war average of 16 that's a little high in 2000 it was 32 that was a bubble and so I think that bubbles are connoted by extremely high evaluations and also by bubble thinking and bubble thinking says for example nothing bad can happen there's no price too high this can't lose now those things sound nutty but I've seen them several times in my life and we've seen bubbles ranging from the nifty 50 bubble in which IBM Xerox Kodak Polaroid Avon Merck and Lilian and it's cetera we're selling at 80 to 90 times earnings in 1968-69 - the tech stocks and the internet stocks you know in in 1999 people said you know the internet will change the world this is an Internet company so consequently there's no price too high so at that that time and times like it you saw people blindly following the herd right but they are if not blindly following the herd today they're also doing some things somewhat blindly like reaching for you yes yes so does the next bubble necessarily need to look like the last one well yeah you have to make judgments you see in these things are not black and white and so this is a time for caution but this is not in my opinion a time of maximum risk you know we are primarily credit investors and if we can buy debt of companies that we believe we think for good reason will pay their debts then the worst that will happen is we'll get the promised return number one the promised return may prove to be inadequate number two there may be interim declines in price which are painful number three those interim declines in price will provide a better time to buy than today all that's true but still if you buy and you're discerning about credit and you're right you'll get the promised return and that's not the end of the world what we're when I talk about a bubble you know in nineteen in 2006 seven it was really easy to issue paper that we were pretty sure wouldn't be repaid and when it's easy to issue paper that won't be repaid there's something wrong in the markets and that's the time to get out here's a question that you touched on and I think in one of your first remarks one of the biggest questions that investors must ask themselves in order to set expectations accordingly is whether the future is going to be as good as the past will it I don't I don't like being a downer but I don't think so you know I was very lucky to be born 70 years ago and to have lived through the greatest period in history the best time in the best place and it it it doesn't stand to reason to think that number one everything will always stay the same or get better and I think we've had our best times I don't enjoy saying it but I think it's true and I don't enjoy saying it to my kids but you know the u.s. coming out of World War two was in the best shape in the world we had the best of everything we had an intact infrastructure and we had great advances on the business side and on the science side and we used to say you know when when when people were questioning why are we were doing better technologically our explanation was that our German scientists were better than the Russians German scientists but you know but if you look at you know and I imagine a lot of people saying well when are we going to get back to normal like right that's that question like the 90s and I when I look at the 90s it was the best of times the economy did well companies did well management advances technological advances productivity advances inflation under control interest rates declining peace in the world and it doesn't get better if by definition it doesn't get better than is a good chance it gets worse now the other thing is this globalization is a very very strong force and you know when I was a kid there was no such thing as a foreign car I believe that the first volcán came to America in 49 and I believe if I'm not mistaken they sold two that year you can look it up but all cars were American and as when you don't have open borders then the workers in one country can be paid more than the workers in another country even if the product is not superior and that was the case and and the I believe for example that the American car worker was the best paid car worker in the world and he didn't make the best car in the world and it was the latter fact that that permitted the vacuum to be filled by foreign cars and and and so I believe that forged in the past and I think it became true that the American car worker would have to accept a declining relative standard of living and I think that's true that's just one example but I think it's true many ways in our economy so globalization is one of the fact very strong operation things on your mind as you look into the future and come to this conclusion that perhaps it's not we're probably not going to be as good as the past what else do you worry about what else if you will factors into your equation well when you combine globalization and the vast numbers of people abroad who want jobs and it will work cheaper than Americans and you combine that with automation which is a much stronger force than than job losses that we hear about so much in this election season you know automation has been an enormous factor you go to a factory that 20 years ago had a hundred workers today it has five and they don't make any of the stuff they only work they only keep the machines going and I despair about where the Americans who worked in agriculture a hundred years ago in the south and then moved to the Midwest to make cars and appliances 50 years ago I wonder I worry about where they're gonna find jobs and this is a question that is not easily solved can you draw a straight line or at the very least connect the dots between the future not looking as good as the past in qualitative terms and the future not being as good as the past in quantitative terms well I do think that that we will grow more slowly in the future than we have in the past and I believe that that will deny opportunities it'll make it harder for government to do things you know I wonder why did we live so well 60 years ago we didn't have deficits we had good public schools they were clean I went to a public school I got a good education why can't you do that today why can't we build infrastructure in this country and so forth either you know so I mean a lot of it has has come from a declining growth rate and from the inroads made by globalization and now the good news is that and I travel a lot and it's clear that the US economy is the envy of the world and so the things I'm saying are not only relevant to the US we're in better shape then I believe Europe or Japan for example but everything is flowing down everything is complicated by globalization and automation you've been on the record with me as saying you're no fan of Donald Trump and don't plan to vote for him but and I asked this question sincerely if you're going to support Hillary Clinton which I take it you will does she have ideas a plan that you support that you think is realistic to address these issues that you raised I haven't heard much that convinces me but I believe that she's well what did your boss say saint-- incompetent and and and I believe she will surround herself with good advisers and I believe she understands the need for good advisers and that she will work tirelessly and long hours of study to come up with plans she is not the candidate of change and we need change and I think the idea of change is a good one I'm not crazy about the current messenger of change that's the problem and you know if there were another candidate at another time who had a message of change and the competence that Mike Bloomberg's talking about I think I'd be all for it I don't want to dwell on politics so let's go back to this idea of turning the qualitative impression into a quantitative expectation as you point out the 1980s were pretty good to investors the 1990s were pretty good to investors until 2008 the 2000s were pretty good to investors that little patch and and since the financial crisis investors have made a lot of money over the past 30 years equities have returned on average 9.8 percent a year high-yield eight point four percent mortgages six point six and Treasuries six point two percent in the great bond bull market it works out to a if you will mix or balanced portfolio returns 60/40 if something in the order of seven and a half percent exactly more or less what pension funds have been targeting and for the most part continued to target today if what you say is true that is an unrealistic target what is a realistic expectation well the first thing that I'm pretty sure of is that five and a half percent high-yield bonds are not going to deliver eight point six and and two percent Treasuries are not going to deliver five and so forth and the biggest mistake you can make in my opinion is by a five percent bond expecting to make seven so today high-yield pays five and a half star most people expect stocks to deliver five or six high grade bonds pay three or four Treasuries pay one two - yeah average those together and you throw in as everybody is doing and as I think they should something called alternative investments be it distressed at private equity real estate or something like that and I think you can do five and a half now from today for the next thirty years well I mean it's a long time I'm not gonna do it for thirty years but but you might but but I mean going forward in some indeterminate period you know I think that it's it's the five and a half is it strikes me intestinal ii as the most reasonable expectation for the long-term returns that's a big problem for this country isn't a big problem because most endowments need eight charities need eight and pension funds need seven and a half-ish you know I meet with a lot of pension funds and they always ask me my view of the world and I I give them my view and and what I think what assets are attractive when I think they can make and then they said well our actuarial actuarial assumption is seven and a half percent what do you recommend and I say I recommend you change it but but the but the problem is that the actuarial assumption which i think is supposed to be the return you think you can make right has morphed into the return you need to turn today's assets and predictable cash flows into the amounts you'll need in the future to pay to meet your needs it's and it has it doesn't necessarily have anything to do with what a prudent investor could make howard i think the audience would agree with me that there's nothing we want to change about talking to you thank you so very much thank you thank you Howard Marks lovely capital

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Keywords: Bloomberg, Howard Marks, Oaktree, wall street, finance, investing, markets

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Length: 22min 51sec (1371 seconds)

Published: Wed Sep 28 2016