0:06

This

0:06

is the memo by Howard Marks.

0:11

Further thoughts on sea change. In

0:17

May, I wrote a follow-up memo to Sea Change,

0:20

December 2022, that

0:22

was shared exclusively with Oak Tree clients.

0:25

In further thoughts on sea change, I

0:28

argued that the trends I had highlighted in

0:30

the original memo collectively represented

0:32

a sweeping alteration of the investment

0:34

environment

0:35

that called for significant capital reallocation.

0:38

This message has only become

0:40

more relevant in recent months, so

0:42

I thought now would be a good time to share this

0:44

memo with a broader audience.

0:48

This time, it really might be different. On

0:52

October 11, 1987, I first

0:54

came across the saying, this time it's different.

0:57

According to an article in the New York

0:59

Times by Anas C. Wallace,

1:02

Sir John Templeton had warned that when

1:04

investors say times are different, it's

1:07

usually in an effort to rationalize valuations

1:09

that appear high relative to history,

1:13

and it's usually done to investors'

1:15

ultimate detriment. In 1987,

1:17

it was high equity prices in

1:20

general.

1:21

The article I cite was written just eight days

1:23

before Black Monday, when the Dow Jones

1:25

Industrial Average declined by 22.6% in a single day.

1:31

A dozen years later, the new thing people were excited

1:33

about was the prospect that the Internet would

1:35

change the world. This belief

1:38

served to justify ultra-high prices

1:40

and P-E ratios of infinity for

1:43

digital and e-commerce stocks,

1:45

many of which went on to lose more than 90% of their

1:47

value over the next year

1:49

or so. Importantly,

1:52

however, Templeton allowed that things might

1:54

really be different 20% of the time.

1:58

On rare occasions, something fundamental is different. fundamental

2:00

does change with significant implications

2:02

for investing. Given the pace

2:05

of developments these days, especially

2:07

in technology, I imagine things

2:09

might genuinely be different more often than

2:11

they were in Templeton's day. Anyway,

2:14

that's all preamble. My

2:16

reason for writing this memo is that, while

2:19

most people I speak with seem to agree

2:21

with many of my individual observations

2:23

in sea change, few have

2:25

expressly agreed with my overall conclusion

2:28

and said, I think you're right, we

2:31

might be seeing a significant and possibly

2:33

lasting change in the investment

2:35

environment. This memo's

2:38

main message is that the changes I

2:40

described in sea change aren't

2:42

just usual cyclical fluctuations.

2:45

Rather, taken together, they represent

2:47

a sweeping alteration of the investment

2:50

environment calling for significant

2:52

capital reallocation.

2:55

In the backdrop,

2:59

I'll start off by recapping my basic arguments

3:02

from sea change. In

3:04

late 2008, the Federal Reserve took the Fed funds

3:06

rate to zero for the first time ever

3:09

in order to rescue the economy from the effects

3:11

of the global financial crisis. Since

3:14

that didn't cause inflation to rise from its

3:17

sub-2% level, the

3:19

Fed felt comfortable maintaining accommodative

3:21

policies, low interest rates, and

3:24

quantitative easing for essentially

3:26

all of the next 13 years. As

3:29

a result, we had the longest economic

3:31

recovery on record, exceeding 10

3:33

years and easy times for

3:35

businesses seeking to earn profits and

3:38

secure financing. Even money-losing

3:41

businesses had little trouble going public, obtaining

3:43

loans and avoiding default and bankruptcy.

3:47

The low interest rates that prevailed in 2009-21 made it a great

3:49

time for asset owners. Lower

3:54

discount rates make future cash flows

3:56

more valuable and for borrowers.

4:00

made asset owners complacent and

4:02

potential buyers eager. And

4:04

FOMO became most people's main concern.

4:07

The period was correspondingly challenging for

4:10

bargain hunters and lenders. The

4:13

massive COVID-19 relief measures combined

4:15

with supply chain snags resulted

4:18

in too much money chasing too few

4:20

goods, the classic condition for

4:22

rising inflation. The

4:24

higher inflation that arose in 2021 persisted into 2022

4:29

forcing the Fed to discontinue its

4:31

accommodative stance. Thus

4:34

the Fed raised interest rates dramatically

4:36

its fastest tightening cycle in four

4:39

decades and ended QE.

4:42

For a number of reasons ultra low

4:44

or declining interest rates are unlikely

4:47

to be the norm in the decade ahead. Thus

4:50

we're likely to see tougher times for corporate

4:52

profits for asset appreciation

4:55

for borrowing and for

4:57

avoiding default. Bottom line

5:00

if this really is a sea change meaning

5:02

the investment environment has been fundamentally

5:05

altered you shouldn't assume the

5:07

investment strategies that have served you best

5:09

since 2009 will do so

5:12

in the years ahead. Having

5:14

supplied this summary I'm going to put

5:16

flesh on these bones and share some additional

5:18

insights. A

5:21

momentous development To

5:25

promote discussion these days I often start

5:27

by asking people what do you consider

5:29

to have been the most important event in the financial

5:32

world in recent decades.

5:34

Some suggest the global financial crisis

5:36

and bankruptcy of Lehman Brothers, some

5:39

the bursting of the tech bubble and some

5:41

the Fed government response to

5:43

the pandemic related woes. No

5:46

one cites my candidate the 2000 basis point

5:49

decline in interest rates between 1980

5:51

and 2020. And yet as I wrote in sea change that decline was

5:57

probably responsible for the lion's

5:59

share of the financial crisis. of investment profits made over

6:01

that period. How could it

6:03

be overlooked? First

6:06

I suggest a metaphor of boiling a frog. It's

6:09

said that if you put a frog in a pot to boiling

6:11

water, it'll jump out. But

6:13

if you put it in cool water and turn

6:15

on the stove, it'll just sit there, oblivious,

6:19

until it boils to death. The frog

6:21

doesn't detect the danger, just as

6:23

people fail to perceive the significance

6:26

of the interest rate decline because of its

6:28

gradual, long-term nature. It's

6:31

not an abrupt development, but

6:33

rather a drawn-out, highly influential

6:35

trend. Second,

6:38

in sea change, I compared the 40-year

6:40

interest rate decline to the moving walkway

6:43

at an airport. If you stand still

6:45

on the walkway, you'll move effortlessly,

6:47

but if you walk at your normal pace,

6:50

you'll move ahead rapidly, perhaps

6:52

without being fully conscious of why. In

6:54

fact, if everyone's walking on the moving walkway,

6:57

doing so can easily go unnoted,

7:00

and the walkers might conclude that their rapid

7:02

progress is normal. Finally,

7:05

there's what John Kenneth Galbraith called

7:07

the extreme brevity of the financial

7:10

memory. Relatively few investors

7:12

today are old enough to remember a time when

7:14

interest rates behaved differently. Everyone

7:18

who has come into the business since 1980, in

7:21

other words, the vast majority of today's

7:23

investors, has, with relatively

7:26

few exceptions, only seen

7:28

interest rates that were either declining or

7:30

ultra-low, or both. You

7:33

have to have been working for more than 43 years,

7:36

and thus be over 65 to have seen

7:38

a prolonged period that was otherwise.

7:41

And since market conditions made it tough to find

7:43

employment in our industry in the 1970s,

7:47

you probably had to get your first job in the

7:49

1960s, like me, to have

7:51

seen interest rates that were either higher and

7:54

stable or rising. I

7:56

believe the scarcity of veterans from the 70s has been a major

7:58

factor in the financial made it easy for

8:01

people to conclude that the interest rate trends

8:03

of 2009-21 were normal. The

8:07

Relevance of History The

8:12

13-year period from the beginning of 2009 through

8:15

the end of 2021, saw two rescues

8:18

from financial crises, a generally

8:20

favorable macro environment, aggressively

8:23

accommodative central bank policies, a

8:25

lack of inflation worries, ultra-low

8:28

and declining interest rates, and

8:31

generally uninterrupted investment

8:33

gains. The question, of course,

8:35

is whether investors should expect a continuation

8:38

of those trends. Recent

8:40

events have shown that the risk of rising inflation

8:43

can't be ignored in perpetuity. Moreover,

8:46

the reawakening of inflationary psychology

8:49

will probably make central banks less likely

8:51

to conclude that they can engage

8:53

in continuous monetary stimulation

8:56

without consequences. Thus,

8:59

interest rates can't be counted on to stay

9:01

lower for longer and produce perpetual

9:04

prosperity, as many thought was the case

9:06

in late 2020. Also

9:09

in late 2020, modern monetary theory

9:12

was accepted by some as meaning deficits

9:14

and national debt could be disregarded

9:17

in countries with control of their currencies.

9:20

We no longer hear anything about this

9:22

notion. In

9:25

C-Change, I listed several reasons

9:27

why I don't think interest rates are going back

9:29

to that period's lows on a permanent basis,

9:32

and I still find these arguments compelling. In

9:35

particular, I find it hard to believe

9:37

the Fed doesn't think it aired by

9:40

sticking with ultra-low interest rates for

9:42

so long. As

9:45

noted previously, to fight the

9:47

GFC, the Fed took

9:49

the Fed funds rate to roughly zero for the

9:51

first time in late 2008. Macro

9:54

conditions were frightening, as a vicious

9:56

cycle capable of undermining the entire

9:59

financial system. system appeared to be underway.

10:02

For this reason, aggressive action was certainly

10:04

called for. But I was shocked

10:07

when I looked at the data and saw that

10:09

the Fed kept the rate near zero for nearly

10:11

seven years. Setting

10:13

interest rates at zero is an emergency

10:16

measure, and we certainly didn't have a continuous

10:18

emergency through late 2015. To

10:21

me, those sustained low rates stand

10:23

out as a mistake not to be repeated.

10:28

However, by 2017-18, with the

10:30

Fed funds rate around 1%, it

10:33

had become clear to many that there wasn't room

10:35

for the Fed to reduce rates if necessary

10:37

to stimulate the economy during a recession.

10:41

But when the Fed attempted to raise rates to

10:43

create that room, it encountered pushback

10:45

from investors. See the fourth quarter

10:48

of 2018. I find

10:50

it hard to believe the Fed would want to re-impose

10:52

that limitation on its toolkit.

10:56

A recurring theme of mine is that even though

10:58

many people agree that free markets

11:00

do the best job of allocating resources,

11:03

we haven't had a free market in money in

11:05

roughly the last two decades, a

11:07

period of Fed activism. Instead,

11:11

Fed policy has been accommodative almost

11:13

the entire time, and interest

11:15

rates have been kept artificially low. Rather

11:18

than letting economic and market forces determine

11:20

the rate of interest, the Fed has

11:23

been unusually active in setting

11:25

interest rates, greatly influencing

11:27

the economy and the markets. Importantly,

11:31

this distorts the behavior of economic

11:34

and market participants. It causes

11:36

things to be built that otherwise wouldn't have

11:38

been built, investments to be made that

11:40

otherwise wouldn't have been made, and risks

11:43

to be born that otherwise wouldn't

11:45

have been accepted. There is no

11:47

doubt that this is true in general, and

11:49

I am convinced it accurately describes

11:51

the period in question. Many

11:55

articles about the problems at Silicon

11:57

Valley Bank and First Republic Bank site

12:00

errors that were made in the preceding easy

12:02

money period. Rapid growth,

12:05

unwise inducements to customers, and

12:07

lax financial management were all encouraged

12:10

in a climate with accommodative Fed policy,

12:13

uniformly positive expectations,

12:16

and low levels of risk aversion. This

12:19

is just one example of a time-worn

12:22

adage in action. The worst of

12:24

loans are made in the best of times.

12:27

I don't think the Fed should return us to an

12:30

environment that has been distorted

12:32

to encourage universal optimism, belief

12:35

in the existence of a Fed put, and

12:37

thus a dearth of prudence. If

12:40

the declining and or ultra-low interest

12:43

rates of the easy money period aren't going

12:45

to be the rule in the years ahead, numerous

12:47

consequences seem probable. Economic

12:50

growth may be slower, profit margins

12:53

may erode, default rates

12:55

may head higher, asset

12:57

appreciation may not be as reliable. The

13:00

cost of borrowing won't trend downward

13:02

consistently, though interest rates

13:05

raised to fight inflation likely will

13:07

be permitted to recede somewhat once

13:09

inflation eases. Investor

13:11

psychology may not be as uniformly

13:13

positive, and businesses

13:16

may not find it as easy to obtain financing.

13:20

In other words, after a long

13:22

period when everything was unusually easy

13:25

in the world of investing, something closer

13:27

to normalcy is likely to set in. Please

13:31

note that I'm not saying interest rates, having

13:33

declined by 2,000 basis points

13:35

over the last 40 or so years, are

13:38

going back up to the levels seen in

13:40

the 1980s. In fact, I

13:42

see no reason why short-term interest

13:44

rates five years from now should

13:46

be appreciably higher than they are today.

13:48

But still, I think

13:51

the easy times, and easy

13:53

money, are largely over. How

13:56

can I best communicate what I'm talking about?

13:59

Try this. Five years

14:01

ago, an investor went to the bank for a loan

14:03

and the banker said, we'll give you $800 million at 5%. Now

14:08

the loan has to be refinanced and

14:10

the banker says, we'll give you $500 million at 8%.

14:15

That means the investor's cost of capital

14:17

is up, his net return on the

14:19

investment is down or negative,

14:22

and he has a $300 million hole to fill. What

14:27

strategies will work best? It

14:31

seems obvious that if certain strategies

14:33

were the best performers in a period with

14:35

a given set of characteristics, it

14:37

must be true that a starkly different environment

14:40

will produce a dramatically altered list

14:42

of winners. As

14:45

mentioned previously in the recap of

14:47

C-Change, the 40 years of

14:49

low and declining interest rates were hugely

14:52

beneficial for asset owners. Declining

14:55

discount rates and the associated reduction

14:57

in the competitiveness of bond returns

15:00

led to substantial asset appreciation.

15:03

Thus, asset ownership, whether

15:05

related to companies, pieces of companies,

15:08

equities, or properties, was

15:10

the place to be. Falling

15:13

interest rates brought down the cost of capital

15:15

for borrowers. As this occurred,

15:18

any borrowing automatically became more

15:20

successful than originally contemplated.

15:24

And as I also mentioned in C-Change,

15:27

the combined result of these factors

15:29

for investors who bought assets on borrowed

15:31

money was a double bonanza. Think

15:34

back to the first of the C-Changers I mentioned

15:36

in that memo, the advent of high-yield

15:38

bonds in 1977-78, which

15:42

brought about the trend toward bearing risk

15:44

for profit and the emergence of

15:46

levered investment strategies. It's

15:49

very notable that almost the entire history

15:51

of levered investment strategies has

15:54

been written during a period of declining and

15:56

or ultra-low interest rates. For

15:59

example, I... I would venture that nearly 100% of

16:02

capital for private equity investing has

16:05

been put to work since interest rates began

16:07

their downward move in 1980. Should

16:10

it come as a surprise that levered investing

16:12

thrived in such salutary

16:14

conditions? At the same

16:16

time, declining interest rates rendered

16:19

lending, or buying debt instruments,

16:22

less rewarding. Not only were

16:24

prospective returns on debt low throughout

16:26

the period, but investors who were eager

16:29

to get away from the ultra-low yields

16:31

on safer securities like treasuries

16:33

and investment-grade corporates competed

16:36

spiritedly to deploy capital in

16:38

higher-risk markets, and this caused

16:41

many to accept lower returns and

16:43

reduced lender protections. Finally,

16:47

conditions in those halcyon days created

16:49

tough times for bargain hunters. Where

16:52

do the greatest bargains come from? The

16:55

answer? The desperation of panicked

16:57

holders. When times are untroubled,

17:00

asset owners are complacent, and

17:02

buyers are eager. No one has any

17:04

urgency to exit, making it very

17:06

hard to score significant bargains. Investors

17:10

who profited in this period from asset

17:12

ownership and levered investment strategies

17:14

may overlook the salutary effect

17:17

of interest rates on asset values and

17:19

borrowing costs, and instead

17:21

think the profits stemmed from the inherent

17:23

merit of their strategies, perhaps

17:26

with some help from their own skill and wisdom.

17:29

That is, they may have violated a basic

17:31

rule in investing. Never

17:33

confuse brains and a bull market. Given

17:37

the benefits of being on the moving walkway

17:39

during this period, it seems to me

17:42

it would have required really bad decision-making,

17:45

or really bad luck, for a purchase

17:47

of assets made with borrowed money to

17:49

have been unsuccessful. Will

17:53

asset ownership be as profitable

17:55

in the years ahead as in the 2009-21 period?

17:59

leverage, add as much to returns

18:02

if interest rates don't decline over time,

18:05

or if the cost of borrowing isn't

18:07

much below the expected rate of return

18:09

on the assets purchased. Whatever

18:12

the intrinsic merits of asset ownership and

18:14

levered investment, one would

18:16

think the benefits will be reduced in the years

18:18

ahead. And merely

18:21

riding positive trends by buying and

18:23

levering may no longer be sufficient

18:26

to produce success. In

18:28

the new environment, earning exceptional

18:30

returns will likely once again require

18:33

skill in making bargain purchases, and

18:36

in control strategies, adding value

18:38

to the assets owned. Lending,

18:42

credit, or fixed income investing should

18:45

be correspondingly better off. As

18:47

I mentioned in my December memo,

18:49

the 13 years in question were a difficult,

18:52

dreary, low return period

18:54

for credit investors, including Oaktree.

18:57

Most of the asset classes we operate

18:59

in were offering the lowest prospective

19:01

returns any of us had ever seen. The

19:04

options were to a.) hold

19:06

and accept the new lower returns, b.)

19:09

reduce risk to prepare for the correction

19:12

that the demand for higher returns would eventually

19:14

bring, or c.) increase

19:17

risk in pursuit of higher returns.

19:20

Obviously, all of these had drawbacks. The

19:22

bottom line was that it was quite challenging to

19:25

safely and dependably pursue

19:27

high returns in a low-return world

19:29

like the one we were experiencing. But

19:33

now, higher prospective returns are

19:35

here. In early 2022,

19:38

high-yield bonds, for example, yielded

19:41

in the 4% range, not a

19:43

very useful return. Today,

19:45

they yield more than 8%, meaning

19:48

these bonds have the potential to make a great

19:50

contribution to portfolio results.

19:53

The same is generally true across the entire

19:55

spectrum of non-investment-grade

19:57

credit. asset

20:00

allocation today. My

20:04

thinking about the sea change materialized

20:06

mostly as I was visiting clients last

20:08

October and November.

20:10

When I got home, I wrote the memo and began

20:13

to discuss its thesis and

20:15

at the December meeting of a nonprofit investment

20:17

committee, I said the following. Sell

20:20

off the big stocks, the small stocks, the

20:23

value stocks, the growth stocks, the

20:25

US stocks and the foreign stocks, sell

20:28

the private equity along with the public equity,

20:30

the real estate, the hedge funds and the venture

20:33

capital. Sell it all and put the

20:35

proceeds into high yield bonds at 9%.

20:39

This institution needs to earn an

20:41

annual return of 6% or so on

20:44

its endowment and I'm convinced

20:46

that if it holds a competently assembled

20:48

portfolio of 9% high

20:50

yield bonds, it would be overwhelmingly

20:53

likely to exceed that 6% target. But

20:57

mine wasn't a serious suggestion. More

21:00

a statement designed to evoke discussion

21:02

of the fact that thanks to the changes

21:04

over the last year and a half, investors

21:07

today can get equity like returns

21:09

from investments in credit. The

21:12

Standard & Poor's 500 Index

21:14

has returned just over 10% per year

21:17

for almost a century and everyone's

21:20

very happy. 10% a year for 100 years

21:22

turns $1 into almost $14,000. Nowadays,

21:28

the ICE B of A US

21:30

High Yield Constrained Index offers

21:33

a yield of over 8.5%. The

21:36

CS Leveraged Loan Index offers

21:38

roughly 10.0% and

21:41

private loans offer considerably more. In

21:44

other words, expected pre-tax

21:46

yields from non-investment grade

21:49

debt investments now approach

21:51

or exceed the historical returns

21:53

from equity. And

21:56

importantly, these are contractual

21:58

returns. When I

22:00

shifted from equities to bonds in 1978,

22:03

I was struck by a major difference With

22:06

equities the bulk of your return in

22:08

the short or medium term depends

22:11

on the behavior of the market if Mr.

22:13

Markets in a good mood has been Graham

22:16

put it your return will benefit and

22:18

vice versa With credit

22:20

instruments on the other hand your return

22:23

comes overwhelmingly from the contract

22:25

between you and the borrowers You

22:28

give a borrower money upfront they

22:30

pay you interest every six months and

22:33

they give you your money back at the end and to

22:36

greatly oversimplify if the

22:38

borrower doesn't pay you as promised you

22:41

and the other creditors get ownership of the company

22:43

via the bankruptcy process a

22:46

possibility that gives the borrower a lot

22:48

of incentive to honor the contract the

22:51

Credit investor is independent on the market

22:53

for returns if the market shuts

22:55

down or becomes illiquid The

22:57

return for the long-term holder is unaffected

23:00

the difference between the sources of return on

23:03

stocks and bonds is profound Something

23:06

many investors may understand intellectually,

23:08

but not fully appreciate It's

23:12

been years since prospective returns

23:14

on credit were competitive with those on equities

23:17

now. It's the case again Should

23:19

the nonprofit whose board I sit on

23:21

put all its money into credit instruments?

23:24

Perhaps not, but Charlie Munger

23:27

exhorts us to invert or flip

23:29

questions like this To

23:31

me this means allocators should

23:34

ask themselves What are the arguments

23:36

for not putting a significant portion

23:38

of our capital into credit today? Here

23:42

I'll mention that over the years I've

23:44

seen institutional investors pay lip

23:46

service to developments in markets and

23:49

make modest changes in their asset

23:51

allocation in response When

23:54

the early index funds outperformed active

23:56

management in the 1980s. They

23:59

said we've got that covered, we've

24:01

moved 2% of our equities to

24:03

an index fund. When emerging

24:05

markets look attractive, the response

24:08

is often to move another 2%. And

24:11

from time to time, a client tells me they've put 2%

24:13

in gold. But if

24:16

the developments I describe really constitute

24:18

a sea change, as I believe, fundamental,

24:22

significant, and potentially long-lasting,

24:25

credit instruments should probably represent

24:27

a substantial portion of portfolios,

24:31

perhaps the majority. What's

24:34

the downside? How could this be a mistake?

24:38

First, individual borrowers can

24:40

default and fail to pay. It's

24:42

the main job of the credit manager to

24:44

weed out the non-payers, and

24:46

history shows it can be done. Isolated

24:49

defaults are unlikely to derail

24:52

a well-selected and well-diversified

24:54

portfolio. And if you're worried

24:56

about a wave of defaults hitting your credit

24:58

portfolio, think about what the implications

25:01

of that environment would be for equities

25:04

or other ownership assets.

25:07

Second, by

25:07

their nature, credit instruments don't

25:10

have much potential for appreciation.

25:13

Thus, it's entirely possible that equities

25:15

and levered investment strategies will

25:17

surprise on the upside and outperform

25:20

in the years ahead. There's no denying

25:22

this, but it should be borne in mind that

25:24

the downside risk here consists

25:27

of the opportunity cost of returns foregone,

25:30

not failing to achieve the return one

25:33

sought. Third, bonds

25:36

and loans are subject to price fluctuations,

25:38

meaning having to sell in a week period

25:41

could cause losses to be realized. But

25:43

credit instruments are far from a loan in

25:45

this regard, and the magnitude

25:48

of the fluctuations on money, good, bonds,

25:50

and loans is constrained significantly

25:53

by the magnetic pull to par exerted

25:56

by the promise of repayment upon

25:58

maturity.

25:59

Fourth,

26:01

the returns I've been talking about are nominal

26:03

returns. If inflation

26:06

isn't brought under control, those nominal

26:09

returns could lose significant value

26:11

when they're converted into real returns, which

26:13

are what some investors care about most. Of

26:17

course, real returns on other investments

26:19

could suffer as well. Many

26:21

people think of stocks and real estate as potentially

26:24

providing inflation protection, but

26:26

my recollection from the 1970s is

26:28

that the protection typically takes hold only

26:31

after prices have declined so

26:34

as to provide higher prospective returns.

26:38

Finally, the sea change could end

26:40

up being less long-lasting than I

26:42

expect, meaning the Fed takes

26:44

the Fed funds rate back down to zero

26:46

or 1 percent and the yields

26:49

on credit recede accordingly. Fortunately,

26:52

by buying multi-year credit

26:54

instruments, an investor can tie up

26:56

the promised return for a meaningful period,

26:59

assuming the investment provides some degree

27:01

of call protection. Reinvesting

27:04

will have to be dealt with upon maturity or

27:06

call, but once you've made the credit

27:08

investments I'm suggesting, you

27:10

will at least have secured the promised yield, perhaps

27:14

minus losses on defaults with

27:16

the term of the instruments.

27:23

The overarching theme of my

27:25

sea change thinking is that, largely

27:27

thanks to highly accommodative monetary

27:29

policy, we went through unusually

27:32

easy times in a number of important

27:34

regards over a prolonged period,

27:36

but that time is over. There

27:40

clearly isn't much room for interest rate declines

27:42

from today's levels, and I don't

27:44

think short-term interest rates will be as low

27:47

in the coming years as in the recent past.

27:50

For these and other reasons, I

27:53

believe the years ahead won't be as easy,

27:56

but while my expectations may prove

27:58

correct, there's no evidence that the Fed will be able to do that. evidence yet

28:00

on which I can hang my hat. Why

28:02

not? My answer is

28:05

that the economy and markets are in

28:07

the early stages of a transition that's

28:09

far from complete. Asset

28:13

prices are established through a tug of war

28:15

between buyers, who think prices will

28:17

rise, and sellers who think they'll fall.

28:20

There's been an active one over the last year

28:22

or so, as sentiment has waxed and

28:24

waned regarding the outlook for inflation,

28:27

recession, corporate profits, geopolitics,

28:30

and especially a Fed pivot

28:32

back to accommodation. The tug

28:34

of war is ongoing, and as a result,

28:37

the S&P 500 is within

28:39

a half percent of where it was a year ago.

28:43

I've been thinking lately about the fact that being

28:45

an investor requires a person to be somewhat

28:48

of an optimist. Investors

28:50

have to believe things will work out, and

28:52

that their skill will enable them to wisely

28:55

position capital for the future. Equity

28:58

investors have to be particularly optimistic,

29:01

as they have to believe someone will come along who

29:03

will buy their shares for more than they paid.

29:06

My point here is that optimists surrender

29:09

their optimism only grudgingly,

29:11

and phenomena such as cognitive dissonance

29:14

and self-delusion permit opinions

29:16

to be held long after information

29:18

to the contrary has arrived. This

29:21

is among the reasons why they say of the

29:23

stock market, things can

29:25

take longer to happen than you thought they would,

29:28

but then they happen faster than you thought they could.

29:31

Today's sideways or range-bound

29:34

market tells me investors

29:36

possess a good amount of optimism despite

29:39

the worries that have arisen. In

29:41

the coming months, we'll find out if the

29:43

optimism was warranted. The

29:46

positive forces that shaped the 2009-21 market

29:50

began to change around 18 months

29:52

ago. The higher inflation turned

29:54

out not to be transitory. This

29:57

brought on interest rate increases, concerned

30:00

a recession would result, some resurrection

30:02

of worry over the possibility of loss,

30:05

and thus insistence on greater compensation

30:07

for bearing risk. But

30:09

while most people no longer see an outlook

30:11

that's flawless, few think

30:14

it's hopeless either. Just

30:16

as optimism abetted a positive cycle

30:18

in those thirteen years, I

30:21

believe a lessening of optimism will

30:23

throw some sand into the financial gears

30:25

in a variety of ways, some

30:28

of which may be unforeseeable. In

30:31

this latter regard, it's essential to

30:34

acknowledge that since we haven't lived through

30:36

times exactly like the years that lie ahead,

30:39

and since changes in the economic-financial

30:41

environment limit the applicability of history,

30:45

we're likely to encounter surprises,

30:47

and if the environment is less favorable, the

30:50

surprises are likely to be on

30:52

the downside. Please

30:54

note, as mentioned earlier, that

30:57

I'm absolutely not saying interest

30:59

rates are going back to the high levels from which

31:01

they've come. I have no reason

31:03

to believe that the recession most people believe

31:05

lies ahead will be severe or

31:08

long-lasting, and with valuations

31:10

high, but not terribly so, I

31:13

don't think a stock market collapse can reasonably

31:15

be predicted. This isn't a call

31:17

for dramatically increased defensiveness.

31:21

Mostly, I'm just talking about

31:23

a reallocation of capital, away

31:25

from ownership and leverage, and

31:27

toward lending. This

31:30

isn't a song I've sung often over the course

31:32

of my career. This is the first

31:34

sea change I have remarked on and

31:37

one of the few calls I've made for substantially

31:39

increasing investment in credit. But

31:42

the bottom line I keep going back to

31:44

is that credit investors can access

31:47

returns today that are highly

31:49

competitive versus the historical returns

31:52

on equities, exceed many

31:54

investors' required returns or actuarial

31:56

assumptions, and are much

31:59

less uncertain.

31:59

than at play returns.

32:03

Unless there are serious holes in my logic,

32:06

I believe significant reallocation

32:08

of capital toward credit is

32:10

warranted. May 30, 2023.

32:19

Thank you for listening to the memo by

32:21

Howard Marks. To hear more episodes,

32:24

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32:33

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32:36

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