0:06

This is the memo by

0:08

Howard Marks. On Bubble

0:10

Watch. Exactly 25 years

0:12

ago today, I published

0:14

the first memo that

0:16

brought a response from

0:19

readers, after having written

0:21

for almost 10 years,

0:24

without receiving any. The

0:26

memo was called Bubble.com.

0:29

and the subject was the

0:31

irrational behavior I thought was

0:33

taking place with respect to

0:36

tech, internet, and e-commerce stocks.

0:38

The memo had two things going for

0:40

it. It was right, and it was right

0:42

fast. One of the first great investment

0:45

allergies I learned in the

0:47

early 1970s is that being

0:49

too far ahead of your

0:51

time is indistinguishable from being wrong.

0:53

In this case, however, I wasn't too

0:55

far ahead. This milestone anniversary

0:57

gives me an occasion to write

1:00

again about Bubbles, a subject that's

1:02

very much of interest today. Some

1:04

of what I write here will be

1:06

familiar to anyone who read my December

1:09

memo about the macro picture. But

1:11

that memo only went to Oak

1:13

Tree clients. So I'm going to

1:15

recycle here the part of its

1:17

content that relates to the subject

1:19

of Bubbles. Since I'm a credit

1:21

investor, having stopped analyzing stocks

1:23

nearly five decades ago, and

1:25

since I've never ventured far

1:27

into the world of technology,

1:30

I'm certainly not going to say

1:32

much about today's hot companies and

1:35

their stocks. All of my

1:37

observations will be generalities, but

1:39

I'm hopeful they'll be

1:41

relevant nonetheless. In this

1:43

century's first decade, investors had

1:45

the opportunity to participate

1:48

in and lose money due to

1:50

two spectacular bubbles. The first was

1:52

the Tech Media Telecom. TMT

1:54

bubble of the late 90s

1:57

which began to burst in

1:59

mid-2000s. and the second, was

2:01

the housing bubble of the

2:03

mid-oughts, which gave rise to

2:05

A, extending mortgages to subprime

2:07

borrowers who couldn't or wouldn't

2:10

document income or assets, B,

2:12

the structuring of those loans

2:14

into levered tranched mortgage-backed securities,

2:16

and consequently, C, massive losses

2:18

for investors in those securities,

2:20

especially the financial institutions that

2:22

had created them and retained

2:24

some. As a result of

2:26

those experiences, many people these

2:28

days are on heightened alert

2:31

for bubbles. And I'm often

2:33

asked whether there's a bubble

2:35

surrounding the Standard and Poor's

2:37

500 and the handful of

2:39

stocks that have been leading

2:41

it. The seven top stocks

2:43

in the S&P 500, the

2:45

so-called Magnificence 7, are Apple,

2:47

Microsoft, Alphabet, Google's parent, Amazon.com,

2:49

Envideo, Meta, Meta, Onra, Facebook,

2:52

WhatsApp, WhatsApp, WhatsApp, WhatsApp, Meta,

2:54

Onra, Facebook, WhatsApp, Whatzapp, Whatzapp,

2:56

Whatzapp, Whatzapp, and Tesla. I'm

2:58

sure I don't have to

3:00

go into detail regarding the

3:02

performance of these stocks. Everyone's

3:04

aware of the phenomenon. Suffice

3:06

it to say that a

3:08

small number of stocks have

3:10

dominated the S&P 500 in

3:13

recent years and have been

3:15

responsible for a highly disproportionate

3:17

share of its gains. A

3:19

chart from Michael Semblist, chief

3:21

strategist at JP Morgan Asset

3:23

Management, shows that the market

3:25

capitalization. of the seven largest

3:27

components of the S&P 500

3:29

represented 32 to 33% of

3:31

the index's total capitalization at

3:34

the end of October. That

3:36

percentage is roughly double the

3:38

leader's share five years ago,

3:40

and prior to the emergence

3:42

of the Magnificence 7, the

3:44

highest share for the top

3:46

seven stocks in the last

3:48

28 years was roughly 22%

3:50

in 2000. At the height

3:52

of the TMT bubble. It's

3:55

also important to note that

3:57

at the end of November

4:00

US stocks rep presented over

4:02

70% of the MSCI World

4:04

Index, the highest percentage since

4:06

1970, according to another assemblist

4:08

chart. Thus, it's clear that

4:10

A, U.S. companies are worth

4:12

a lot compared to the

4:15

companies in other regions, and

4:17

B, the top seven U.S.

4:19

stocks are worth a heightened

4:21

amount relative to the rest

4:23

of U.S. stocks. But is

4:25

it a bubble? What is

4:28

a bubble? Investment

4:31

lingo comes and goes. My young

4:34

oak tree colleagues use a lot

4:36

of terms these days for which

4:38

I have to request translation. But

4:41

bubble and crash have been in

4:43

the financial lexicon for as long

4:46

as I've been in the investment

4:48

business and I imagine they'll remain

4:50

there for generations to come. Today

4:53

the mainstream media uses them broadly

4:55

and people seem to consider them

4:57

to be subject to objective definition.

5:00

But for me, a bubble or

5:02

crash... is more a state of

5:04

mind than a quantitative calculation. In

5:07

my view, a bubble not only

5:09

reflects a rapid rise in stock

5:12

prices, but it is a temporary

5:14

mania characterized by, or perhaps better

5:16

resulting from, the following. Highly irrational

5:19

exuberance to borrow a term from

5:21

former Federal Reserve Chair Alan Greenspan.

5:23

Outright adoration of the subject companies

5:26

or assets and a belief that

5:28

they can't miss. Massive fear of

5:30

being left behind if one fails

5:33

to participate, FOMO, and resulting conviction

5:35

that for these stocks, there's no

5:38

price too high. No price too

5:40

high stands out to me in

5:42

particular. When you can't imagine any

5:45

flaws in the argument and are

5:47

terrified that your office mate, golf

5:49

partner, brother-in-law, competitor, will own the

5:52

asset in question and you won't,

5:54

it's hard to conclude there's a

5:57

price at which you shouldn't buy.

6:00

as Charles Kindleberger and Robert

6:02

Alber observed in the fifth

6:04

edition of manias, panics, and

6:06

crashes, a history of financial

6:08

crises, there is nothing so

6:10

disturbing to one's well-being and

6:13

judgment as to see a friend get rich.

6:15

So to discern a bubble, you

6:17

can look at valuation parameters, but

6:19

I've long believed a psychological

6:22

diagnosis is more effective. Whenever

6:24

I hear, there's no price too high,

6:26

or one of its variance. A more

6:28

disciplined investor might say, of course

6:31

there's a price that's too high,

6:33

but we're not there yet. I consider

6:35

it a sure sign that a bubble is

6:37

brewing. Roughly 50 years ago, an

6:40

elder gave me the gift of one

6:42

of my favorite maxims. I've written

6:44

about it several times in my

6:46

memos, but in my opinion, I

6:48

can't do so often enough. It's

6:50

the three stages of the bull

6:52

market. The first stage usually

6:54

comes on the heels of a

6:57

market decline or crash that has

6:59

left most investors licking their wounds

7:02

and highly dispirited. At this point,

7:04

only a few unusually insightful

7:06

people are capable of imagining

7:08

that there could be improvement

7:10

ahead. In the second stage, the

7:12

economy, companies and markets are

7:15

doing well, and most people

7:17

accept that improvement is actually

7:19

taking place. In the third

7:21

stage, After a period in which

7:24

the economic news has been great,

7:26

companies have reported soaring earnings, and

7:28

stocks have appreciated wildly, everyone

7:31

concludes that things can only

7:33

get better forever. The important

7:35

inferences aren't with regard to

7:37

economic or corporate events.

7:40

They involve investor psychology.

7:42

It's not a matter of what's happening

7:44

in the macro world. It's how

7:46

people view the developments. When

7:48

few people think there can

7:50

be improvement, Security prices

7:52

by definition don't incorporate

7:54

much optimism. But when everyone believes

7:57

things can only get better forever,

7:59

it can... be hard to find

8:01

anything that's reasonably priced. Bubbles

8:03

are marked by bubble thinking.

8:05

Perhaps for working purposes we

8:07

should say that bubbles and

8:10

crashes are times when extreme

8:12

events cause people to lose

8:14

their objectivity and view the

8:16

world through highly skewed psychology.

8:18

Either too positive or too

8:20

negative. Here's how Kindleberger put

8:23

it in the first edition

8:25

of Manias, Panics, and Crashes.

8:27

As firms or households see

8:29

others making profits from speculative

8:31

purchases and resales, they tend

8:33

to follow. When the number

8:36

of firms and households indulging

8:38

in these practices grows larger,

8:40

bringing in segments of the

8:42

population that are normally aloof

8:44

from such ventures, speculation for

8:46

profit leads away from normal

8:49

rational behavior to what have

8:51

been described as manias or

8:53

bubbles. The word mania emphasizes

8:55

emphasizes the irrationality. Bubble foreshadows

8:57

the bursting. For me, it's

8:59

psychological extremeness that marks a

9:02

bubble. Often, as Kindleberger indicates,

9:04

it can be inferred from

9:06

widespread participation in the investment

9:08

fad of the moment, especially

9:10

among non-financial types. Legend has

9:12

it that J.P. Morgan knew

9:15

there was a problem when

9:17

the person shining his shoes

9:19

started giving him stock tips.

9:21

My partner John Frank says

9:23

he saw it in 2000,

9:25

when he heard the dads

9:27

at his son's soccer game

9:30

bragging about the tech stocks

9:32

they owned, and again in

9:34

2006, when a Las Vegas

9:36

cab driver told him about

9:38

the three condos he'd purchased.

9:40

When Mark Twain purportedly said,

9:43

history doesn't repeat itself, but

9:45

it often rhymes, it's this

9:47

kind of thing he was

9:49

talking about. The new, new

9:51

thing. If

9:54

bubble thinking is irrational, what

9:56

is it that permits investors

9:58

to get away from rational

10:00

thinking? Like the thrust of

10:02

a rocket ship that breaks

10:04

free of the limits imposed

10:06

by gravity and attains escape

10:08

velocity. There's a simple answer.

10:10

Newness. This phenomenon relies on

10:13

another time-honored investment phrase. This

10:15

time is different. Bubbles are

10:17

invariably associated with new developments.

10:19

There were bubbles in the

10:21

Nifty-50 stocks in the 1960s

10:23

in the 1960s. More on

10:25

them later. Disc drive companies

10:27

in the 1980s. TMT slash

10:29

internet stocks in the late

10:32

1990s, and subprime mortgage-backed securities

10:34

in 2004-06. These relatively recent

10:36

manias followed in the tradition

10:38

of ones like A, 1630s

10:40

craze in Holland, over recently

10:42

introduced tulips, and B. the

10:44

South Sea bubble in 1720

10:46

England concerning the riches that

10:48

were sure to ensue from

10:51

a trading monopoly that the

10:53

crown had awarded to the

10:55

South Sea Company. In normal

10:57

circumstances if an industry's or

10:59

a country's securities are attracting

11:01

unusually high valuations. Investment historians

11:03

are able to point out

11:05

that in the past those

11:07

stocks had never sold at

11:10

more than an X percent

11:12

premium over the average or

11:14

some similar metric. In this

11:16

way, attention to history can

11:18

serve as a tether, keeping

11:20

a favored group grounded on

11:22

terra firma. But if something's

11:24

new, meaning there is no

11:27

history, then there's nothing to

11:29

temper enthusiasm. After all, it's

11:31

owned by the brightest people,

11:33

the ones who are showing

11:35

up in the headlines, and

11:37

on TV, and they've made

11:39

a fortune. Who's willing to

11:41

throw a wet blanket over

11:43

that party or sit out

11:46

that dance? The explanation often

11:48

lies in Hans Christian Anderson's

11:50

story, The Emperor's New Clothes.

11:52

Khan men sell the Emperor,

11:54

an allegedly gorgeous suit of

11:56

clothes, that only intelligent people

11:58

can see. But in actuality,

12:00

there is no suit. When the

12:03

Emperor parades around town naked, the

12:05

citizens are afraid to say they

12:07

don't see a suit, since that would

12:09

mark them as unintelligent. This

12:11

goes on unchecked until a young boy

12:14

steps out of the crowd and, in

12:16

his naive tay, points out that the

12:18

Emperor has no clothes. Most people would

12:20

rather go along with a shared

12:23

delusion that's making investors buckets of

12:25

money than, say something to the

12:27

contrary and appear to be dummies.

12:30

When a whole market or a

12:32

group of securities is blasting

12:34

off and a specious idea

12:36

is making its adherence rich,

12:39

few people will risk calling

12:41

it out. My baptism under fire.

12:43

They say experience is what

12:45

you got when you didn't get

12:47

what you wanted, and I got

12:49

my most formative experience at

12:52

the very beginning of

12:54

my career. As many of my

12:56

memo readers know, I joined

12:58

the Equity Research Department at

13:00

First National Citibank, now Citi,

13:03

in September 1969. As was

13:05

the case with most of the

13:07

so-called Money Center banks, Citi

13:09

invested mainly in the

13:11

Nifty-50, stocks of the best and

13:13

fastest growing companies in

13:16

America. These companies were considered to

13:18

be so good that, A, nothing

13:20

bad could ever happen, and B,

13:22

there was no price too high for

13:24

their stocks. Literally. Literally.

13:27

Three factors contributed to

13:29

investors' fascination with these

13:31

stocks. First, the US economy grew

13:34

strongly in the post-World War II

13:36

period. Second, these companies

13:38

benefited from their involvement

13:40

with areas of innovation,

13:42

such as computers, drugs,

13:44

and consumer products. And

13:46

third, they represented the first

13:48

wave of growth stocks. A

13:51

new investment style that separately

13:53

became a fad in itself.

13:55

The nifty 50 were the object of

13:57

the first big bubble in roughly 40

13:59

years. And since there hadn't been

14:01

one for so long, investors

14:03

had forgotten what a bubble

14:06

looks like. As a result

14:08

of the popularity that was

14:10

conferred on them, if you

14:12

bought these stocks on the

14:14

day I started work and

14:16

held them tenaciously for five

14:18

years, you lost well over

14:20

90% of your money in

14:22

the best companies in America.

14:24

What happened? The Nifty-50 had

14:26

been put on a pedestal.

14:28

and investors get hurt when

14:30

something falls from it. The

14:32

stock market as a whole

14:34

declined by about half in

14:36

1973 to 74, and it

14:38

turned out these stocks had

14:40

been selling at prices that

14:42

actually were too high. In

14:44

many cases, their price to

14:46

earnings ratios fell from the

14:48

range of 60 to 90

14:50

to the range of 6

14:52

to 9. That's the easy

14:54

way to lose 90 percent.

14:56

Further, the bad things actually

14:58

did happen to several of

15:00

the companies in fundamental terms.

15:02

My early brush with a

15:04

genuine bubble caused me to

15:06

formulate some guiding principles that

15:08

carried me through the next

15:10

50-odd years. It's not what

15:12

you buy, it's what you

15:14

pay that counts. Good investing

15:17

doesn't come from buying good

15:19

things, but from buying things

15:21

well. There's no asset so

15:23

good that it can't become

15:25

overpriced and thus dangerous, and

15:27

there are few assets so

15:29

bad that they can't get

15:31

cheap enough to be a

15:33

bargain. Things can only get

15:35

better. The bubbles I've lived

15:37

through have all involved innovations,

15:39

as I noted previously, and

15:41

many of those were either

15:43

overestimated or not fully understood.

15:45

The attractions of a new

15:47

product or way of doing

15:49

business are usually obvious, but

15:51

the potholes and pitfalls are

15:53

often hidden and only discovered

15:55

in trying times. A new

15:57

company may completely outclass its

15:59

predecessors, but investors who by

16:01

definition lack experience. in this

16:03

new field often fail to

16:05

grasp that even a bright

16:07

newcomer can be supplanted. The

16:09

disruptors can be disrupted, whether

16:11

by skillful competitors or even

16:13

newer technologies. In my early

16:15

decades in business, technology seemed

16:17

to evolve gradually. Computers, drugs

16:19

and other innovative products improved

16:21

a little at a time,

16:23

but in the 1990s innovation

16:26

came in a big rush.

16:28

When Oak Tree was founded,

16:30

In 1995, I insisted that

16:32

I could get by with

16:34

just Word Perfect for Word

16:36

Processing and Lotus 123 for

16:38

spreadsheets. But when we moved

16:40

to our current office in

16:42

1998, I threw in the

16:44

towel and let our IT

16:46

team install email and the

16:48

internet. And of course Word

16:50

Perfect gave way to Word

16:52

and Lotus 123 to Excel.

16:54

At the time, investors were

16:56

sure the internet will change

16:58

the world. It certainly looked

17:00

that way, and that assumption

17:02

prompted tremendous demand for everything

17:04

internet related. E-commerce stocks went

17:06

public at seemingly high prices,

17:08

and then tripled the first

17:10

day. There was a real

17:12

gold rush. There's usually a

17:14

grain of truth that underlies

17:16

every mania and bubble. It

17:18

just gets taken too far.

17:20

It's clear that the internet

17:22

absolutely did change the world.

17:24

In fact, we can't imagine

17:26

a world without it. But

17:28

the vast majority of internet

17:30

and e-commerce companies that soared

17:32

in the late 90s bubble

17:34

ended up worthless. When a

17:37

bubble burst in my early

17:39

investing days, the Wall Street

17:41

Journal would run a box

17:43

on the front page listing

17:45

stocks that were down by

17:47

90%. In the aftermath of

17:49

the TMT bubble, they'd lost

17:51

99%. When something is on

17:53

the pedestal of popularity, the

17:55

risk of a decline is

17:57

high. When people assume and

17:59

price in and expectation that

18:01

things can only get better, the

18:03

damage done by negative surprises

18:06

is profound. When something

18:08

is new, the competitors

18:10

and disruptive technologies have yet

18:12

to arrive. The merits may be

18:14

there, but if it's overestimated, it

18:16

can be overpriced, only to

18:19

evaporate when reality sets in.

18:21

In the real world, trees don't grow

18:23

to the sky. The

18:25

foregoing discussion centered on

18:27

the risk of overestimating

18:29

fundamental strength, but optimism surrounding

18:32

the power and potential of the

18:34

new thing often causes the error to

18:36

be compounded through the assignment of too

18:38

high a stock price. As mentioned

18:41

previously, for something new

18:43

thereby definition is no

18:45

historical indicator of what

18:47

an appropriate valuation might be.

18:49

Further, the company's potential hasn't yet

18:51

been turned into steady state

18:53

profits. Meaning the thing that's

18:56

being valued is conjectural. In

18:58

the TMT bubble, the companies didn't

19:00

have earnings, so PE ratios were out.

19:02

And as startups, they often

19:04

didn't have revenues to value. As

19:07

a result, new metrics were

19:09

invented, and trusting investors ended

19:11

up paying a multiple of

19:13

clicks or eyeballs, regardless of

19:16

whether these measurables could be

19:18

turned into revenues and profits.

19:20

Since bubble participants can't

19:23

imagine there being any

19:25

downside, they tend to

19:27

award valuations that assume success.

19:29

In fact, it's not infrequent

19:32

for investors to treat all

19:34

contenders in a new field as likely

19:36

to succeed, whereas in reality,

19:39

only a few may thrive, or perhaps

19:41

even survive. Ultimately, with

19:43

a really hot new thing, investors

19:45

can adopt what I call

19:48

a lottery ticket mentality. If

19:50

a successful startup in a

19:52

hot field can return 200x,

19:54

it's mathematically worth investing in,

19:57

even if it's only 1% likely to

19:59

succeed. And what doesn't have a

20:01

1% likelihood of success? When investors

20:04

think this way, there are few

20:06

limits on what they'll support or

20:09

the prices they'll pay. Obviously investors

20:11

can get caught up in the

20:13

race to buy the new new

20:16

thing. That's where the bubble comes

20:18

in. What's the appropriate price to

20:21

pay for a bright future? If

20:23

there's a company for sale that

20:25

will make $1 million next year

20:28

and then shut down... How much

20:30

would you pay for it? The

20:32

right answer is a little less

20:35

than $1 million, so that you'll

20:37

have a positive return on your

20:40

money. But stocks are priced at

20:42

PE multiples, that is multiples of

20:44

next year's earnings. Why? Because presumably

20:47

they won't earn profits for just

20:49

one year, they'll go on making

20:52

money from any more. When you

20:54

buy a stock, you buy a

20:56

share of the company's earnings every

20:59

year into the future. The price

21:01

of the S&P 500 has averaged

21:04

roughly 16 times earnings in the

21:06

post-World War II period. This is

21:08

typically described as meaning you're paying

21:11

for 16 years of earnings. It's

21:13

actually more than that though because

21:16

the process of discounting makes $1

21:18

of profit in the future worth

21:20

less than $1 today. The current

21:23

value of a company is the

21:25

discounted present value of its future

21:27

earnings. A PE ratio of 16

21:30

means you're paying for more than

21:32

20 years of earnings, depending on

21:35

the interest rate at which future

21:37

earnings are discounted. In Bubbles, hot

21:39

stocks sell for considerably more than

21:42

16 times earnings. Remember the 60

21:44

to 90 times for the Nifty-50?

21:47

Investors in 1969 were paying for

21:49

companies earnings, even after giving them

21:51

credit for significant earnings, many decades

21:54

into the future. Did

21:56

they do so consciously and

21:58

analytically? Not that I... recall,

22:00

investors thought of a PE

22:03

ratio as just a number,

22:05

if they thought about it

22:07

at all. Today's S&P leading

22:09

companies are in many ways

22:12

much better than the best

22:14

companies of the past. They

22:16

enjoy massive technological advantages. They

22:18

have vast scale, dominant market

22:21

shares and thus above average

22:23

profit margins. And since their

22:25

products are based on ideas,

22:27

more than metal, the marginal

22:30

cost of producing an additional

22:32

unit is low, meaning their

22:34

marginal profitability is unusually high.

22:36

The further good news is

22:39

that today's leaders don't trade

22:41

at the PE ratio's investors

22:43

applied to the Nifty-50. Perhaps

22:45

the sexiest of the seven

22:48

is invidia, the leading designer

22:50

of chips for artificial intelligence.

22:52

Its current multiple of future

22:54

earnings is in the low

22:57

30s. depending on which earnings

22:59

estimate you believe, while double

23:01

the average post-war PE on

23:03

the S&P 500, that's cheap

23:06

compared to the nifty 50.

23:08

But what does a multiple

23:10

in the 30s imply? First,

23:12

that investors think invidia will

23:15

be in business for decades

23:17

to come. Second, that its

23:19

profits will grow throughout those

23:21

decades. And third, that it

23:24

won't be supplanted by competitors.

23:26

In other words, Investors are

23:28

assuming invidia will demonstrate persistence.

23:30

But, persistence isn't easily achieved,

23:32

especially in high-tech fields where

23:35

new technologies can arise and

23:37

new competitors can leapfrog incumbents.

23:39

It's worth noting, for example,

23:41

that only about half the

23:44

nifty-50, as enumerated by a

23:46

Wikipedia, there is no agreed-on

23:48

list, are in the S&P

23:50

500 today. That figure undoubtedly

23:53

looks worse than the reality,

23:55

since mergers and acquisitions caused

23:57

some of the old names

23:59

to... disappear, not failures. Leading

24:02

lights of 1969 that are

24:04

missing from the S&P 500

24:06

today include Xerox, Kodak,

24:09

Polaroid, Avon, Burrows,

24:11

digital equipment, and my

24:13

favorite, simplicity pattern. How

24:15

many people make their

24:17

own clothing these days? Another

24:19

indication of how hard

24:21

it is to persist can be

24:24

seen in the names of the

24:26

top 20 S&P 500 companies. At

24:28

the beginning of 2000, according to Finn Hacker.cZ, these

24:30

20 companies were the most heavily represented in the

24:32

index. Microsoft, General Electric, Cisco Systems,

24:34

Walmart, Exxon Mobil, Intel, Citigroup, Citigroup,

24:37

IBM, Oracle, Home Depot, Merck, Coca-Cola, Proctor and

24:39

Gamble, AIG, Johnson and Johnson, Qualcomm, Qualcomm,

24:41

Qualcomm, Johnson and Johnson and Qualcomm, Qualcomm,

24:43

Qualcomm, Qualcomm, Qualcomm and Qualcomm, Qualcomm,

24:45

Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm and

24:47

Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm,

24:50

Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm,

24:52

Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm,

24:54

Qualcomm, Qualcomm, Qualcomm, Qualcomm, Qualcomm,

24:57

Qualcomm, Qualcomm, Pfizer, AT&T,

24:59

Verizon. At the beginning

25:01

of 2024, however, only six of

25:03

them were still in the

25:05

top 20. Microsoft, Walmart,

25:08

Exxon Mobil, Johnson, Proctor

25:10

and Gamble, Home Depot.

25:13

Importantly, of today's

25:15

magnificent seven, only Microsoft

25:17

was in the top 20,

25:19

24 years ago. In Bubbles,

25:21

investors treat the leading

25:24

companies for their stocks.

25:26

as though the firms are sure

25:28

to remain leaders for decades. Some

25:30

do and some don't. A change seems

25:32

to be more the rule than

25:35

persistence. Whole Markets The greatest

25:37

bubbles usually originate

25:39

in connection with innovations,

25:42

mostly technological or financial,

25:44

and they initially affect

25:47

a small group of stocks.

25:49

But sometimes they extend to whole

25:51

markets as the fervor for

25:53

a bubble group spreads to

25:55

everything. In the 1990s, the S&P

25:58

500 was born. off by

26:00

A, the continuing decline of

26:02

interest rates from their inflation

26:04

fighting peak in the early

26:06

1980s, and B, the return

26:08

of investor enthusiasm for stocks

26:10

that had been lost in

26:12

the traumatic 70s. Technological innovation

26:14

and the rapid earnings growth

26:16

of the high-tech companies added

26:18

to the excitement. And an

26:20

upswing in the popularity of

26:22

stocks was reinforced by new

26:24

academic research. showing there had

26:27

never been a long period

26:29

in which the S&P 500

26:31

failed to outperform bonds, cash,

26:33

and inflation. The combination of

26:35

these positive factors caused the

26:37

annual return on the index

26:39

to average more than 20%

26:41

for the decade. I've never

26:43

seen another period like it.

26:45

I always say the riskiest

26:47

thing in the world is

26:49

the belief that there's no

26:51

risk. In a similar vein,

26:53

heated buying spurred by the

26:55

observation that stocks had never

26:57

performed poorly for a long

26:59

period caused stock prices to

27:01

rise to a point from

27:03

which they were destined to

27:05

do just that. In my

27:07

view, that's George Soros' investment

27:09

reflexivity at work. Stocks were

27:11

tarred in the bursting of

27:13

the TMT bubble. and the

27:15

S&P 500 declined in 2000,

27:17

2001, and 2002 for the

27:19

first three-year decline since 1939

27:21

during the Great Depression. As

27:23

a consequence of this poor

27:25

performance, investors deserted stocks en

27:27

masse, causing the S&P 500

27:29

to have a cumulative return

27:31

of zero for the more

27:33

than 11 years from the

27:35

bubble peak in mid-2000 until

27:37

December 2011. Lately, I've been

27:39

repeating a quote I attribute

27:41

to Warren Buffett. When investors

27:43

forget that corporate profits grow

27:45

about 7% per year, they

27:47

tend to get into trouble.

27:49

What this means is that

27:51

if corporate profits grow at

27:53

7% a year and stocks,

27:55

which represent a share, and

27:57

corporate profits appreciate at 20%

27:59

a year for a while,

28:01

eventually stocks will be so

28:03

highly priced relative to their

28:05

earnings that they'll be risky.

28:07

I recently asked Warren for

28:09

a source on the quote

28:11

and he told me he

28:13

never said it. But I

28:15

think it's great, so I

28:17

keep using it. The point

28:19

is that when stocks rise

28:21

too fast, out of proportion

28:23

to the growth in the

28:25

underlying company's earnings, they're unlikely

28:27

to keep on appreciating. Michael

28:29

Semblist has another chart that

28:31

makes this point. It shows

28:33

that prior to two years

28:35

ago, there were only four

28:37

times in the history of

28:40

the S&P 500 when it

28:42

returned 20% or more for

28:44

two years in a row.

28:46

In three of those four

28:48

instances, a small sample, mind

28:50

you, the index declined in

28:52

the subsequent two-year period. The

28:54

exception was 1995 to 98.

28:56

when the powerful TMT bubble

28:58

caused the decline to be

29:00

delayed until 2000. But then

29:02

the index lost almost 40%

29:04

in three years. In the

29:06

last two years it's happened

29:08

for the fifth time. The

29:10

S&P 500 was up 26%

29:12

in 2023 and 25% in

29:14

2024 for the best two-year

29:16

stretch since 1997 to 1998.

29:18

That brings us to 2025.

29:20

What lies ahead? The cautionary

29:22

signs today include these, the

29:24

optimism that has prevailed in

29:26

the markets since late 2022,

29:28

the above average valuation on

29:30

the S&P 500, and the

29:32

fact that its stocks in

29:34

most industrial groups sell at

29:36

higher multiples than stocks in

29:38

those industries in the rest

29:40

of the world. The enthusiasm

29:42

that is being applied to

29:44

the new thing of AI,

29:46

and perhaps the extension of

29:48

that positive psychology to other

29:50

high-tech areas. the implicit presumption

29:52

that the top seven companies

29:54

will continue to be successful

29:56

and the possibility that some

29:58

of the appreciation of the

30:00

S&P has stemmed from automated

30:02

buying of these stocks by

30:04

index investors without regard for

30:06

their intrinsic value. Finally,

30:08

while I'm at it, although it's

30:11

not directly related to stocks,

30:13

I have to mention Bitcoin.

30:15

Regardless of its merit, the

30:17

fact that its price rose 465%

30:19

in the last two years doesn't

30:21

suggest an overabundance of

30:24

caution. I often find that just

30:26

as I'm about to release a

30:28

memo for publication, Something

30:30

comes along that demands

30:32

inclusion, and it has happened

30:35

again. On the last day

30:37

of 2024, I received something

30:39

from two sources that fits

30:41

that description. The graph

30:43

from JP Morgan Asset

30:46

Management has a square for

30:48

each month from 1988 through

30:50

late 2024, meaning there are

30:52

just short of 324 monthly

30:55

observations, 27 years

30:57

times 12. Each square shows

30:59

the forward PE ratio on the

31:01

S&P 500 at the time and

31:03

the annualized return over the

31:05

subsequent 10 years. The graph

31:08

gives rise to some

31:10

important observations. There's a strong

31:12

relationship between starting

31:14

valuations and subsequent

31:17

annualized tenure returns.

31:19

Higher starting valuations consistently

31:21

lead to lower returns

31:24

and vice versa. There are

31:26

minor variations in the

31:28

observations, but no serious

31:31

exceptions. Today's PE ratio

31:33

is clearly well into the

31:35

top decile of observations. In

31:38

that 27-year period, when

31:40

people bought the S&P

31:42

at price-to-earnings ratios in

31:44

line with today's multiple

31:47

of 22, they always earned

31:49

10-year returns between plus 2%

31:52

and minus 2%. In November a

31:54

couple of leading banks came out with

31:56

projected 10-year returns for the S&P 500

31:58

in the low to mid-single digits.

32:00

The just-mentioned relationship is the

32:03

reason. It shouldn't come as

32:05

a surprise that the return

32:07

on an investment is significantly

32:09

a function of the price

32:11

paid for it. For that

32:13

reason, investors clearly shouldn't be

32:15

indifferent to today's market valuation.

32:17

You might say making plus

32:19

or minus 2% wouldn't be

32:21

the worst thing in the

32:23

world, and that's certainly true

32:25

if stocks were to sit

32:27

still for the next 10

32:29

years as the company's earnings

32:31

rose. bringing the multiples back

32:33

to earth. But another possibility

32:35

is that the multiple correction

32:37

is compressed into a year

32:39

or two, implying a big

32:41

decline in stock prices such

32:43

as we saw in 1973

32:45

to 74 and 2002. The

32:47

result in that case wouldn't

32:49

be benign. These are the

32:51

things to worry about. Here

32:53

are the counter arguments. A

32:56

PE ratio on the S&P

32:58

500 is high, but not

33:00

insane. The magnificent seven are

33:02

incredible companies, so their high

33:04

PE ratios could be warranted.

33:07

I don't hear people saying

33:09

there's no price too high,

33:11

and the markets, while high

33:13

priced and perhaps frothy, don't

33:16

seem nutty to me. As

33:18

I said at the start

33:20

of this memo, I'm not

33:22

an equity investor, and I'm

33:24

certainly no expert on technology.

33:27

Thus, I can't speak authoritatively

33:29

about whether we're in a

33:31

bubble. I just want to

33:33

lay out the facts as

33:35

I see them and suggest

33:38

how you might think about

33:40

them. Just as I did

33:42

25 years ago. I hope

33:44

you'll keep listening for the

33:47

next 25. January 7th 2025.

33:49

Thank you for listening to

33:51

the memo by Howard Marks.

33:53

To hear more episodes be

33:55

sure to subscribe wherever you

33:58

listen to podcasts. This

34:04

podcast expresses the views of the author

34:06

as of the date indicated and such

34:08

views are subject to change without notice.

34:11

Oak Tree has no duty or obligation

34:13

to update the information contained herein. Further,

34:15

Oak Tree makes no representation and

34:17

it should not be assumed that

34:19

past investment performance is an indication

34:21

of future results. Moreover, wherever there

34:23

is a potential for profit, there is

34:25

also the possibility of loss. This podcast

34:27

is being made available for educational purposes

34:30

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34:32

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34:34

here in does not constitute and should

34:36

not be construed as an offering of

34:39

advisory services, or an offer to sell

34:41

or solicitation to buy any securities or

34:43

related financial instruments in any jurisdiction. Certain

34:46

information contained herein concerning economic

34:48

trends and performances based on

34:50

or derived from information provided

34:53

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34:55

Tree Capital Management LP, Oak Tree, believes

34:57

that the sources from which such information

34:59

has been obtained are reliable. However,

35:01

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35:04

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35:06

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35:08

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35:10

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