The transcript from this week’s MIB: Howard Marks, Oaktree Capital is below.
You can stream/download the full conversation, including the podcast extras on iTunes, Bloomberg, Overcast, and Stitcher. Our earlier podcasts can all be found at iTunes, Stitcher, Overcast, and Bloomberg.
This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast I have an extra special guest. What can I say? Howard Marks is the cofounder and cochairman of Oaktree Capital Management.
If you are at all interested in everything from bond investing to market cycles to what matters most and that includes the most important thing, to the importance of human psychology and emotions, to mastering the market cycle, you will find this to be an absolutely fascinating conversation rather than have me go on at length, instead, I’m just going to step away and say with no further ado, my conversation with Howard Marks.
I have an extra special guest, his name is Howard Marks and he is cochairman and cofounder of Oaktree Capital which manages over $122 billion. Howard comes to us by way of the Wharton school at Pennsylvania where he did his undergraduate, got his MBA at the University of Chicago Booth School. He formed Oaktree in 1995 after spending about a decade at Trust Company of the West. According to the most recent Bloomberg data I looked at, Oaktree’s 17 distressed debt funds have averaged annual gains of 19% after fees since inception, about 700 basis points better than its peers according to Boston-based consulting firm Cambridge Associates.
His first book was called “The Most Important Thing” and he has authored a new book called “Mastering the Cycle, Getting the Odds on your Side.”
Returning for his third Masters in Business, Howard Marks, welcome to Bloomberg.
HOWARD MARKS, COCHAIRMAN AND COFOUNDER, OAKTREE CAPITAL MANAGEMENT: Thank you, Barry, it’s great to be here.
RITHOLTZ: So I was excited to see your new book because I figured it would be an excuse to get you back in here, let’s talk a little bit about what motivated you to write another book? Who is the intended audience, what was the thinking behind this?
MARKS: When I wrote the first book, I thought would sell about 3000, and I thought it would be diehard professional investors.
MARKS: It has sold about three quarters of a million so far.
RITHOLTZ: That’s fantastic.
MARKS: And I believe it’s the professionals of do-it-yourself investors and maybe even some people who just want to hear about a new topic.
RITHOLTZ: So the first book came about because some guy named Warren Buffett said “Hey Howard, why don’t you write a book? Why don’t you take all these chairman memos and turn them into a book if you write it I’ll give you a blurb for the front cover.” that’s pretty good motivation. What was the motivation in this book?
MARKS: Well as you know, the first book was called the of “The Most Important Thing” and talked about 20 different things each of which was labeled The Most Important Thing because in investing there really are many, many things that are essential and all of which have to be dealt with simultaneously.
But I do believe, Barry, that recognizing and dealing with risk and understanding where we stand in the cycle are really the two keys to success and if you’re going to be an active investor, an active manager, I think those are the two areas in which you can best make a contribution.
RITHOLTZ: So let’s talk a little about cycles, there is a quote of yours that I really like. “Rule number one is most things will prove to be cyclical and rule number two, some of the greatest opportunities for gains and losses come when other people forget rule number one.”
Tell us about that.
MARKS: Well, you know back in the nearly 70s, somebody gave me a great gift, they shared with me the three stages of a bull market, the first stage when only a few incredibly insightful people believe there could be improvement, the second stage when most people accept that improvement is taking place, and the third stage when everybody thinks things will get better forever.
MARKS: And you know it’s obvious that if you buy in the first stage, because so few people are optimistic, you can get a real bargain, and if you buy in the last stage when everybody and his brother is on board, you know, you’re likely overpay, it’s almost as simple as that.
So you know what I try to do in the book is go through understanding where we are in the cycle why and what we should do about it.
RITHOLTZ: So let’s talk a little bit about this cycle. Clearly ’09, very few people thought all right this is an opportunity where we’re at the bottom of the cycle and those folks have been pretty well rewarded, if we look at I don’t know, 2012, 2013, is that a fair assessment for phase 2 where people felt hey, things are getting better, are we at that final stage yet? Have we gotten there because so many people have been so negative this whole run up, it it makes a little tricky to figure out where that last stage where everybody thinks hey, this can’t ever stop, it’s going to keep going.
MARKS: Sure, well, you know, that’s the key question, it’s the hard question, my approach on these kinds of things is we never know where we’re going, we sure as hell ought to know where we are, what do we know Barry about this market? As you say, we’re not in ’08 ’09 when everybody thought we were heading for meltdown.
We’re not in ’12 or ’13 when things were beginning to lift off. By some measures, this is the longest bull market in history, the S&P has quadrupled from the lows and so I think the first thing I would say is the easy money’s been made, we’re not in that first stage anymore where most people are nonbelievers.
MARKS: That’s the easy thing to say. I think that and lately, you get more and more people, you know that the higher things go, the more people say well I guess it could keep on.
It’s usually prefaced by those four dangerous words “it’s different this time” you know the historic rules do not apply the P/E ratio history doesn’t matter and so forth but you know the –when you’re in the 10th year of her economic recovery and there’s never been one of more than 10 years, the only thing you know is that the odds are not really on your side anymore and nobody can say it’s going to end tomorrow, it’s going to end a year from now, in investing we sometimes know what’s going to happen but we never know when, but you know, if you accept that the easy money’s been made and that the P/E ratios for example are higher than the postwar norm and that interest rates are rising, et cetera, then I think you have to conclude that the odds are not strongly in your favor, you have to take some risk off.
RITHOLTZ: Makes sense. Back in 2015, you said you were thinking we were falling into an everything bond bubble, what are your thoughts about that today? Is our bond still in a bubble and how does this resolve itself?
MARKS: You know, at that time Barry, I think interest rates were the lowest that they’d ever been, period.
And you know it seemed that with the strengthening economy and with the Fed no longer wanting to be so stimulative that interest rates would be rising, rising interest rates, falling bond prices, that’s the math.
So you know, we’ve seen eight interest rate increases from the fed already, most forecasters think will see a half a dozen more over the next couple years, clearly the interest rates are no longer the lowest in history although still low, they will probably continue to rise, so, you know, a straight high-grade bond is nothing but an interest rate machine.
And as interest rates go higher, the prices of existing bonds with old-fashioned low interest rates go down. I don’t think you want to own straight long-term bonds in a period of rising interest rates and the consensus is the rates will rise.
RITHOLTZ: So if you don’t want to own straight up bonds and we’re in a rising rate environment and a lot of people have fairly substantial exposure to equities, how do you offset that risk if you want some form of a balanced portfolio?
Where is the value on the fixed-income side if anywhere?
MARKS: Well you know, that I think that across the board and what I say about rates has really affected all bonds of you know the impact of our rates on bonds is universal and you know, at the present time, there are no exceptions.
The one thing you want to think about is this, Barry, one of the main reasons that we will probably have rising interest rates is that we will probably have continued prosperity and maybe even a pickup in inflation. Those two things — prosperity and inflation add to the profitability of corporations.
MARKS: And so the strengthening corporate profits will translate into a positive influence for corporate bonds, so you have the negative influence of rising rates, but the positive influence of improving profitability and that suggest the corporate bonds are somewhat sheltered from the deleterious effects of rates alone.
But you know, I believe that most asset classes are fully to fully valued to at the beginning of rich and this is a time for caution you know, the book is about trying to figure out what time it is for what and which form of behavior is appropriate if we are low in the cycle we should be aggressive, if we are high in the cycle, we should be defensive, I think on balance through most asset classes, we are high in the cycle and I think that calls for defense.
RITHOLTZ: So if we were putting this in terms of a baseball game, what inning are we in that longer cycle?
MARKS: I get that question a lot.
They started asking it back in 08 when they said when will the — what inning are we in in the crisis, meaning when will the financial crisis end?
RITHOLTZ: Sure, I remember Eighth-Inning Fisher, the Fed governor from Texas who basically said we were in the eighth-inning of what — turned out we in the second inning but still…
MARKS: Exactly, and today when they say what inning are we in? They really mean when will the bull market end?
RITHOLTZ: How far we in the cycle?
MARKS: Exactly, now I think we’re in the eighth-inning, but about a year ago I figured out there’s a problem with saying which is this isn’t baseball…
MARKS: And we know in baseball the game is nine innings.
MARKS: Except ties. But in investing we have no idea how many innings there will be in a game. So I think we’re in the eighth-inning but this game could go nine or 11 or 13 and I think that the outlook is not so poor and the prices are not so high that this is a time for defense, our own motto at Oaktree has been move forward but with caution and we are essentially fully invested, that’s what move forward means, but I also think it’s time for caution because I do think we are elevated in the cycle.
RITHOLTZ: So how does an investor manage that risk? Is it just staying away from the most expensive most speculative paper be it fixed income or stocks on the equity side? How do you stay fully invested but cautious?
MARKS: Well, I think that’s the right idea, everything you want to do in the investment business you can do it aggressively or you can do it defensively, as you say you can be in quality stocks as opposed to speculative stocks, you can be in large companies rather than small, you can be in the lower price not the higher price.
Now usually the higher price has a prettier story, that’s why it’s higher-priced, but you pay smartly for that, the FANG, the techs, these are the ones that have been selling very high, high in price great story, but if you want to be defensive you drop down to a little less glamorous story at a lower price.
In bonds, you can go for quality, you can certainly go for a shorter duration, shorter maturities and I would not advocate getting out of the market, it’s not so egregious that cash is preferable. I do think that the things you want to do in your portfolio are better done in a cautious way than an aggressive way. So you talked about corporate, you talked about high-grade low-grade before we came into the studio, we’re discussing tips, if we see even modest inflation, is that a bad place to hide or is that a half decent place to think about?
MARKS: There are two risks in bonds, one is the risk of a negative price fluctuation, interest rates up, prices down. The other is the risk of not getting paid, what is a bond? That’s a promise of a string of payments interest and then principal at the end, so you know most people should not buy bonds where the risk of being unpaid is substantial, so let’s assume that we or our managers can exclude the ones that default.
Now, we’re down to the ones that pay but could experience a negative fluctuation. We don’t know rate what rates are going to do, we don’t know what how they will fluctuate, but if you buy bonds that are going to pay, you buy a bond today, let’s say it’s a high-yield bond and you can buy it at a 6% yield. If rates go up, there could be a negative price fluctuation, but if the company is credit worthy it’ll still pay at the end and you’ll get your 6% and I think that you know if somebody — if somebody can live with a fluctuation and if 6% is good for them, I think they should be buying 6% bonds.
The biggest mistake you can make in my opinion is the by 6% bonds in the hope of getting 9% because that’s probably not in the cards.
RITHOLTZ: To say the least. So let’s talk a little bit about mastering the market cycle, what is it that most people seem to get wrong with longer-term cycles?
MARKS: What is it that makes the market go up and down? When you see a market this rising, it’s usually the news is good, the economy is doing well, the corporations are reporting good earnings, the investors are happy, the media are putting out positive stories and prices are rising. Everybody feels good.
But if you take those things together, Barry, what they mean is that prices are probably high. The enthusiasm to buy thus is the highest when the prices are the highest, which is not when we should be buying the most.
So and the reverse is true in the opposite direction you know in the — in the very bad times, people get depressed ,the news is poor, everybody wants to get out regardless of how the low the price is. So you know what when I was a kid my mother said, buy low sell high, most people’s emotions lead them to buy high sell low, we want to counter that.
So the element that causes the problems in investing is psychology. If we knew that positive news would result in good price-performance life would be very easy, but it would be only true if we could buy in at a fair price or an attractive price, if the news will be good but we overpay for the security to get in then we may be looking at losses despite the good news, so it’s all a matter of emotion and you know the reason I wrote this book is so that people could understand what it is that contributes to market cycles, could understand perhaps the mistakes others make, perhaps the mistakes they’ve been making historically and stop it.
Get the you know — the subtitle is the key, getting the odds on your side.
RITHOLTZ: So let’s talk a little about that in terms of one of your favorite subjects which is value and one of the quotes that I really like of yours is the essential character of value is not what you buy but what you pay.
RITHOLTZ: That clearly has a cyclical element to it if we’re talking about the overall market. What motivated you to phrase that quite not — that way?
MARKS: Very easy, I started in business 50 years ago at and that you know I started at Citibank and all the New York banks adhere to what was called the nifty 50 investing, the stocks of the 50 best and fastest growing companies in America to which nothing bad could ever happen and in most cases, they were right, they were great companies, they went on to great success but they were valued so high in 1968 that if you if you bought them and held them for five years you lost almost all your money.
MARKS: Because there is no asset which is so good that it can’t be overpriced and thus dangerous.
RITHOLTZ: And the inverse?
MARKS: And the inverse, there are very few assets which are so bad that you can’t make money at them if you buy them right. So in 1978 — when I had 10 years under my belt, I was asked at Citibank to start up the fund for high-yield bonds. So in the first few years we bought the best companies in America and lost a lot of money starting in ’78 I bought the dead of some of the worst companies in America and made a lot of money steadily and safely, and that’s when I concluded it’s not what you buy, it’s what you pay.
RITHOLTZ: I’ve always hated the phrase that came out of the financial crisis toxic assets because it wasn’t the assets that were toxic, it was the prices, you could buy the worst bond portfolio if you paid a low enough price, a lot of people bought blocks of paper and doubled and triple their investment because the price they paid was so low.
MARKS: Exactly, you know, Barry, at the beginning of the hour, you quoted returns for our distressed debt funds, well in our distressed debt funds, we are buying securities of companies that are bankrupt or that everybody thinks will become bankrupt.
RITHOLTZ: But you’ve had very consistent returns over time.
MARKS: We’ve had very good returns buying stuff that was very dubious in its financial merits but so cheap that the odds were on our side.
RITHOLTZ: And that’s all about price not quality.
MARKS: Exactly, exactly.
RITHOLTZ: Let’s talk about one of your more recent chairman’s memos and we’ll get into the chairman memos in a in a bit, you said something that kind of caught my eye and was sort of fascinating, you asked about computers, we were discussing computers and you asked the following questions, can they sit down with the CEO and figure out whether he’s the next Steve Jobs or not? Can they listen to a bunch of venture capital pitches in know what’s the next Amazon?
So I thought that was really a an intriguing question but it made me stop and ask myself well, can people do that either — also? I don’t know how good humans are at that process.
MARKS: Well that’s exactly the right question, Barry.
Certainly not everybody can.
RITHOLTZ: For sure.
MARKS: Certainly the average person can’t, there’s a few percent at the top, the people with the most foresight who can figure those things out, they can be great investors, they should be paid a lot their services but the average person that can’t do those things and the computer may be able to do a better job than the average person because it can digest a lot of data, it doesn’t make mistakes you know one of the themes of the book is that emotions are the investors enemy, computers are not very emotional, so in many regards I believe computers can probably do a better job than some very large percentage of investors but just not as good as the best.
RITHOLTZ: And those folks who are the people who can hear into the future and spot the next Steve Jobs of the next Amazon, they are really outliers, we’re talking about a teeny tiny percentage of investors.
RITHOLTZ: It’s not it’s not even the best of the average investors, you are talking about two and three standard deviations away from that normal bell curve. I don’t want people listening to think, well I could be one of the better — the average person is never to be a starting player on an NBA team and most people are not going to be those outlier who can spot the future 10 years before it happens.
MARKS: So if you think about it, what your listeners should spend their time doing is in my opinion is figure out how they should position themselves in the market and that really comes back to the cycle.
You know in this business, there are only really two things we do, we want to select the better securities and avoid the worst ones.
MARKS: And we want to have more risk exposure when the time is appropriate and less when it’s not, that latter thing, that is cycle positioning and you know that’s the reason for the book, that’s my main job at Oaktree is to figure out how we should be positioned in those regards, most people can’t figure out the next Amazon, you’re right, they should they buy passive products or handoff their capital to a professional manager who can add value but I do think that that you, the listener should be figuring out where are we in the cycle, what does that imply for my behavior and how do I want to be positioned vis-à-vis risk at this time?
RITHOLTZ: So let’s talk a little about the institutional investor versus the individual, we know most mom-and-pop investors at home can’t do the things that these outliers are capable of doing, your office works with a lot of institutions, what sort of challenges do institutional investors face that perhaps mom-and-pop don’t or are they just human in and suffer the same emotional consequences as anybody?
MARKS: Institutions don’t make investments, people make investments for institutions.
MARKS: And you’re right, those people have emotions too, those people are bombarded with the same news that the mom-and-pop investor is, news is good, news is bad, taxes up taxes down, this company beat, this company fell short, end of the world, you know, trees growing to the sky, whatever it is everybody gets those same inputs, everybody has emotion.
So it’s not true, now the institutional investor may be better educated in finance, may have more experience et cetera, but it’s just not that easy in general. The professional has the advantage of doing the things full-time but guess what the mom-and-pop investor has the advantage that they can’t get fired.
MARKS: The institutional investor has to worry about getting fired and that makes it hard to do the right thing at the extremes. You know let’s go back Barry to the fourth quarter of ’08, Lehman Brothers has gone bankrupt the stock market is cascading down, bond prices are collapsing, and you had to buy, but maybe you say, you know what, if I buy today and the market goes down further, maybe I will lose my job so I can’t do it.
And the personal concerns make it very hard even for the professional.
RITHOLTZ: Career risk is certainly present all the time.
RITHOLTZ: So around that time and I’m doing this off the top of my head, somewhere in October we saw the markets that fall about 30% before they recovered in ’08, you had already raised money from clients for new distressed bond fund, tell us what you were doing during the fourth quarter of ’08 when really I was about as early in the cycle as anyone could’ve thrown a dart and got lucky with?
MARKS: Well it really goes back to what I’ve been saying which is to do the right thing vis-à-vis the cycle, you have to kind of understand what’s going on around you. In ’05 ’06, we vastly reduced our risk because we felt that that implausible undisciplined deals were getting done and that shows that the market is undisciplined, so we cut our risk.
First day of ’08, of ’07 excuse me, we thought there was something coming, we went to our investors, we said would like to raise a fund for distressed debt, we went out for the biggest amount of money we ever raised, we got much more than that because I guess we told the story well, our clients…
RITHOLTZ: You are looking for $3 billion, you raised something like 7 billion or 8 billion?
MARKS: We actually ended up at 14.
MARKS: So we took we took the first 3 1/2, we put that in a fund, we said okay that’s for active management today, we are going to start investing that, but we took the other 11 we said we got to put that on the shelf in a standby fund that we think there’ll be a big opportunity, that’s when we’ll invest that money.
So the first close was March ’07 we didn’t start investing it and then only slowly until June 2008 and we had a lot of cash — money we could call when Lehman went under and then we concluded that that was the time to spend it and from September 15 ’08 which was the Lehman bankruptcy until the end of the year, over those 15 weeks, we invested over half a billion a week.
RITHOLTZ: Wow, that’s amazing, that’s quite amazing.
So during that period are you getting any sort of pushback from clients? Howard, what are you doing? It’s crazy out there. Can’t you just sit on your hands for a few months and how do you deal with that sort of stuff?
MARKS: Well I am proud of my clients because I did not get the pushback I think they credit us with the doing the right thing and that I think they were perhaps glad to have us behaving in a countercyclical way you know so many people were afraid in that fourth quarter that — and remember, and these were people who had bought into our story that there was an opportunity coming, had given us money for that occasion, they realized that it would be a mistake to try to talk us out of spending. So the point is you know the negativity around us was so great that again it’s all about recognizing what is going on in the environment, where we are in the cycle, prices were down so much and there was no limit to people’s negativism.
RITHOLTZ: No limit, I’ve never anybody quite phrase it that way.
MARKS: Well I tell a story in the book about a pension fund I went to see and I talked to the CEO and every time I made a conservative assumption about what would happen to my bond portfolio, the CIO said well but what if it’s worse than that? I said okay well, what if this happened? No, what if it is worse than that? OK, then this could happen. No, what if it is worse than that? And there was no assumption I could make that would satisfy the CEOs fear and I ran back to my office literally ran probably and I wrote a memo called the limits to negativism.
RITHOLTZ: I recall that very specifically.
MARKS: And what I said was a good investor, be it the mom-and-pop you talked about, be it the institutional investor, a good investor has to be skeptical.
You know everybody sees the same story, the great investor has to be able to figure out the truth as opposed to the story. Skepticism is an important element that, we all know that that in times of high optimism the key is to say no that’s too good to be true.
If people had said that they wouldn’t have invested with Madoff for example, too good to be true, but what I realized when I wrote that memo in at the low point for the credit markets of mid-October ’08 was that if we are professionals and if we want to be great investors, we have to be skeptical and in times of excessive pessimism, it’s our job to say no that’s too bad to be true.
And that’s the kind of thinking this the cyclical inference that permitted us to invest aggressively when people were talking about the end of the world.
RITHOLTZ: We have been speaking with Howard Marks of Oaktree Capital.
If you enjoyed this conversation be sure and come back for the podcast extras where we continue discussing all things cyclical as well as distressed debt and other such things.
We love your comments, feedback and suggestions, write to us at MIBPodcast@Bloomberg.net, you can check my daily column on Bloomberg.com, follow me on Twitter @RITHOLTZ. I’m Barry Ritholtz, you’re listening to Masters in Business on Bloomberg Radio.
Welcome to the podcast. Howard, thank you so much for doing this. I’m not sure if this is our second or third time around but every time I sit and have a conversation with you, my email lights up and people are always so intrigued and fascinated by your philosophy.
I want to spend a little time talking about the ark of your career and some of the really interesting things that you have seen and done in written, and all that has to start with memos to clients, but I’ve been calling them chairman’s memos for a long time.
And the last time you were here, you told me something that I found absolutely fascinating when you began doing these, you were literally — this wasn’t just an email or web thing, you were literally printing them out and mailing them to various people, when did the chairman’s memos to clients begin?
MARKS: I started in 1990.
RITHOLTZ: Okay so kind of pre-email, pre website.
MARKS: We carved them in s stones in the cave right but you know I observed a couple of facts the juxtaposition of which I thought really told a great story, it talked about the importance of consistency in investing and risk control.
And so I wrote it out and I folded it up a nice put it in envelopes and put stamps on we sent it out to our clients and I did one in 1990 and I did one in 1991 and you know I don’t remember ever making a conscious decision to make this a regular thing, I never remember saying that I thought would result in a advantage businesswise, I just thought they were interesting observations that I wanted to share with my clients and they did you know they were — they went out a few hundred of them at a time.
RITHOLTZ: And what was the feedback when you sent the first one out?
MARKS: For 10 years, Barry, I never had a response.
RITHOLTZ: Crickets, just nothing?
MARKS: Not only did nobody say they thought it was good nobody said I got it.
RITHOLTZ: That’s amazing.
MARKS: And so the interesting question is what kept me going and I have no idea and the answer I think is that I was writing for myself. Number one, it’s creative, I enjoy the writing process, number two I thought that the topics were interesting and that I wanted to put them on paper, number three writing makes you tighten up your thinking.
RITHOLTZ: That’s Daniel Boorstin’s famous quote I write to figure out what I think and besides at that hour, the bars were all closed, it’s what the Librarian of Congress once said.
But, I’m you know, we live in an era where it’s immediate feedback, you posted a tweet or something to Instagram immediate likes, immediate up votes, it’s just you know that feedback loop is designed to give you that dopamine hit, it’s amazing that you spent a full decade sending these out and not a peep from anybody.
So what was the one that the changed it but you look like you’re about to say something?
MARKS: On the first day of 2000, I put out a memo that I’ve been working on called bubble.com.
RITHOLTZ: I recall that also, that was a huge (Behren) story.
MARKS: That’s right and it not — it had two advantages, number one, it was right and number two it was right fast.
MARKS: Because in our business, being too far ahead of your time is indistinguishable from being wrong, here you know, I raise some questions about the tech stocks and within.
RITHOLTZ: Two months.
MARKS: Few months.
RITHOLTZ: It was January 2000…
MARKS: That’s right, that’s right.
RITHOLTZ: By the first or second week of March, it was all over but the crime.
MARKS: They kind of turned over and collapsed and the way I put it is after 10 years, I became an overnight success and you know and there was a lot of response to that memo of course by that time we did have email and Internet, things did go viral you know that I’ve had the opposite experience of the first decade then I had the experience of you not put out a memo on a Tuesday morning and Tuesday afternoon, one of my friends would call and some guy in Russia just sent me this, it’s terrific, you know, so you know it’s been it’s been really great, there are well over 100 memos now all available by the way at www.Oaktree capital.com under the heading “Insights” and the price is right, they are free and you know I take I take great pride and have great fun with it.
RITHOLTZ: Well I know in my office whenever new memo comes out everybody starts talking about it, it becomes lunchtime conversation or people printed out read on the way home or what have you I hope you continue to do these for the long-term because I’ve personally found them to be very educational and very thought-provoking.
Let’s talk a little bit about one other thing before I get to the other questions that I missed.
You describe the importance of cycles in the new book, knowing where you are in the cycle is so crucial for your investment posture, how do you figure out where you are in that cycle?
MARKS: I describe a process that I call taking the temperature of the market and there’s the quantitative which is looking at you know for every investment there is a valuation parameter, for stocks, it’s P/E ratio, for bonds it’s the yield and the yield spread over other bonds, for real estate, it’s what we call it the capitalization rate, the income, for companies it’s the profitability, they’re all these indices. And so we can figure out quantitatively what’s going on, are things expensive or cheap relative to the past but the other thing is qualitative and that what I look at is how are people behaviorally? Are they excited or depressed? Are they greedy or fearful? Are they optimistic or pessimistic? Are they risk tolerant or risk-averse?
And you know if I look at a stock or an investment and if I could only ask one question Barry it would be how much optimism is in the price? We want to buy things where the price falls short of the real value, that’s called a bargain and we get that when people are not optimistic about that stock or company. if everybody thinks is terrific, could never stumble like the nifty 50 of 50 years ago, then the optimism is high, the chances are that the price is high relative to the value, so we want to take the temperature to understand where we are in the cycle and always say that if I go to a cocktail party and people gather around, I know the market’s too high.
RITHOLTZ: Someone else describe that is conversational alpha when people start chitchatting at barbecues and cocktail parties hey that’s the that’s a sign that we’re getting close to the to the top.
How do you identify that when you’re talking about individual stocks, are you thinking about this in terms of the whole market because there’s always stocks that seem to become unhinged and take off, look at what happened with Bitcoin from practically nothing to 19,000, what does that tell us about the sentiment that’s out there?
MARKS: Well, you know most of my references are to the market that’s why the book title “References to the Market Cycle” I imagine similar thinking can be applied to individual investments, individual stocks and as you say even individual currencies. But you know that the same thing is true when you consider making an investment whether you’re operating at the market level or the individual security level, try to figure out has this stock or bond been the beneficiary of a buying frenzy in which case you probably want to avoid or it has been disrespected and downtrodden in which case it may be worth a good look?
RITHOLTZ: And one of the things I didn’t get to before was your time at Trust company of the West, you worked with a gentleman named Jeff Gundlach who very famously left and launched Double Line with yours and Oaktree’s help.
RITHOLTZ: I believe at one point in time, Oaktree was a 20% owner, is that still the case?
MARKS: Yes, we still are.
RITHOLTZ: Still 20% owner and that was one of the fastest-growing funds from zero to 100 billion like almost like that.
MARKS: Yes I think it probably took it felt like a snap of the fingers, it might’ve taken five years but as you say probably for an investment management firm, the fastest zero to hundred in history and it you know Jeff is a contrarian, Jeff marches to his own drummer, does a very good job of managing money and it’s been a great investment for us.
RITHOLTZ: And that’s owned by Oaktree?
RITHOLTZ: So you buy Oaktree, you get to get Howard Marks, and you get a little bit of a hedge with Jeff Gundlach as a 20% slug.
RITHOLTZ: Quite interesting. What was it like when you were working with Jeff a Trust Company and of the West and how did you know he was going to end up being as successful as he turned out to be or did you?
MARKS: 1994, the my last year at TCW around February, interest rates rose the fastest they had ever arisen in history and Jeff was probably seven years of experience at that point in time his portfolios ran into some problems and that Jeff and I began to work together at that point formally, I was asked to let him report to me, together, we verified the values in the portfolios and importantly we were able to convince the client to stay with it.
You know the cardinal sin in investing is not buying something close down, the cardinal sin is selling out at the bottom and not participating in the recovery and we were able to enable Jeff’s clients to participate in a great recovery, it was obvious that he was supersmart and so when Jeff left TCW in the in ’09 you know we were very glad to join forces.
RITHOLTZ: So what I’ll see you looking at these days that has you worried? I know you said the value — that valuations are pretty stocks and bonds are both pretty fully valued on the verge of richness, what else is a potential move forward with caution type of a factor?
MARKS: Well, what is unloved today? That is a question.
RITHOLTZ: Hardly anything.
MARKS: Except maybe emerging markets?
RITHOLTZ: For sure.
MARKS: Okay maybe China you know now Turkey, Argentina, these are pretty terrifying but…
RITHOLTZ: Russia for that matter.
MARKS: But they are unloved which means you maybe you should start looking there I’m not saying buy but investigate, but you know the truth of the matter is that as you say, there is very little today on the bargain counter and if your criterion for investing is that you want bargains, for the most part, they’re not there.
RITHOLTZ: You’re a decade too late.
MARKS: Exactly. Now, now, Warren Buffett talks about one of the greatest things about investing is that you know you can stand at the plate with the bat on your shoulder.
MARKS: And in investing, you can’t get called out on strikes. So you can you can wait until you get a fat pitch and today it’s very challenging because there are few fat pitches and at the same time, those of us with money, be it my institutional clients, be it the individual investor with money, the money has to go someplace.
MARKS: You want to get a credible return, you want to control your risk, and you know in theory one could figure out when the market is at a real high and sell, you could figure out when the markets terribly depressed and buy and these things are exciting and they are extremely rewarding but much of the time, the market is somewhere in between.
MARKS: And what you do in those times?
Not so obvious bought you know figuring it out is key standing with the bat on your shoulders may be key, reducing your risk in the ways we discussed before, these are the keys but again they all start with figuring out where we stand.
RITHOLTZ: That’s behind the concept move forward but with caution.
MARKS: That’s been our mantra for a couple years now and you know when you when you apply caution you don’t get the full return of the market when it soars but you also stay in the game.
RITHOLTZ: And it makes sense. Let’s talk about another chairman’s memo, I really like the title “What does the market know?” tell us a little bit about the thinking behind that.
MARKS: In 2016, the market got off to its worst start in history and I wrote a memo called on the couch and I talked about the fact is that sometimes the market is nutty and needs a trip to the shrink, and that you know good sometimes the market obsesses about the positives and ignores the negatives and that’s dangerous, and sometimes it ignores the positive and obsesses about the negatives and that’s the time to move.
And that market was collapsing and I didn’t see any reason for it. So I talked about the non-fit between reality and market behavior. I came in to Bloomberg TV as I often do when I write the memos to talk about it and the anchors were saying to me, well doesn’t the fact that the market is going down is not a sell signal, again I ran back to the office to write a memo called what does the market know? There is no market, there’s only a bunch of people and their decisions are not better then there — the collective decision of the people in the market are not better than the decisions of the individuals and they are driven with psychology and they are everything in our bodies is directed at making us do the wrong thing and one of the — one of my major themes is how to figure that out and resisted but you know you don’t want to buy at the top when things are great, you don’t want to sell at the bottom when things are terrible and so the if the market is down you can’t take that as a sell signal, all it tells you is the people have lost faith, but it they’ve lost faith, maybe that’s a buy opportunity.
So you must not let the market give you your signals, your investing has to come from place of an analysis and not emotion.
RITHOLTZ: So in other words, the market just doesn’t go straight up or straight down, if you have a bad January so what it’s one month, is that the thinking?
MARKS: Well that’s for sure I mean that the thinking, Barry, is that the fact that things have gone down is not a cell signal I mean look at the stores, when they put stuff on sale, people buy more, in the investment business when they put stuff on sale, people sell when they should be buying and you know in order to be an effective investor, one of the themes in the book says you have to develop kind of a contrarian way of thinking, if I said to you, you know, Barry you should buy this because nobody else is willing to, well 9 people out of 10 probably would say well if everybody else is selling, then it’s probably not a good thing to buy.
RITHOLTZ: They must know something.
MARKS: But that one person out of ten says, well if nine people at it than a selling, it must be cheap, I’m going to be a buyer, that’s a contrarian, and you know that’s the opposite of letting the market tell you what to do and believe me in the long run, it pays off better.
RITHOLTZ: Even though it’s more difficult and more emotionally uncomfortable and more challenging and fill in the blank.
MARKS: All of that and you know I never in my books or anyplace else, I never want to give people the impression that this is easy.
RITHOLTZ: If it was easy ,everyone would be wealthy.
MARKS: Exactly. But it can be done, that’s the point, if you can — if you can learn the lessons you can learn to do this thinking, you can learn to assess what’s going on in the market, where is it cycle, what should I do, and you know that was my purpose in writing, that’s what I hoped to do with the book.
RITHOLTZ: So let me get to my last couple of questions before I jump to my list of favorites. We haven’t discussed very much about the Fed or the possibility of an inverted yield curve, we watch that spread narrow and tighten but hasn’t quite inverted yet, let’s talk about the cycle with the Federal Reserve which you reference also in Mastering the Market Cycle, where is the Fed relative to what’s going on? Are they behind the curve? Are they just right? Are they ahead of the curve? What do you think about the US central bank and what they’ve been doing?
MARKS: We’ve gone through a unique period the significance of which is hard to discern, in ’08 ’09, we had the worst crisis since the great crash of ’29 and the following depression. As a result, the Fed engaged in the greatest program of stimulus that it ever has. It took interest rates to the lowest level they’ve ever been.
RITHOLTZ: You mentioned that earlier and I want to tell you I had Richard Sylla in who runs the Museum of Financial History, he said literally this is the lowest interest rates since the Babylonian, since the Romans, since the Macedonians, the lowest in human history.
MARKS: I wonder if the Macedonian banks stayed in business.
RITHOLTZ: I don’t see any around.
MARKS: So anyway, the point is we had a terrible financial crisis, we had an ultra-strong period — program of stimulus and quantitative easing, we had it usually low interest rates and now we’ve had a long economic recovery, a long bull market now the Fed as we said before is raising rates, it has done it eight times already, they are up to 2 plus, and they’re probably going to go on another half a dozen times and get them into the threes, I don’t know if they’ll get the Fed funds rate up to four.
But the point is that this has never been done before on this scale and this duration and we cannot say for sure what the outcome will be, you know, if you if something is going on that has never been seen before, you certainly can’t say that you know how the movie’s going to end, and so you know, can they overshoot? Can they raise rates so high that that the — it results in a recession, what is the result of the withdrawal, so much liquidity from our economy? Nobody can say they know for sure and I think that uncertainty over what the fed will do and more importantly what the consequences will be is one of the great unknowns out there today.
RITHOLTZ: One of the great unknowns. So let’s talk a little bit about for a while, we went about the yield curve for a while, people were really obsessing about what the tightening spread meant, is the yield curve an always accurate forecaster of recession or given that this time is a case of first impression, I’m not saying this time is different but since we’ve never experienced this before, what are we to make about the fears of the inverted yield curve?
MARKS: I’m not sure that’s my profound answer.
RITHOLTZ: That is a profound…
MARKS: Well look…
RITHOLTZ: Because I can tell you how many people would give me a long-winded answer full of confidence and bravado and basically, I like your answer better.
MARKS: You know Mark Twain said “It’s not what you don’t know that gets you into trouble, it’s what you know for certain that just ain’t true.”
MARKS: The best thing you can do in investing and in many walks of life is when you don’t know, admit it, how many people are there out there who ever say you know what? I don’t know.
So everybody says that the that the yield spread between long and short interest rates has a significance, it has been observed that when the short rate is higher than the long rate, it has always been followed by a recession.
RITHOLTZ: Sometimes a few months later, sometimes a year or two later, but eventually.
MARKS: So the real question is it coincidental or is it causal and if it’s causal, what is the linkage? And does it work every time?
I don’t know, I don’t manage — I don’t care that much about rates, I don’t I’m not a so-called Fed watcher, I don’t — you know one of the of one of the six tenets of Oaktree’s investment philosophy is that our investment decisions are not governed by this kind of macro forecasting, we don’t believe in forecasting, Barry, you know, I always want to say we may not know where were going but we sure as hell ought to know where we are and that’s what I know.
RITHOLTZ: So that — that’s a pretty savvy observation, I wish more investors would recognize that, the making forecast and then sticking to them despite the evidence that they’re not coming to pass is a problem that investors have. I actually love to tell television anchors they asked where is the Dow going to be next year? Say I don’t know and just watch them try and process it. Their heads explode.
So given that we’re not paying close attention to the Fed we don’t really care a whole lot or try and predict it and when the yield curve is going to invert on the inflation side and on the yield side what’s the most important factors to look at for that longer-term cycle?
MARKS: What do we know? Rates are lower than usual, current level of rates is not consistent with economic prosperity.
RITHOLTZ: It’s not….
MARKS: It’s not.
MARKS: Usually in prosperity we have higher rates.
MARKS: The current level of inflation is unusually low, usually when we have such a low unemployment rate and such economic growth, we start to get higher inflation and we’re not getting it, so we don’t know for sure you know one of the things people have to understand is that economics is not a science, there is no schematic diagram which says how things work, there are no rules that work all the time, you know, if you have an apple in your hand as Newton said and you drop it, it’s going to fall down, it never falls up.
In the sciences, things work the same every time, but and if you come in this room and you turn on the light switch, the lights go on, every time, but in investing, that’s not true, sometimes A happens and B happen sometimes A happens and B doesn’t happen, sometimes A happens and C happens. And you know Richard Feynman, the great physicist said that physics would be much harder if electrons had feelings.
The point is that investing and the markets are dominated by humans, humans have feelings so they don’t always do what they’re supposed to do, that’s really the purpose of the book, that is one of the main themes, and you know nobody can tell you answers on these questions which are dependable enough to be investable.
RITHOLTZ: That seems pretty reasonable.
I know I only have you for a finite amount of time, let’s get to some of my favorite questions, tell us one thing that people who know you don’t know about Howard Marks?
MARKS: Well I think most people would say that I’m quantitative and financial and analytical but I really think I have a creative side.
MARKS: And I think that the memos are an expression of the creative side, and in the memos, in the book, and in my work with clients, I do a lot of graphical presentations which I draw by hand and I think that’s an expression of my creative side.
And so what investors influenced your approach to thinking about value in distressed assets and everything else that Oaktree does?
MARKS: Well at a great example is the John Kenneth Galbraith, he wrote a book called the Short History of Financial Euphoria which really was probably my first introduction to the discussion of cycles and also to an understanding of the need for contrarianism. So that was terrific.
Charlie Ellis who’s the real great investment banker…
RITHOLTZ: Greenwich Associates, used to be in Vanguard’s board as well…
MARKS: Told the story about the amateur tennis player if the game is not within your control than you win a tennis not by hitting winners but by avoiding losers and I think I’ve spent a lot of my career trying to avoid losers.
And Peter Bernstein was a great sage and you know he’s written a great deal about risk which I try to incorporate into my own thinking, so these are some examples.
RITHOLTZ: Bernstein’s book, The Story of Risk is really every page is so rich, it’s astonishing. Speaking of books, tell us about some of your favorite books, what are you reading? What do you like — what do you fiction, nonfiction, finance? What have you?
MARKS: I read more on finance and I tried to read a lot on the behavioral side, so a terrific book which I got a lot out of which has very important ideas is “Fooled by Randomness.”
RITHOLTZ: Nassim Taleb.
MARKS: Exactly and you know, people see the past and they think that the past expresses a fundamental truth, but in actuality, there were many different histories which could’ve come to pass and only one did. That’s a great way to think about the world because that’s really the right way to think about investment risk.
RITHOLTZ: So you want to avoid hindsight bias and you want to avoid thinking that each outcome is the only outcome that could have been.
MARKS: Elroy Dimson who retired from the London Business School said that risk means more things can happen than will happen.
MARKS: So you know I think we do better thinking about the future if we realize that a lot of different possibilities are out there and one of the ways to come to that conclusion is by realizing that in the past, there were a lot of possibilities, only one of which transpired.
RITHOLTZ: And one has to be careful not to draw a conclusion based on what may have turned out to be a random outcome as opposed to…
RITHOLTZ: To something…
MARKS: I always talk about this between Alexander the Great and George the Unlucky.
It was that it was the name at birth, is that what doomed the George the Unlucky?
MARKS: It could’ve been.
RITHOLTZ: So you mentioned Peter Bernstein and any other books that you want to make reference of? Pretty much everything he’s ever written is spectacular.
MARKS: Well he wrote a book called Against the Gods, which talked about the beginnings of the science of probability and if you think about it, it’s only by appreciating probabilities that we can deal rigorously with risk. The whole creation of the insurance industry for example is based on an understanding of the science of probability.
RITHOLTZ: I love that book, I thought that was just absolutely fascinating. So you mentioned Charlie Ellis and tennis, I know you’re a bit of a tennis fan, what do you do when you’re not in the office? What do you do for fun?
MARKS: Well I spend a lot of time with my kids, now my grandkids, and the you know my wife and I moved from California to New York at the beginning of 2013 because our kids came here after college and put down roots and we concluded they’re not going back to California so we have been here, we love it here, but it’s — it’s all family centric.
Great friends, you know, California and London and then again since we moved here we’ve made fabulous friends here in New York, it’s such an interesting city. And then you know to pass the time, I love to play games, I love to play jinn, I love to play backgammon, backgammon by the way it is a great exercise for anybody who wants to be an investor because it’s all about probabilities and getting the odds on your side, you know, no matter what the layout of the board is, there’s a move which will optimize your chance of having success, it may be improbable, you may be able to little pick something else which has a higher probability, but it will not be so optimal, that’s life, and that’s investing.
RITHOLTZ: Quite interesting. Tell us about a time you failed and what you learn from the experience?
MARKS: Well, good one, Barry.
I don’t think it’s necessarily failure but one of the most important things is that we each should understand ourselves and assess ourselves. And I am a conservative person, slow, plodding, the cautiously — cautious, mistake averse, so for example, you know, I was the last of my group of my peers to leave Citibank, they all left I said “what’s wrong with me? why am I hanging around” but I think I ended up with very, very sound foundation for my investing and when I left, it was for a good opportunity at TCW, worked out well.
So you know it follows through into other areas of my life, I’m a cautious investor, if in 1978 Citibank would have said to me we want you to start a venture capital fund, I think that would’ve been a disaster, I’m not a seer, I’m not a dreamer or a futurist, but instead they said we want to start a high-yield bond fund, all I had to do was figure out which ones wouldn’t be able to pay and exclude them from my portfolio and that I could do. My conservatism or caution paid off.
RITHOLTZ: So I have to push back on your claim that you are an inherently cautious person because as I’ve prepped for this and gone over your whole career, I see measured risk but I see a lot of embracing of risk-taking, a lot of people would have been presented with hey there these newfangled distressed bonds, see what we can do, set up a distressed bond funds.
When Gundlach lock left Trust Company of the West case this guy seems to be a budding superstar, there’s a lot of risk and in launching new fund but we want to get behind that and obviously the ’07 – ’08, hey let’s embrace distressed assets because the market is in freefall, I see you not as someone who’s risk-averse but rather as someone who makes intelligent risk-based decisions. So I want to push back a little bit.
MARKS: Okay, I think you got me on that, you know, I think I think the key is intelligent bearing of risk not because it’s fun not because you – not out of the spirit that a lot of people say well you know in Vegas they say the more you bet the more you win when you win, that’s not a good spirit for risk taking…
RITHOLTZ: But intelligent risk bearing makes a lot of sense and by the way, risk control, not risk avoidance, so in the early 80s when the first cable TV networks interviewed me about my work with a high-yield bonds and they said how can you invest in high-yield bonds when you know some of them are going to go bankrupt?
MARKS: And I said well how can life insurance companies ensure people when they know they’re all going to die? And the answer is it’s intelligent risk bearing so I’ll cop to that, but I do think that it is my caution that makes me insist on intelligence in risk bearing.
RITHOLTZ: And let’s talk a little about the state of the industry today, what do you think is in the midst of changing? What do you think is worth thinking about as being a person who’s been within the finance industry for 50 years?
MARKS: Rewind this podcast 30 or 45 minutes.
MARKS: And we were talking about the fact that it’s really only the exceptional few who can add value by making active decisions, and for many years, that realization did not dawn, so all money was run what we now call actively…
MARKS: There were no index funds, there were no passive products, they all had high fees, and not all of them earn those fees.
MARKS: And it was really that combination I think you’ll agree that led to the dawning of the age of passive products and now anybody wants to invest has the option of doing it passively or in an index vehicle at a very low fee that I know you’re a believer in that.
RITHOLTZ: I certainly think a chunk of people’s portfolio not necessarily all of it, but some.
And so now, we’re in a new era where you’re more likely to get what you pay for. So you know exceptional people can still make an exceptional contribution to be very well-paid but you know, this isn’t like woe be gone where everybody’s above average and nowadays not everybody gets paid as if they are above average. So I think that’s been a big change.
Now they say that something like 3/8 of all mutual fund equity capital is now run passively.
MARKS: That’s what they say.
RITHOLTZ: Okay, in the US anyway.
RITHOLTZ: Certainly not overseas.
And what that means is that there are fewer people looking for bargains every day because by definition, a passive vehicle doesn’t look for bargains they just emulate, and if they go – if that trend goes far enough maybe some inefficiencies, what we call them some bargains will come back into the marketplace, maybe active management will begin to pay off better.
RITHOLTZ: Are you suggesting it’s cyclical between passive and active?
MARKS: Well said.
RITHOLTZ: And let’s talk about other millennials and recent college grads if someone came to you and said they were debating thinking about having a career in finance, what sort of advice would you give them?
MARKS: I think the most important thing is to figure out what you’re good at and what’s good for you know my favorite quote is from Christopher Morley the English writer who said “There’s only one success and that’s to be able to live your life your own way.” figure out your way, pursue it, take it on, stick to it, keep your head down, work hard, even if it’s the right thing for you, don’t assume that every day is going to be fun, you know, the millennials are used to constant stimulus and frequent rewards, and if they don’t get them, they move on but I think that that being steadfast at something, sticking with it, getting good at it and rising to the top is a good idea.
Do what you love, don’t expect to love it every day and you know my ultimate advice is we only get one life, optimize that life, and we pride — other than sleeping, we spend, well maybe including sleeping, we spend more time on work than anything else.
If you look at it that way, isn’t it a mistake to just do what pays the most? If you have the luxury of being able to choose between careers and still support yourself and your family, don’t just take what pays the most, take the thing that is good for you, that you’ll enjoy maybe that’s good for society that will give you a quality of life but not dominate your life I think, you know, investment has done it for me but it certainly isn’t the right thing for everybody.
RITHOLTZ: And our final question, tell us something you known today that you wish you knew 50 years ago when you began.
MARKS: 50 years ago, 40 years ago, the world felt like a steady place where the environment was stable and events played out in front of that backdrop and now the world changes every day and now we can’t imagine how fast the change is.
If I had known 30, 40, 50 years ago what the world would be doing today, maybe I would’ve gravitated towards technology investing instead or maybe not because it didn’t fit with my personality. But clearly, you know the people who are — who have optimized their benefits from this change in the environment you know have been extremely well situated, you know, could’ve been me, I don’t know but clearly that’s the most profound change in my lifetime and you know, the world the changes so fast.
By the way, you know, Barry, I was thinking about this the other day. You go back long enough and the number one company was probably twice as big as the number two company and made three times as much money and now the number one company maybe 100 times as big as the number two company and make two hundred times as much money because of these technological advantages, the payoffs are enormous, and that’s a big change in my lifetime.
RITHOLTZ: Quite fascinating.
We have been speaking with Howard Marks, cochairman and cofounder of Oaktree Capital Management. If you enjoyed this conversation, well, be sure to look up an inch or down an inch on Apple iTunes, Bloomberg.com, Stitcher, or Overcast wherever finer podcasts are sold and you can see any of the other 200 plus conversations we’ve recorded over the past 4 plus years.
We love your comments, feedback, and suggestions, write to us at MIBPodcast@Bloomberg.net. I would be remiss if I did not thank our crack staff who helps put these podcast together each week. Madena Parwana is my producer, Taylor Riggs is our Booker, Atika Valbrun is our project manager, Michael Batnick is my head of research.
I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.