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VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week we have an extra special show. On Monday we did Masters in Business Live, and my guest was the incomparable Howard Marks of Oaktree Capital. They run about $120 billion and have put up numbers that have been quite astonishing for their entire 24-year history.
This is the second Masters in Business Live we’ve done. The first one was Ray Dalio. We’re going to continue doing these every few months, and we have an interesting list of guests coming up.
If you are anywhere near the New York City headquarters on the day we do one of these, I strongly advise you to get tickets. Not only is it live, so anything can happen, but it’s really a fascinating conversation and, in both cases, our guests stick around chat with the — the — the audience, take questions, sign books. It’s very informal. And how often you get to really hang around and — and have that sort of interaction with legends in finance like that.
Plus, Bloomberg is a great place to come to an event. They always serve drinks and appetizers. They really roll out the red carpet. It was — it was a lovely and delightful evening. Everybody who attended had a great time.
Rather than me continue to babble, with no further ado, my Masters in Business Live with Oaktree Capital’s Howard Marks.
And once again I — I get to start out by announcing that I am cheating by bringing someone like Howard here makes my job really easy. If you’re not familiar with his background, I’m going to give you just a really short C.V. of Howard Marks. He is the co-chairman and co-founder of Oaktree Capital, which now manages over $120 billion in assets. Howard formed Oaktree to run high-yield bonds, distressed debt and private equity and other strategies back in 1995. They run 17 separate distressed debt funds unless it’s risen to more, which have averaged annual gains of 19 percent after fees for the past 24 percent, about 700 basis points above its peers in the fixed income space and handily beating a lot of equity funds over the same time period. He is the author of “The Most Important Thing: Uncommon Sense for the Thoughtful Investor.” His new book, which everyone here will get a copy of, is “Mastering the Market Cycle: Getting the Odds on Your Side.”
Howard Marks, welcome to Bloomberg Live.
MARKS: Barry, it’s great to be here.
RITHOLTZ: So I’ll — I’ll get to the books in a few minutes, but I want to start with an interesting question that I think people may not be aware of your background. You began again as an Equity Analyst.
RITHOLTZ: How does one of the world’s most famous bond managers began his career as an Equity Analyst?
MARKS: Well, I think that — I think that certainly, at that point in time, be — starting off as an Equity Analyst was the — was the normal course. No — bonds at that time were considered a backorder that nobody was interested. And I’ve — they had two old European refugees in the Research Department of Citibank. And I remember they would publish a biweekly bond summary, and I remember, at one point, one came around with a black box in the upper right-hand corner that says “the last issue” because everybody lost interest. But stocks were doing so well. You know how it works. Stocks were doing so well, bonds were doing so poorly that people lose interest.
Now, what the contrarian says is I want to get out of the thing that’s been doing well and into the things that’s doing poorly. But contrarianism hadn’t become invented yet at that point in time.
But anyway, so I started off in — in equity research. As you say, I had a summer job in ’68, came back full-time after grad school in ’69, became a Senior Analyst, a Unite Head, Director of Research from ’75 to ’78. And then I got my lucky break in ’78 when I switched to what was called the Bond Department, but I wasn’t ever managing straight fixed income. I was sided with convertible bonds. And then in the summer of ’78, I got the phone call that changed my life. The Head of the Bond Department called me and he said, “There’s some guy in California name Milken or something, and he deals in something called high-yield bonds. Can you figure out what that means because the client had that come in and asked for a high-yield bond portfolio?” And I was smart enough to say yes.
RITHOLTZ: So that’s the transition from equities to regular bonds to high-yield bonds. How do you end up over a Trust Company of the West?
MARKS: In — in the first business trip of my life in January 1970, I went to California, and I was studying a group that doesn’t exist anymore called “The Conglomerates.” And after the — doing the — the company visits, my boss and I, his in-laws lived in Laguna Beach so we went down there and spent the week and I fell in love with California. And I spent the 70’s trying to figure out a way to get to California, which I did in 1980. Citi — I got Citibank to move me in 1980.
And then in ’85, Trust Company of the West, which was an L.A. company, approached me because they wanted to expand into my asset classes. And that’s how I moved there in ’85.
RITHOLTZ: So it’s worth mentioning in passing that when you were working at Trust Company of the West, you were supervising a young whiz kid named Jeff Gundlach you were working with.
MARKS: Right, that’s right.
RITHOLTZ: Tell us what it was like riding herd on him. He — he seems to be a person that doesn’t lend himself to being told what to do.
MARKS: Well, I never kidded myself into thinking that — that I was actually supervising him. But, you know, I was — I was asked to — well, you used the term right “herd,” which is as good as any. And, you know, he kind of respected me intellectually, and so — and so we got along. And — and I think with Jeff that’s the key, you know.
And he was very innovative in his approach. He — he was managing mortgage-backed securities from the late 80’s, which was innovative and, you know, he would — he would figure out strategies and then share them with me in the hope that I would understand.
RITHOLTZ: So — so fast-forward, and — and I would assume you — you probably did understand pretty well. Fast-forward a couple of years, you launched Oaktree in ’95, and then a decade or so after that, Jeff decides to part ways with Trust Company of the West and he comes to you for some career advice. How — how did that work out?
MARKS: Well, of course, he didn’t decide to part ways with TCW.
RITHOLTZ: I guess.
MARKS: They decided to part ways with him.
MARKS: And he got canned is the technical term.
And — and — and I think it was December ’09 if I’m not mistaken. And, you know, he — he had a great following among his clients and among his — his staff. And as soon as he got let go, I think the rest of them all quit and …
RITHOLTZ: His whole team.
MARKS: I think his whole team. And then he — through a brokerage firm or they — nowadays they say investment bank — approached us and said, “Would you — would you help us get started in exchange for 15 percent of our company?” And so we were, again, smart enough to say yes.
And it wasn’t a matter of finances, it was a matter of infrastructure, back office, tax, legal, registration, all those things. And there’s a — you know, when we started Oaktree in ’95, people would say what’s been the biggest surprise. I said the biggest surprise is how much noninvestment stuff there is in an investment management job. So we helped him with that. He’s in our building in California. And we just meet and chat periodically. But as I say, we started with 15 percent of the company.
Then we realized that under accounting rules, in order to bring in our share of their profits, we would have to own 20 percent. So we bought another seven percent and we got diluted down to 20, which is where we are now. We had dilution protection. We’re extremely happy to be a 20 percent owner of DoubleLine.
RITHOLTZ: And — and I want to say DoubleLine is the fastest-growing asset management firm to reach $100 billion. Is that about right?
MARKS: I believe — I — I wouldn’t swear to it, but I believe that’s right.
RITHOLTZ: So let’s talk a little about the chairman’s memos, which you’re somewhat infamous for. I’m going to quote Warren Buffett. “When I see memos from Howard Marks in my mailbox — they’re the first thing I open and read — I always learn something.” Tell us what led you to publishing the chairman’s memos. When did they start and why did you feel the need to write them?
MARKS: They started in 1990, so this is the 30th year.
MARKS: And — thank you. And I don’t remember thinking that if I wrote them I’ll get more business or anything like that. But there were two events that happened in my environment, the juxtaposition of which was I thought extremely informative, and so I wanted to write it up and share with my clients. Now is all.
RITHOLTZ: And — and you’re — you’re well-known for them today. Buffett had — has lauded them and other people have talked so approvingly of them. But when you first started publishing these, what was the response like?
MARKS: A big fat zero.
MARKS: Literally, Barry, the — it was 10 years before I ever had a response. Not only did nobody say, oh, that was good. Nobody ever said I got it. So it — you know, and this is….
RITHOLTZ: This wasn’t email. This was …
MARKS: That’s right.
RITHOLTZ: … regular paper.
MARKS: Paper. This is the day of running the — the — the Xerox machine, folding them up, putting them in envelopes, addressing them, putting stamps on, and then as far as I knew, tossing them down the sewer …
… because I never had a response for 10 years.
RITHOLTZ: For a day.
MARKS: And so — so I kind of remember what made me write the first one. I have no idea what kept me going.
RITHOLTZ: So you said there’s response for a decade. That response though, I very specifically remember that one because Barron’s had a giant cover on it, bubble.com …
RITHOLTZ: … in January 2000 …
RITHOLTZ: … not only were you right, but the timing couldn’t have been any better. Tell us about that particular chairman’s memo.
MARKS: Sure. Well, of course, in our business, it doesn’t do you any good to be right if the timing is not good. You know, there’s an old saying in our business that being too far ahead of your time is indistinguishable from being wrong. So if I were to publish the same insight in 1997, I’d be forgotten because it would have taken three plus years to work. It happens it only took a few months to work.
And basically the premise of the menu — memo was that the TMT — tech, media, telecom — bubble that had been pushing stocks up for the last few years of the 90’s and into 2000 was overdone, the subject of excessive optimism and excessive faith in the future, and — and entirely free of any kind of analytical or valuation rigor, you know. I mean, we’re used to paying 15 times earnings for an average company and maybe 30 times earnings for what we think is a great company. But how do you value a company that has no earnings? Hold on, how do you value a company that has no sales?
You know, I mean, you were valuing an idea and people were — you see. And — and in the investment business, there’s a tendency to succumb to platitudes, generalizations. And so what was going on in ’98, ’99 was the Internet will change the world. And as a consequence, any stock which is Internet or e-commerce-related is the right price is infinity.
There’s — and — and as I say in the book — can I say in the book? OK, slight …
RITHOLTZ: Sure, absolutely.
MARKS: But as I say in the book, if you want to understand bubbles, to me, the defining characteristic of a bubble is the belief that, quote, “There’s no price too high.”
If it’s — if it’s an Internet stock, there’s no price too high. If it was the Nifty 50 back when I started in 1968 — Xerox, Kodak, Merck, Lilly — no price too high. And of course, it’s obvious that everything, there is no — there’s nothing so good that it can’t be overvalued. And if you buy something at a price, which is excessive for its merits, by the — it’s going to require magic to make it into a successful investment. So, that was the theme of the memo.
You know, I talked about — I talked about businesses. And, by the way, we still some — see some today, which — which don’t have a profit plan, you know, and the — the companies that, you know, that — as I said in the memo, well, people used to say the great thing about this company is that its costs are almost zero. And I wrote, well, that’s great because it’s revenues are absolutely zero, you know.
And I — I quoted my dad, who was a big joke teller, and he said that two guys were talking, one guy says, “Everything I sell, I sell at cost.” He said, “How do you make money?” This is why buy below cost.
But — but the — but the Internet business model, at that time, seemed equally irrational and yet the stocks are selling at sky high prices. And, of course — and as I said in a — in a memo, which — which reviewed this progression later, you know, in my first 30 years in the business, after a bubble popped, we would see a table in the upper right-hand corner of the Journal and they’d show all the stocks that were down 90 percent. Remember?
And then with this, they showed all the stocks were down 99 percent or more. And so the bubble popped, the memo looked smart. I said in the — in the introduction to my first book, after 10 years, I became an overnight success and that’s the story.
RITHOLTZ: So — so let’s talk about that first book, which is “The Most Important Thing: Uncommon Sense for the Thoughtful Investor.” You’re writing these memos on a regular basis.
RITHOLTZ: What motivated you to say, I know, let’s — let’s now spend 300 pages in a year writing a book.
MARKS: That was simple. I got a letter from Warren.
MARKS: Buffett, saying — saying if — you know, I — I — I wrote a memo, I think I forget which one it was which was right up his alley, and I — I wrote them afterwards and I said, “Did you see this one?” He says, “Yeah, I saw it. It was fine.” And he says, “By the way, if you’ll write a book I’ll give you a quote for the jacket.” Enough said.
RITHOLTZ: A blurb.
MARKS: Enough said.
MARKS: And — and, you know, you don’t pass that one body.
MARKS: So I had always thought that I would write a book pulling the philosophy together when I retired, and instead, it got — it got accelerated.
RITHOLTZ: What was experience writing a book like?
MARKS: It — it was great. You know, for me, the challenge is not to think up what to say. The challenge is to get it from here to there, you know. And yeah — the thoughts are coming so fast, you’re afraid they’re going to evaporate …
MARKS: … so you have to sit there and you have to …
RITHOLTZ: So — so let’s talk about some of those thoughts, which I’ve pulled from both books. Quote, “We can make excellent investment decisions on the basis of present observations …
RITHOLTZ: … with no need to make guesses about the future.
MARKS: Right, right.
RITHOLTZ: Doesn’t not run kind of contrary to how lots and lots of people invest their capital?
MARKS: Yeah. I mean, the — the irony is that what is — what is investing? Investing is positioning your capital to profit from the future that unfolds. And yet, in my book, we can’t know what the future holds. So I and Oaktree, through its investment philosophy, specifically eschew macro forecasts. And I don’t believe we ever know enough about the coming economy, markets, currencies and interest rates to make us a successful and a superior investor. It’s very hard to hold the view, which is different from the consensus, and it’s very hard to have a non-consensus view, which turns out to be more correct than the consensus. And so I — so I don’t believe in forecasts.
Now, everybody says — but the macro is so important. It’s the macro that moves the markets these days and it — it truly does feel, let’s say for the last 15 or 20 years that, yes, the — the macro is much more important than company knows in moving the market. So they say, well, how can you — how can you not do macro forecasting?
And I was sitting and having dinner with Warren, you know who.
RITHOLTZ: That one.
MARKS: That one, a few years ago, and he said to me, “For a piece of information to be desirable, it has to satisfy two criteria. It has to be important and the macro is extremely important. And it has to be knowable.” So you can have something, which is very important, but if you spend your time trying to figure it out, it could be a waste of time if it’s not knowable. And I believe that the macro future is not knowable.
So in — in the first book, “The Most Important Thing,” there are 21 chapters and each one starts off the title. The most important thing is and that’s a different thing because in investing, there is no one thing which is the most important, there are in that — according to the book, there are 21 things, all of which are the most important thing. And one of those is knowing where we stand in the cycle. And when it was time to write a second book, I pulled that out and that’s what I devoted the book to.
RITHOLTZ: So — so since you brought that up, let’s talk about the second book, “Mastering the Market Cycle: Getting the Odds on Your Side.” Of all those 21 chapters in the first book, why cycles? Why did you pick that shooing the other 20 …
RITHOLTZ: … when you — really you can write a 21-volume encyclopedia each chapter being a book.
MARKS: Well, Barry, I believe of the things — of all the 21 most important things, I think that there are two that are more important than the others. And — and they are risk and where we stand in the cycle. I believe that risk management, risk control is the mark of an exceptional investor. It’s not hard to make money in the market. It’s especially not hard when the market goes up, and the market goes up most of the time, and most of the time, everybody in the market makes money.
But if you don’t know what you’re doing, if — if you’re throwing darts, if you’re just surfing, you know, what we call “beta schlepping,” that’s not an accomplishment. To me, an exceptional investor is someone who makes a lot of money when things go well, but does it with the risk under control so that he — he or she won’t lose a lot of money when the market does poorly. So I think that — I devote actually three chapters in the first book to risk, understanding risk, recognizing risk, controlling risk. And I think that is the mark of the superior investor. That’s number one.
Number two, the cycle. There’s a connection here because I believe that where the market is in its cycle determines how risky it is. When — when everything has been going swimmingly and, as a consequence, the market is elevated in its cycle relative to something we might think of as the midpoint or the intrinsic value, then I think it’s risky. And when it’s depressed in its cycle and low relative to intrinsic value, or the midpoint or the norm, then I think the risk is very low.
So, understanding even though we can’t benefit from predictions of the future, I believe that where the market is in its cycle can tell us a lot about what the odds are. And that — that you mentioned the subtitle of the book, “Getting the Odds on Your Side,” and I — I — I actually prefer the subtitle to the title because it conveys, I hope, a sense for my belief that we cannot know what the future holds. The future is nothing but a probability distribution. But if we think and study right, we can have an idea about the shape of the probability distribution and what returns are most likely.
RITHOLTZ: It’s interesting you say that you prefer the subtitle …
RITHOLTZ: … because the title itself sort of is at odds with some things you’ve said before about you really have a mantra. Not only can people not predict the future, they can’t time the market especially well either. How do you reconcile mastering a market cycle that seems a little contradictory to being able to time it?
MARKS: Sure. Well, let me say up front. I believe very firmly that we sometimes have a sense for what’s going to happen. We never know when. So when you say timing, the word “time” is — is — is something I just discard. You know, since I’m a writer, everybody at Oaktree has a habit of writing. Everybody at Oaktree writes a letter every quarter to his clients.
And there’s a guy there who — who I was — and I review all the letters before they go out. And one of them, he — the portfolio manager said, “If you name a date, don’t name a price. And if you name a price, don’t name a date.” And if you think about it, if you never name both the date and a price, you can never be wrong.
MARKS: And — and — but — but I do think that you can have an idea about what the future holds, you can have an idea whether this is a good time to invest or not, but you — you’ll never know when the things you’re hoping for will unfold. And if you — if you think about it, I believe that everything an investor does — what you do, what I do — falls under one of two headings: asset selection and what I call “cycle positioning” in order to avoid using the word “timing.”
What do they mean? Asset selection means trying to hold more of the things that will do better and less of the things that will do worse. Pretty easy. And cycle positioning means trying to have more of your capital invested and more aggressively when the odds are favorable and less of your capital invested more defensively when the odds are against you. I think you can — we can know something about the odds. That doesn’t mean we’re going to be right or we going to be right right away especially. And that can enable us to effectively do cycle positioning through an understanding of where we stand in the cycle.
RITHOLTZ: So you mentioned two things earlier that I have to circle back to. One was the concept of intrinsic value where assets might be above or below that. And the second is the implication about psychology, which really we went by too quickly so I have to …
MARKS: Right, good.
RITHOLTZ: … come back to that.
RITHOLTZ: Intrinsic value clearly refers to paying less for an asset than you think it’s …
RITHOLTZ: … ultimately we worth. I think you — you’ve written extensively about the advantages of being a value investor.
RITHOLTZ: But let’s — let’s explore the psychology of that because it seems much easier to buy when things are going up than to sell, and conversely when everything is down, it’s much easier to sell with the crowd than take the other side of the trade.
MARKS: Well, first of all, intrinsic value, every — every asset that produces cash flow, you can talk reasonably about its intrinsic value. What would you pay to get those cash flows? It might be a company, a stock, a bond, a building. Anything that produces cash flow can be valued. That’s what value investors do. We try to figure out the value and buy for less. That makes perfect sense, in — in my opinion.
Now, the next question is do assets sell at their intrinsic value and the answer is no. The asset — the prices of assets vary — vary significantly from intrinsic value from time to time. Why? Well, you said it, psychology. Sometimes people are excited and the — the — the price goes way above the intrinsic value. Sometimes they are depressed and the price goes below the intrinsic value.
Now, you were — the next thing you mentioned was how easy it is to buy things that are going up. You mean, easy psychologically.
MARKS: Right. You know, Dave Swensen who runs the endowment at Yale, which is the — probably the best performing endowment in the country over the last 30 plus years that he’s been doing it, wrote a book in which he said that superior performance in investment management requires the adoption of uncomfortably idiosyncratic positions. In other words, if you — the job in investing — well, let me say this, investing is a funny area because it’s really easy to be average and it’s really hard to be above average.
But for a professional like myself or like Swensen, since it’s easy, being average is not what we seek. We seek to be above average. This may shock you, but professional investors do it for the money and they hope to be paid highly. But clearly, since anybody can be average without any effort or professionalism, the payoff is in being above average.
If you think like everybody else, you’ll behave like everybody else. If you behave like everybody else, you’ll perform like everybody else. So clearly, exceptional performance has to come from diverging from the crowd. And that’s what Swensen means when he — when he says uncomfortably idiosyncratic because if — if you are behaving in an idiosyncratic way, that is to say everybody else is buying and you say, well, their buying has raised the price too high relative to the intrinsic value, I’m going to sell. If they’re all buying and you’re selling, believe me, it’s uncomfortable.
Now we do it because we believe we have performed a competent intellectual process doesn’t make it comfortable, yeah.
RITHOLTZ: What about the flip side? When everybody is selling, is that …
MARKS: Exactly the same.
RITHOLTZ: … is that a little — I would imagine that’s a little more comfortable because the sell-off and a panic at least makes it appear things are falling below that intrinsic value. So there’s that …
MARKS: Well, there is some truth in that because the trouble with — the difficulty in selling when a market has been rising for several months or years comes from the fear that it will continue to rise and you’ll miss out. FOMO, right? And that’s a very strong force.
You know, there’s a book out on bubbles and crashes by a guy named Charles Kindleberger.
MARKS: And he says in there something like there is nothing as injurious for your mental well-being as to what your friend get rich. And, you know — and it’s — that’s — that’s one of these sayings, which is it captures it all right there. That’s human nature. So — so FOMO is very challenging.
On the other hand, I don’t know if it’s any easier on the way down. I mean, intellectually, you should be able to look at assets like stocks and bonds that have gone on sale and say that’s ridiculously inexpensive, I’m going to jump in. But as I spend a lot of time in the book dissecting a common phrase, which is “catching a falling knife,” and so many people say I’m not going to try to catch a falling knife. You know, this thing is collapsing; I have no idea how far it’s going to go. I don’t want to stand in front of that process. I’m going to wait until the dust settles and the uncertainty is resolved.
And believe me, Barry, as I know you know well, when the dust settles and the certainly has been resolved, there’s no more bargains left …
RITHOLTZ: Right, it’s too late.
MARKS: … because what causes great bargains — and, by the way, let’s diverge for a second. What is a bargain? A bargain is an asset that’s selling too cheap.
What causes assets to sell too cheap? Error. If — if — for you to get a great bargain in the market, somebody else has to be making a big mistake. If you can buy something that is exceptionally cheap, somebody else has to be selling something which is exceptionally cheap. What makes anybody want to sell something at a price, which is exceptionally cheap, and the answer is human nature or what you call psychology.
And the answer is that when prices go up, people get excited and buy. When things go down, people get depressed and sell. They don’t say, well, you know, it’s on sale. It used to be 100, now it’s 75. I’m a buyer.
Warren, you know who, says I like hamburgers and when hamburgers go on sale, I eat more hamburgers. And that’s how value investors try to behave. We try to be unemotional, not get down because prices have fallen. Even, you know, the prices of the things we own have fallen, but we try to say it’s a bargain, I’m going to buy more. But — but that requires you to get control of your psychology.
RITHOLTZ: Let me bring you back to the book for at least one more question, and I wanted to ask you write rule number one, most things will prove to be cyclical. Rule number two, some of the greatest opportunities for gain and loss come when other people forget rule number one.
RITHOLTZ: That’s pretty much what you’re referring to …
RITHOLTZ: … that people …
RITHOLTZ: … panic selling.
MARKS: And when — when things are rising, when stock prices have been rising like, you know, in a — in a great bull market for five, six, eight, nine years, what do they say? I think it’s going to go up forever. And when it’s been collapsing and the prices and an asset is a third of what it was a year or two ago, what do they say? I think it’s going to zero.
And in fact — and so what they — they — what they do is they extrapolate unidirectional trends, whereas I believe most events are cyclical. And trees don’t go to the sky and very little goes to zero.
RITHOLTZ: So let me — let me bring up one of your pet peeves that I’m — I’m amused by. What inning is this? People ask you the question and you — you hate that question. Explain why.
MARKS: Well, I don’t — I don’t hate it, but I — I — I mean, it’s — it’s challenging to know the answer. I — right now, I say I think we’re in the eighth inning. That’s great, Howard. The only trouble is I’ve been saying the eighth inning for a couple of years now.
MARKS: And what I realized about a year ago — by the way, that question started to come up really initiative ’08 …
MARKS: … when we were in the global financial crisis, and people used to say what inning are we. And — and what they really meant is when is the collapse going to end.
Now, they mean when is the upcycle going to end. And most people say I — I — I realize that it can’t go well forever, but I can’t imagine what’s going to make it come to an end. But the truth is, you know, we are at an advanced stage of the economic recovery and of the bull market, and there are very secure — few securities around that are absolutely cheap. And most investors are happy doing risk investing and have lots of money for the purpose so they’re bidding up asset prices.
RITHOLTZ: So let’s …
MARKS: So — but — but — so I think we’re in the eighth inning. But I realized about a year ago an important distinction. This isn’t baseball. In baseball, we know that a regulation game has nine innings. And in this game, it could go nine or 11 or 14. We have no idea. So again, the fact that I think we’re in the eighth and that things are extended, it doesn’t mean that the game is just about to end.
RITHOLTZ: So let’s talk a little bit about that. The Fed, some people have been complaining they’ve tightened too much. Other people are saying they’re behind the curve. You’ve been a student of the credit markets for decades. What do you think of what — we’re the Fed is and what their future behavior might be?
MARKS: Well, I talked about the Fed a little bit in the — in the book. There’s a — there’s the — there’s a chapter on the role of government and central banks with regard to the economic cycle. The Fed has a tough job. Well, actually, it has three tough jobs.
Number one, it’s supposed to manage inflation and keep it under control, which means that the economy shouldn’t get too hot. Number two, it’s supposed to support economic growth and employment for which they would rather the market did get hot. And number three, there are now a lot of people who think that the Fed job is to prevent a recession and the declining stock market. I don’t think Jay Powell certainly feels the — the latter.
But, you know, I think that interest rates — low interest rates have been the outstanding characteristic of the financial markets for the last 10 years. They have dominated behavior over that period. They’ve been too low. They’ve been unnaturally low. They were made unnaturally low in order to bring the economy back from the global financial crisis and the abyss of collapse.
There are reasons why rates should be higher. Number one, rates should probably be at their naturally occurring levels so that — so that the — the free market will allocate resources prudently. To date, it has been subsidizing borrowers and penalizing savers and lenders.
Number two, the Fed wants rates to be high enough so that if the economy slows down, they can drop rates and stimulate the economy and — and so forth. So, you know, there’s a belief that there’s a correlation — inverse correlation between unemployment and — and inflation that when — when unemployment gets really low, that — that triggers inflation. That’s called the Phillips curve. And everybody — since we now are at a 50-year low in unemployment, everybody has been waiting for inflation to get going, which is the — the — the Fed’s main concern is that it shouldn’t get going too strongly, and so that’s why they have been talking about raising rates, but it hasn’t happened. And everybody is mystified by why we don’t have inflation. And there’s no easy answer, I think.
RITHOLTZ: Is that a risk factor for a credit investor like yourself?
RITHOLTZ: Well, the Fed, inflation, lack of inflation.
MARKS: Well, it is, but I also think it’s unpredictable. You know, to me, that my — might the question over the last five years or more has been are rates going up or not. And I believed that they would, and they have for good reason as I’ve explained and not — you know, people — people — for years, you’ll remember, people would — would talk to you and they say, “Do you think that rates are going up in January or March?” And I would say, what do you care? What’s the difference? That — what month they go up doesn’t matter.
People were so preoccupied especially when — when they were looking for the first rate increase, remember? And I would say, the only thing that matters are they going to go up, and are they going to go up a lot, and are they going to go up fast. And what month it starts happening in doesn’t matter. And of course, nobody got it right, proving, I think, my point as to the timing, but they did raise rates. And my guess is that they’ll raise them a little more. But I never thought they would go — go up far or fast and I still don’t.
RITHOLTZ: So at one point in time, debt investors were concerned with deficits from the federal government. It seems like we’ve kind of lost our enthusiasm …
RITHOLTZ: … for — for fighting deficits. What are your thoughts on the government balance sheet and perhaps modern monetary theory? What — are deficits now OK or …
MARKS: My mother’s term for that, Barry is passé. Worry about the debt and the deficit is passé. Nobody seems to care anymore. When I was a boy, there used to be debates about whether it was OK to have debt, for a nation to have debt. I don’t see anybody discussing that anymore. The only question is whether there’s such a thing as having too much debt and some people think there is, but nobody can say what it is, of course.
Historically, of course, the Democrats believed in tax and spend and I would say deficits, and the Republicans were the fiscal disciplinarians who would fight against deficits. That seems to have gone out the window. Nobody really stands four-square for deficit and debt reduction. And in fact, most recently, we — we start seeing articles saying it — it’s old-fashioned to worry about deficits and debt. And it’s much more important to pursue society’s needs at — even at the cost of a deficit.
So, it’s troublesome. I mean, I think there probably is such a thing as too much. You know, the bottom line is it probably doesn’t matter how much debt you have. As long as you can print the – -the world’s reserve currency, you know, we run the debt. It goes up, up, up, up. The interest rate bill goes — interest goes up with the debt or it’ll go up faster if rates rise as — as they have been. But — and — and paying the interest will occupy an increasing and increasing, increasing percentage of the federal budget. It doesn’t matter as long as you can print money, as long as you can sell an infinite number of bonds overseas at the world’s lowest rates because of the quality of the credit.
And the question is what if that ever stops?
RITHOLTZ: So that’s the risk factor. What is the risk …
RITHOLTZ: … factor of deficits to fixed income purchasers?
MARKS: It’s — it’s — it’s — well, to the nation, it is that some day China says, you know what, we have enough treasuries. We’re going to start buying your — but the — the difficulty is what are you going to buy if it’s not the dollar. You’re going to invest in the — in the — in the euro? That looks precarious. You’re going to invest in the pound? That’s difficult with Brexit. Are you going to invest in — in the ruble, won, whatever it might be?
So it looks like we’re going to, you know, this is all — this is — when you look at the government and how badly it functions, the optimism with regard to the future comes from the belief that we always have muddled through and we will continue to muddle through. And that we don’t have to worry about the debt and the deficit because we can always print money to pay the interest.
RITHOLTZ: Until we can’t.
MARKS: Until we can’t, but …
RITHOLTZ: OK. So …
MARKS: … but the — but the arrival of the date when we can’t it comes under the heading of what I call “improbable disasters.” It would be a terrible thing. It would have a lot of negative ramifications, but you can’t assign a very high probability to it next year or the year after, the year after that, you know.
So — and one of the most interesting dilemmas is what does the investor do about the improbable disaster. Since it’s improbable, you can’t do enough in your portfolio to prepare for it. And — and certainly, if it happens it’ll have disastrous consequences and it’ll turn out you didn’t do enough. But — but given that it’s improbable, you can’t do a lot. That’s — that’s — there’s a lot of things. Hyperinflation, deflation, all these things fall under that category.
RITHOLTZ: So, we have two segments left. I want to be able to get — save some time to get to some questions from the room, but not yet. The last thing I want to do with you is our speed rounds, 10 questions, five minutes, short answers.
MARKS: Well, by now, you probably know I don’t know anything about speed rounds or short answers, but — but I’ll try.
RITHOLTZ: Well, let’s — let’s give it a shot. Let’s start out. First car you ever owned, year, make and model?
MARKS: 1965 Olds Cutlass …
RITHOLTZ: Now collectible.
MARKS: … aquamarine, $3,200. My parents paid half.
RITHOLTZ: What’s the biggest political surprise we might see over the next couple of quarters?
MARKS: Well, it might be the Mueller report. But — I mean, it’s — it’s a great example of having no idea what’s — what’s going to happen.
RITHOLTZ: Going to be a surprise. Favorite NBA team?
MARKS: I guess, the Lakers.
MARKS: I’ve lived in L.A. for the last 34 years until recently.
RITHOLTZ: You platooned back and forth.
MARKS: Well, I came — we moved — my wife and I moved back here six years ago because our kids moved here. And she said that we’re going to be in New York.
RITHOLTZ: So that’s …
MARKS: And we are.
And I was — again, I was smart enough to say yes.
MARKS: That’s the — that’s a — maybe I’ll make that the title of my book.
RITHOLTZ: Smart enough to say yes. Name three of your favorite books about any subject.
MARKS: There’s a book called “Fooled by Randomness” by Taleb which — you know, when you talk about the limits on for knowledge, when you talk about the fact that things are unpredictable because of randomness, I think this book contains very, very important ideas and I know it was very valuable for me.
Peter Bernstein, who is a great investment sage, wrote a book called “Against the Gods.”
RITHOLTZ: “Story of Risk.”
MARKS: “Story of Risk.” And again it all — understanding risk. Risk is so provocative and so important.
And then I would say there’s a book by John Kenneth Galbraith called “A Short History of Financial Euphoria,” which talks about — introduced me to cycles, the extremes of cycles, the error of cycles. And one of my favorite quotes from Galbraith was that we have two kinds of forecasters: the ones who don’t know and the ones who don’t know they don’t know.
RITHOLTZ: That’s a classic quote. What do you do for fun?
MARKS: Well, I spend a lot of time with the kids and their kids now because my wife was prescient. Since we moved back here six years ago, they both got married and they both had children. So, you know, we’re in a great place in that regard. And I like architecture and decorating and that kind of thing.
RITHOLTZ: You — you actually do a little bit of an architectural tour when you visit other cities. Is that right?
MARKS: Right, sure.
RITHOLTZ: I recall you talking about that not too long ago. Favorite asset for the next decade?
MARKS: Well, I mean, I — I hate to say that kind of thing because I hate to think of anybody else buying on my say-so. But I mean, I’m — I’m willing to be a long-term investor in the emerging markets, both debt and equity. I think that the — you know, the way I put it, Barry, is that Japan and Europe are senior citizens economically speaking. The U.S. is a mature adult and the emerging markets are teenagers. And if you ever had a teenager in your house, you know, it can be chaotic …
MARKS: … chaotic and volatile, but you know that the teenagers’ best decades lie ahead, and that’s the way I think about the emerging markets.
RITHOLTZ: So — so let me ask you the same question, favorite asset for the next century?
MARKS: A house high up in a hill.
RITHOLTZ: Who is the investor goat, the greatest of all time, the greatest investor of all time?
MARKS: Oh, of all times. Well, I don’t know. I mean, I haven’t read that much about the personalities, but everybody assumes it is that Warren guy. And, you know, he — he — he has a — he has a great record with a lot of money.
He — and there’s a book out called “The Warren Buffett Way,” and I was asked to write the preface. And I wrote — it’s for the like fourth or fifth edition. And I wrote something called “What makes Warren Buffett Warren Buffet?” And I talked about the fact that he’s intelligent and unemotional, and he figures out what’s important. And he — he has a quick study on what’s important. He ignores the things that are unimportant and all these different things. And then at the end, I said, “And he’s not afraid to lose a job.”
And, you know, if you are afraid to lose your job, it’s hard to do things that are different and bold. And yet, being different and bold is necessary to be superior. And, you know, he — he spends long periods of time in the wilderness. In 2000, when I wrote the memo, everybody was saying, “Well, it’s too bad about Warren Buffett,” but, you know, he’s lost his touch …
MARKS: … because he didn’t have any of the tech stocks. And then, of course, a year later, everybody was saying, you know, what a genius.
We — but you — you know, there is no approach in the investment world. There is no approach, which will always be right. No matter what approach you have, there will be periods when you’re in the doghouse and this — the more strongly you hold your philosophy, the more strongly you hue to it, the worst those periods in the doghouse will be. And yet, what else is there?
You certainly can’t — especially since we can’t time the events, it — it — it can’t work to jump from style to style to style and expect to be — have the right style at the right time. You have to hold a style. It has to be the one you believe in. It has to be the one you’re good at, and then you have to live through and survive the periods in the doghouse. And that’s, to me, the mark of a — of a great investor. And, by the way, it’s — it’s not how well you do while you’re style is in favor, it’s how you do when your style is out of favor that determines whether you’re excellent or not.
RITHOLTZ: That’s a perfect spot to open this up to questions from the audience. Before we do, let’s hear it for Howard Marks and …
… and sharing his insights.
We have — we have a microphone. Raise your hand if you have any questions and identify yourself by name and company. Who has some questions?
MARKS: I …
RITHOLTZ: Right over here?
MARKS: That …
RITHOLTZ: Not a plant.
QUESTION: Quick question, if you’re like a crystal ball, I could tell you anything, any question you want answered about the world, what — what would you want to know?
MARKS: You know, let me change it a little bit, not crystal ball. If I could get an accurate answer with regard to every security that I’m thinking of buying, it would be how much optimism is baked into the price. Remember that the — the psychology causes the price to diverge from the intrinsic value. If the optimism is really high, then the price is high relative to intrinsic value, that’s a dangerous investment. If the optimism is really low, the price is probably depressed and very attractive.
So, if I could get a measure and this is something I tried to do, especially with regard to the overall market rather than individual securities, I try to do what I call “take the temperature of the market,” and I would spend my one phone-a-friend question on that.
RITHOLTZ: Any other questions? Right over here, if we can bring the mike over here.
QUESTION: What was the lowest low when you started Oaktree?
RITHOLTZ: The lowest low.
MARKS: It may not be very interesting, but the lowest low was the day we figured out that we didn’t have a publishable record. When I moved from Citi to TCW in 1985, I walked in and I said, “Here’s my record. They published it. Bingo.”
When I went from TCW to Oaktree in ’95, I said, “Here’s a record, publish it.” They said, “Well, where’s the data. You — you have to have monthly auditable data in order to publish a record.” Well, of course, we walked out of TCW without that information and we said — I said, “My God, we don’t have a record we can publish. How are we ever going to get any business?” And — and we figured out a solution. It worked out pretty well because what we said is we — we wrote the clients and we said, “We’d love to have you come over to Oaktree. And if you come and give us your monthly statements over the years, we’ll audit them and we’ll ascertain what your performance really was.”
And — and — and so I was kind of a bootstrap operation. The — the accounts we got permitted us to develop a record, which — which enabled us to get more accounts. It was a — that was the lowest day.
RITHOLTZ: Interesting question. Thank you, Andy. Anybody else? Any other questions out here for Howard Marks, here on the back?
QUESTION: How do you go about spotting the above five average investors that you mentioned before — before they have become one? And do you think you’re good at spotting that?
MARKS: Well, clearly we hire people before they have track records. And we look for a high degree of intelligence, a natural contrarian streak, I would say, a willingness to be wrong. We give people cases to analyze and we look at what they call attention to. And hopefully, it will be the things that — hopefully, they’ll put a great emphasis on — on finding the things that other people haven’t figured out.
If you figure out what everybody else has figured out, you have no advantage. So I — I think — and then the other thing is I use the — the word “inference” a lot. I use it all over the book. Not seeing events, but figuring out what they mean, deeper significance. So we try to hire people like that. In addition, we try to hire good people that other people, including us, will — will enjoy working with and people who want to be part of a long-term team rather than maximize for themselves.
RITHOLTZ: Howard, I’m going to give you a fire — a follow-up question. You’ve talked in the past about second level thinking or second order thinking.
RITHOLTZ: Describe that a little more detail. What is it …
MARKS: Sure, sure.
RITHOLTZ: … when — that that’s the allusion when you’re — you’re looking to hire somebody. How is second level thinking applies to either that or to investing?
MARKS: Sure. Well, you know, Barry, when — when I was thinking about writing the first book and I said it was — I had been approached by Columbia Business School press about writing a book. And I told them my idea for the most important thing. They said, “Well, send us a sample chapter.” And the funny thing is that I sat down at the keyboard and I wrote a chapter that I had never even thought about writing before and it wasn’t even something that — that was in front of mind before that, but it was — and so the first chapter in the book says, “The most important thing is second level thinking.”
And it go — I go through the thing that I just said to you that if you think the same as others, you’ll perform, behave the same, behave the same, you’ll have the same performance. That’s clearly in a — a formula for superiority. So the answer is that you have to perform — you have to think differently. But it’s not so easy because most of the time when people think differently, it’s the consensus, it’s rights or the different thing goes wrong. You have to think differently and better. Those are the two criteria for second level thinking.
And we look for second level thinkers, which requires, number one, exceptional insight and, number two, willingness to be wrong because when you diverge from the crowd, you — you — you can’t do it with certainty that you’re going to be right.
But, you know, just to give you a simple idea, the — the first level thinker says, “This is a great company. We should buy the stock.” The second level thinker says, “It’s a great company as everybody thinks. It’s not as great as everybody thinks, we should sell the stock.”
If you — if you get that or like, you know, you might say if you get the joke then you have an insight that we think is valuable. There are people who just don’t get that. There are people who don’t understand contrarian thinking. And I think it’s extremely important that one does.
RITHOLTZ: We still have time for one of two more questions.
MARKS: There’s a question over here.
RITHOLTZ: How about right over here?
QUESTION: The length of the cycles could be different, right?
QUESTION: So, some cycles could have prices depressed for one year, two years, three years, five years.
QUESTION: So when that happens, for example, to the energy industry or anything like that, how do you manage around that?
MARKS: Well, you know, I’d love to be able to say I have a brilliant answer to that, but there is no answer because — because the — because as I said, we sometimes know — have an idea, I don’t even want to use the word “know.” We sometimes have an idea for what’s going to happen. We never know when. We know — we may know that oils looks cheap. We never know when it’s going to go up.
And I think that everybody has to get rid of this illusion that these things are noble. You know, Mark Twain said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for certain that just ain’t true.”
A lot of my answers start with I have no idea, but — and when you say — when you start your answer that way, it’s impossible to get into trouble. You get into trouble when you say I’m confident of X, Y, Z and you bid heavily and you’re wrong. So if you accept that the — that the investment world is a — is a place where there’s a lot of uncertainty, you’re going to stay out of trouble.
Henry Kaufman who was the Chief Economist at Salomon Brothers in the 1970’s once said, “There are two kinds of people who lose a lot of money: the ones who know nothing and the ones who know everything.” And I think it’s very important not to be either of those.
RITHOLTZ: I saw some more questions over here. How about right here?
QUESTION: So my question is you mentioned that — that macroeconomics doesn’t influence your investment decisions. But how do you know where you are in the cycle without paying attention to or being influenced by the macroeconomics? For example, you know, the trade war may — may be something that’s going to blow over soon, and we can focus on the fundamentals again of, you know, the investments. But then what about China 2025 and all that, the kinds of things that they’re investing in? When I look at a country, don’t I pay attention to the politics among different countries and what they do, what they invest in, what they — what they want to do in the future?
MARKS: Well, the short answer is yes. The long — but short answer is they’re no good. The long answer is that, number one, the things you’re talking about are not cyclical. These are one-time what we call the exogenous events, whether we’ll have a trade war, et cetera. And this goes back to really what I said about the macro.
What’s going to happen in these regards, China, future growth, trade war, et cetera is very important, but is it knowable. And if it’s not knowable, then you just have to understand that it’s an uncertainty out there and — and — and you — you may — you may say, you know, I’m concerned about China. The possibility of a trade war raises the uncertainty for me, so I’m going to invest conservatively. That’s not a cyclical consideration, but that’s a prudent consideration.
And — but, you know, I keep coming back to this thought that it would be nice to know what’s going to happen, but you don’t know and nobody knows. And you’re an architect, and what that means is you build buildings and you put in enough steel and brick so that it won’t fall down because it — it works according to certain physical laws and you have to understand that there are no physical laws at work in investing. And the — the future is uncertain, and vague and — and random, and psychology dominates.
And I — I say in the book, I quote Richard Feynman who is the great physicist, and he said, “Physics would be much harder if electrons had feelings.”
A great quote. You know, you come in the room, you’d flip up the switch, the lights go on every time. Why is that? Because the electrons flow from the switch to the lights. They never flow this way. They never go on strike. They never fall asleep. They never say, ah, today, I don’t feel like flowing from the switch to the light. That’s physical science.
You have to understand the distinction between your field and the field of investing where there are no laws. There are only tendencies. We can get the tendencies on our side, but we can’t — you can’t build a bridge that’s incapable of falling down.
RITHOLTZ: I think that’s a perfect place to leave us off. So before I ask for a round of applause, I just want to let everybody know, there’ll be drinks and snacks on the other side of those doors as well as copies of Howard’s book. I know you have to leave.
MARKS: Free copies, free copies?
RITHOLTZ: Well, somebody paid for them.
There is — there is no free lunch.
RITHOLTZ: But Howard is going to be able to stick around for another 10 minutes, and I promised his wife I would not make him late for dinner. So let’s hear it for Howard Marks.
MARKS: Thank you. Thank you, all.