Oct 2, 2018

Howard Marks on market cycles, pot, and why 2018 is like 2006

Howard Marks, Co-Chairman of Oaktree Capital Management. Photo illustration: Axios Visuals

Understanding timing is everything, according to famed investor Howard Marks, in his new book "Mastering the Market Cycle."

Between the lines: Marks' book is essentially a how-to for forecasting stock market fluctuations, but he tells Axios that his intent isn't to warn investors about the bull market's finish line:

"Where we stand in the cycle determines our likely outcomes. Unless you're happy being [a passive investor], I think you should try to figure out where we stand and behave accordingly."

Marks, whose firm Oaktree Capital manages more than $122 billion, is known for his 2007 "Race to the Bottom" memo that predicted the financial crisis.

What past year is most similar to 2018?

"I think that capital market conditions are similar to 2006 in the sense that it's easy to get transactions done, even ones which don't have a lot of virtue. The combination of money and willingness, especially when you add in optimism and the lack of low-level risk aversion — that recipe is very easy to do deals when in some cases should not get done.

[But] there are other ways in which the comparison is not accurate. Financial institutions are not so highly levered and the grist for the global financial crisis was subprime mortgages and mortgage-backed securities and I don't see an analogy in today's market to the subprime mortgages in terms of its magnitude and its fallaciousness or fraudulence."

The downside of market prognostication:

"Macro-forecasting is extremely hard to do right. Usually extrapolation is right, but the trouble is since everybody else extrapolates and you extrapolate, all you're doing is joining the herd. And in order to have a valuable forecast you have to deviate from the herd and you have to be right. Only eccentric, non-consensus forecasts are valuable but most of the time non-consensus forecasts are not correct. And what that means is forecasts, generally speaking, are not valuable."

What could make earnings decline?

"Profit margins are unusually high and may not be durable. Interest rates are rising so future expenses could rise. This is quite a strong year in the economy and strong Year One makes a difficult comparison for Year Two."

On the state of distressed debt:

There haven't been a lot of safe, easy ways to make a lot of money in distressed debt without taking risk. So it's been a slow period. [Oaktree Capital has] reduced the amount of money we have under management in distressed debt and, by doing so, we have been able to remain selective and somewhat agile and I would say we have had good results but made smaller amounts of money. One of these days when the up-cycle ends and the down-cycle begins, we will have a revival in the distressed debt market. I just can't tell you when. “

On pot stocks:

"I haven't looked at [cannabis companies], but if you look at every market boom, one of the ingredients is newness. People haven't seen before, it hasn't been valued before. I talk in the book about the four worst words in the world: it's different this time. When you have something new come into the markets — whether it be the Internet stocks in 1999, or e-commerce stocks or the subprime mortgages in 2006— then people are able to say the old rules and valuation norms don't apply anymore because this is new and you've never seen anything like this...

There may be a company out there that becomes the 'Google of pot stocks' and turns out to be enormously valued. At some point there will be 100 of them, all of which are predicted to become that one. And obviously that's a way to lose money."

What Marks still wants to learn:

"I don't think I could program a computer to do a great job investing... Another is bitcoin. People say to me: 'You've got it wrong. You're missing the merits in bitcoin. It has values you can't see.' Well, maybe it does. Maybe I have to learn more. Maybe it has to unfold."

On the book’s bottom line:

“Where we are in the [market] cycle shapes the probability distribution of returns that you face and so it’s worth trying to figure out where we are.”

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