Oaktree's Howard Marks on Credit Yields, Trump's Tariffs

YouTube Video

Summary

This YouTube transcript features an interview with Howard Marks, co-chairman of Oaktree Capital, discussing his views on the market environment amidst rising global uncertainties, particularly concerning trade and tariffs. The conversation revolves around his recent memo suggesting that credit offers a better investment deal than equities.

Key points from the interview:

• Credit vs. Equities: Marks reiterates his thesis that credit, even with current spreads, offers a healthy absolute return and is fairly priced, making it more attractive than equities in the current climate. He notes that credit yields have even slightly increased since his memo, making it even more appealing.
• Market Sell-off and Uncertainty: The market has sold off significantly since his memo, fueled by rising tariffs and global economic uncertainty. Marks acknowledges the world has changed radically, moving away from free trade and globalization towards protectionism and potential isolationism for the US.
• Globalization and Trade: Marks emphasizes the immense benefits of globalization and free trade for the past 80 years, arguing it was a major driver of economic growth and prosperity. He uses the example of Italy making pasta and Switzerland making watches to illustrate the efficiency gains from international specialization and trade. He warns that restricting trade will likely lead to higher costs and reduced overall welfare.
• Inflationary Pressures: Marks suggests that the shift away from globalization and the implementation of tariffs are likely to be inflationary. He points out that the deflationary pressure from cheap imported goods, particularly durables, has been a significant factor in keeping inflation low for decades. Tariffs, being an added cost, will likely be passed on to consumers, potentially reversing the disinflationary trend.
• Valuation and Returns: Marks challenges the notion that historical stock market returns of 10% annually are easily achievable in the current environment. He argues that these historical averages are based on average P/E ratios of around 16, while current P/E ratios are closer to 19. He suggests that returns from equities bought at higher P/E ratios are likely to be lower, potentially in the 1-7% range. In contrast, credit offers a more predictable return based on promised yields, with a historically low default rate in his experience.
• Dislocation and Opportunity: Marks acknowledges the current market environment as a time of significant dislocation. He emphasizes the extreme uncertainty about the future, making forecasting exceptionally difficult. He suggests that judging whether current asset price reductions are adequate, inadequate, or excessive is crucial for investors. If prices are excessively reduced, it presents a buying opportunity.
• Rejection of Forecasting: Marks expresses his skepticism about macro forecasting, especially in the current environment of extreme flux. He argues that the probability of any forecast being accurate is lower than usual due to the unprecedented level of uncertainty in global economics and geopolitics.
• Bloomingdale’s Analogy: Using the analogy of Bloomingdale’s having a sale, Marks encourages investors to view the market sell-off as a discount opportunity. He argues that lower prices should prompt a re-evaluation of assets rather than a knee-jerk reaction to avoid them.
• US as Investment Destination: While still considering the US as probably the “best” place to invest, Marks acknowledges that its attractiveness has diminished. He points to concerns about the rule of law, predictability of outcomes, and the unsustainable US fiscal situation (high deficits and debt) as factors eroding its relative advantage. He raises the question of whether recent events and policies might lead to a “credit limit” for the US or reduce global appetite for holding US debt, further complicating the fiscal situation.

In essence, Howard Marks presents a cautious view of the current market, highlighting the increased risks and uncertainties stemming from a shift away from globalization. He favors credit as a relatively more attractive asset class compared to equities due to its predictable returns and potentially lower risk in this environment. He urges investors to be discerning, recognize the sale prices in the market, but also acknowledge the unprecedented uncertainty and the need for careful judgment rather than relying on traditional forecasts.

Accuracy

Let’s assess the accuracy of some key claims made by Howard Marks in the transcript:

1. “Tariffs implemented are the highest levels that we’ve seen going back 100 years.”

   • Accuracy: Partially Accurate, Needs Nuance. While recent tariffs imposed by the US have been significant and represent a notable shift in trade policy, it’s not entirely accurate to say they are the “highest levels in 100 years” in all respects.
   • Explanation: The Smoot-Hawley Tariff Act of 1930 imposed historically high tariffs on thousands of imported goods in the US. While current tariffs are substantial, they might not be uniformly higher than the Smoot-Hawley era across all categories and countries. However, in terms of impact on specific sectors and trade relationships, and considering the globalized nature of today’s economy, the disruptive potential and political significance of the current tariffs are arguably comparable to historical periods of high protectionism. It’s more accurate to say that we are seeing a return to levels of protectionism not witnessed in many decades, and the rhetoric and direction are reminiscent of periods with historically high tariffs.

2. “Last 80 years since World War Two have been the best economic period in the history of mankind.”

   • Accuracy: Largely Accurate, Broad Generalization. This is a broad statement but generally supported by economic history and data.
   • Explanation: The post-WWII era, particularly the period from the late 1940s to the early 1970s (often called the “Golden Age of Capitalism”) and the subsequent period of globalization, saw unprecedented levels of global economic growth, technological advancement, and poverty reduction in many parts of the world. GDP growth rates in many developed and developing countries were exceptionally high compared to previous historical periods. While there have been recessions and crises, the overall trend has been one of significant economic expansion and improvement in living standards for a large portion of the global population. Of course, this period also had its challenges and inequalities, but in terms of overall economic progress, Marks’s statement holds considerable weight.

3. “Cost of durables in the U.S. went down by 40% in 25 year period in inflation adjusted terms.”

   • Accuracy: Likely Accurate, Requires Specific Timeframe Check. The claim about a 40% decline in durable goods prices over a 25-year period is plausible and aligns with the narrative of globalization and cheap imports, particularly from Asia.
   • Explanation: Data from sources like the Bureau of Labor Statistics (BLS) on the Consumer Price Index (CPI) for durable goods would be needed to precisely verify this claim. Durable goods, which include items like appliances, electronics, and furniture, have indeed experienced significant price declines in real terms due to factors like technological advancements, efficient global supply chains, and competition from lower-cost manufacturing regions. It’s important to specify the exact 25-year period Marks is referring to for precise verification. However, the general trend of real price decline for durables is well-documented.

4. “Stocks have delivered an average of 10% a year for the last hundred years.”

   • Accuracy: Generally Accurate, Widely Accepted Historical Average. The figure of 10% average annual return for US stocks (often referring to the S&P 500, including dividends and adjusted for inflation in some calculations) over the long term (roughly the last century) is a widely cited and generally accepted historical average.
   • Explanation: This is a commonly quoted benchmark in finance. Long-term studies of stock market returns, while varying slightly depending on the exact period, index used, and methodology, tend to show average annual returns in the vicinity of 9-10% for US equities over very long periods. However, it’s crucial to remember this is an average, and actual returns in any given period can deviate significantly from this average. Furthermore, this historical performance is not guaranteed to repeat in the future.

5. “When the p/e ratio is 19, historically, you probably made 1 to 6% a year or 2 to 7% a year.”

   • Accuracy: Directionally Accurate, Simplification, Depends on Period and Methodology. The inverse relationship between starting P/E ratios and subsequent long-term stock market returns is a well-established concept in finance. Higher starting P/E ratios generally correlate with lower future returns.
   • Explanation: Valuation metrics like the P/E ratio are indicators of how expensive stocks are relative to their earnings. When P/E ratios are high, it suggests that investors are paying more for each dollar of earnings, potentially implying lower future earnings growth or lower returns to normalize valuations. Empirical studies have shown that periods with higher starting P/E ratios have historically tended to be followed by periods of lower average stock market returns over the subsequent years (e.g., 10-year periods). The specific range of 1-7% is a simplification, and the actual range can vary based on the time period analyzed, the specific P/E ratio used (e.g., trailing, forward, CAPE), and the methodology of the study. However, the general principle that higher P/E ratios are associated with lower expected future returns is a valid and widely accepted concept in investment analysis.

6. “Roughly 99% of our issuers have paid as promised.” (Referring to non-investment grade credit)

   • Accuracy: Likely Accurate for Oaktree’s Experience, General Default Rates are Higher. This reflects Howard Marks’s experience at Oaktree Capital, which specializes in credit and distressed debt. While impressive, it’s important to note that general default rates for non-investment grade credit are higher than 1%.
   • Explanation: Oaktree Capital is known for its expertise in credit and distressed debt investing. Their rigorous credit analysis and investment strategy might contribute to a lower default rate within their portfolio compared to the broader non-investment grade credit market. Historically, default rates for high-yield bonds (non-investment grade) have fluctuated but are typically higher than investment-grade bonds. Long-term average default rates for high-yield bonds are in the low single digits annually, with spikes during economic recessions. Marks’s statement likely reflects the performance of their specific portfolio over a long period and may not be representative of the entire non-investment grade credit market. It’s a testament to their credit selection process and risk management.

Overall Accuracy Assessment:

Howard Marks’s statements are generally accurate in conveying broad economic trends and established financial principles. Some claims, like the tariff level comparison, require nuance and context. His statements about historical returns and P/E ratios are directionally correct and reflect widely accepted financial knowledge. His claim about default rates likely reflects his firm’s specific experience and expertise, which might be better than the average for the high-yield market. It is important to consider that in a short interview, some level of simplification is necessary, and the nuances and precise data backing every statement are not always fully elaborated.

Resources

Here are the top 5 resources to learn more about the subjects discussed in the transcript, focusing on investment strategy, macroeconomics, and globalization:

1. Books and Memos by Howard Marks:

   • Why it’s relevant: Howard Marks is the speaker in the transcript, and his insights are central to the discussion. Reading his books and memos provides direct access to his investment philosophy, thought process, and perspectives on market cycles, risk management, and value investing.
   • Specific Recommendations:
     • “The Most Important Thing: Uncommon Sense for the Thoughtful Investor”: A seminal book outlining Marks’s investment principles, emphasizing second-level thinking, understanding risk, and market cycles.
     • Oaktree Capital Memos: Howard Marks’s memos are renowned for their insightful analysis of current market conditions, economic trends, and investment strategies. They are available on Oaktree Capital’s website and offer a continuous stream of his current thinking.

2. “Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail” by Ray Dalio:

   • Why it’s relevant: This book directly addresses the theme of paradigm shifts and changing world orders, which is a central concern in the transcript. Dalio, another prominent investor, provides a historical framework for understanding cycles of rise and decline of empires and nations, which is relevant to Marks’s discussion of globalization, trade, and the US’s position in the world.
   • Content: The book examines historical empires and reserve currencies to identify patterns and principles that drive global power shifts. It offers a broader macroeconomic and geopolitical perspective that complements Marks’s market-focused analysis.

3. “Globalization and Its Discontents Revisited” by Joseph E. Stiglitz:

   • Why it’s relevant: This book delves into the complexities of globalization and its impacts, both positive and negative. Marks discusses the benefits of globalization, but Stiglitz offers a more nuanced view, addressing the challenges and inequalities that can arise from globalization, which are relevant to the current backlash against free trade and globalization discussed in the transcript.
   • Content: Stiglitz, a Nobel laureate in economics, examines the promises and realities of globalization, focusing on issues like inequality, financial crises, and the need for better global governance. It provides a deeper understanding of the economic and social forces shaping the global landscape.

4. Websites and Publications from Reputable Financial Institutions and Economic Think Tanks:

   • Why it’s relevant: To stay updated on current economic data, market analysis, and evolving global trends, accessing reliable sources of financial and economic information is crucial.
   • Specific Recommendations:
     • The Economist: Offers in-depth global news, economics, and business analysis.
     • Financial Times: Provides comprehensive coverage of financial markets and global business news.
     • Bloomberg and Reuters: News agencies providing real-time financial news and market data.
     • Websites of Central Banks (e.g., Federal Reserve, European Central Bank, Bank of England): Offer official economic data, reports, and analysis.
     • Websites of Institutions like the IMF and World Bank: Provide global economic outlooks, research reports, and data on international trade and development.

5. “Irrational Exuberance” by Robert Shiller:

   • Why it’s relevant: Marks touches upon the valuation of equities and the importance of P/E ratios. Shiller’s book is a classic work on market psychology and asset bubbles, emphasizing the role of behavioral factors in driving market valuations and the potential for irrational exuberance to lead to market mispricing.
   • Content: Shiller analyzes historical market bubbles and crashes, exploring the psychological and sociological factors that contribute to them. It provides insights into understanding market sentiment, valuation extremes, and the limitations of traditional valuation metrics, which is relevant to Marks’s discussion about current market conditions and equity valuations.

These resources offer a mix of expert perspectives, in-depth analyses, and up-to-date information to help further understand the complex topics discussed in the transcript and to develop a more informed view of the current investment landscape.