Tue, 23 Jul 2013
For several years, investors have been acting bullish (if not thinking bullish) in bonds, bidding up safe instruments, while the interest in equities is still modest, with the potential for more relative value, says Oaktree's Howard Marks.
Jason Stipp: I'm Jason Stipp for Morningstar. Howard Marks is the chairman of Oaktree Capital and the author of some of the most enlightening shareholder letters you're likely to read. He is also a keen observer of the market and its many personalities. He is calling in today to give us a sense of where the market is today and the mood of investors today. Thanks for calling in Howard.
Howard Marks: It's my pleasure.
Stipp: Howard, you have a process that you call taking the temperature of the market. This is where you look at things like the attitudes of investors and commentators, headlines, the interest in new issuance, the amount of leverage that's taken out. When we spoke about a year ago, you said that the mood of the market was moderate. It wasn't too pessimistic, it wasn't too optimistic, even though we were facing some European crisis issues. I am interested to check in with you today, given that the market is up about 25% over the trailing 12 months, what's the temperature of the market now that we've seen a continuance of this bull market?
Marks: When we last spoke, by the way, most people when they say "the market," they mean the stock market. I don't, because our business is credit. And when I say the market, I am kind of talking about all the markets together, which is challenging, because they are all different. But when we spoke a year ago, I thought that for equities, the market temperature was actually quite cold, interest in them was quite low and had been low for a decade, and they penalized people for a decade, the so-called lost decade. People had lost interest, and I thought they were quite interesting for that reason because they were overlooked, unloved, underowned, and underrepresented in portfolios. Of course, a good deal of that has changed, thanks to the movement over the last year plus, as you described. I think there is still only a modest interest in stocks. I think the stock representation is not back to what it was 12 years ago or 20 years ago or what have you, and I don't see enormously bullish commentators.
In the debt world, I think that the temperature became quite high, you might even say overheated, in the period 2012 and maybe into the first half of 2013; not so much because people were ravingly bullish in their attitudes or oblivious to risk, you mentioned the risk in Europe. There are lots of risks out there today, and everybody is pretty conscious of them. So why would the market become overheated if psychology was modest, and I think the reason is because, in the way I put it in one of my memos, even though people weren't thinking bullish, they were acting bullish. They were going out the risk curve, talking greater risks to try to get greater returns, especially in the fixed-income world because they were forced to.
Why? Because when the Federal Reserve Bank and the other central banks took interest rates down to zero, what they basically said is you can't get any kind of adequate return from Treasuries and high-grade bonds. If you want a good return, you're going to have to go further out the risk curve. Of course, one of the goals of central banks in a crash or crisis, such as we were experiencing, is to rekindle risk-taking. I think they did a darn good job of it this time around by eliminating the return on safe instruments. This caused people to have to go out the risk curve and it caused prices for assets to become quite elevated, perhaps in the absence of bullish attitudes. I hope that's clear, Jason.
Stipp: So, Howard, we've seen a bit of, what some people are calling, a rotation, especially after the last few weeks in the fixed-income markets where we've seen rates take up and bonds take a hit and fund flows out of fixed income. Do you think that attitudes are changing about the risk-taking in fixed income given what we've seen recently? Are we at an inflection point?
Marks: Well, I think that attitudes have changed somewhat. I don't know if it's permanently or enormously, but most people's answers aren't as long as mine. Most people go for rather simplistic answers, what I call simple mantras. From 1960 to 2000, the mantra for investors was growth, and they fell in love with stocks, I would say to excess, and stocks became too expensive by 2000. And that's the reason why they had the lost decade from 2000 through 2011.
In that period, stocks did poorly. Bonds did well, and they had to develop a new mantra, which was safety and income. Where do you get safety and income? You get it from bonds. So, they went out to buy bonds, and by the time that period was over, they owned many more bonds than they did it at its start. When people opt for simple mantras, they usually overlook something. What they overlooked in this case was the fact that bonds don't give you safety and income, regardless of what you pay for them. One of my constant themes is that there is no such thing as a good idea other than in the context of price.
So people overpaid for bonds, especially high grades and Treasuries, and bid them up too high. I think there was a lot of pain quickly after [Fed chairman Ben] Bernanke hinted at the tapering off of the QE program, the bond-buying program, and I think that did change some attitudes. So, I would hope that people are not so blindly in love with bonds regardless the price now.
Stipp: Howard, if fixed-income markets were looking like they were getting overheated and may still be to some extent, when you're looking across the market, where are you finding areas that are colder which would translate, potentially, to opportunity for you?
Marks: I do think that this love affair of investors with bonds from 2000 to 2012 did cause high-grade and Treasury bonds to be high in price relative to equities, which languished for a decade. These words all have flip sides, and "languishing," the flip side of that is getting cheaper. And so equities did languish. If the stock prices stay the same, which they essentially did for a decade, and the companies double their earnings, which they did, then basically the stocks have gotten half as expensive in P/E terms, and that's what happened. So I think a shorter answer to your question, which you probably wouldn't mind, Jason, is probably that equities, yeah, got cheap relative to bonds.
Another area that's gotten cheaper lately is emerging markets. Four years ago, everybody thought that it was over for the developed world of the United States, Europe and Japan, but that China and the other emerging markets had unlimited potential. So, again, the developed-world stocks languished and the Chinese stocks soared. And the U.S. stocks got too cheap, and the Chinese stocks got too expensive. Now that's been somewhat redressed. I think that Chinese stocks--I don't know, I am not talking about the fundamentals of the economy in the short term and I am not talking about them in detail, but I do think that the emerging markets have gotten cheaper relative to developed world and deserve a look.
Finally I'll mention real estate. I am not talking about A buildings in A cities, but secondary and tertiary real estate in noncore cities, we think, is relatively attractive. Now, again, you can't just say real estate; you have to say at what price. A lot of people rushed out to buy REITs, maybe they bid them up to too high a price and maybe REITs ceased to be the way to play real estate. But we are in the business of buying real estate; that's easier for us than maybe your listeners. And we look for ways to play real estate. So, those are just few examples of how I am thinking today.
Stipp: Last question for you, Howard, is more of a personal one. You've been watching the markets for a long time. You've been studying the swings that occur and recur, but at the end of the day we're all human beings and we're subject to emotions. I am just wondering how you as an investor are able to walk away from those emotional urges. It's easy to say, "Buy low and sell high," but when the time comes it can be a tough thing to do.
Marks: I think that you're right. It's very important, and it's very tough. I think it helps to associate with likeminded people, and my partners and I buttress each other. We keep each other calm in heated times when the market booms and we keep each other more collected in tough times. In 2005, '06, '07, precrisis, we spent most of our time going into each other's office and saying, "Hey, look at this deal. This is crazy. How did this deal get done?" When you can see the deals that are unwise and shouldn't be done are getting done, and that's a way to take the temperature of the market, so we cool each other off.
Then when things collapse and there is a tendency to lose heart, we remind each other how good the values are. Now, of course, I've been doing this for 45 years, and my team and I have been through three crises in the debt world in 1990, '02, and '08. When you've been through a few crises, then you start to realize that things don't just collapse and stay there. They tend to come back, which means that the low prices are more of a signal to buy than a fear factor telling you to get out. I think that experience, understanding the issues and the health of, let's say, a support network.
Stipp: Howard, it's always well worth the time we spend with you. Thanks so much for calling in today and for your insights.
Marks: Well, thanks for these good questions, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.