Howard Marks is out with a new Memo this week. He offers his view on where the market’s stand today and a lengthy discussion on the impact of the tax cuts.
The short version on tax cuts is it’s short-term positive, long-term negative – mostly good for businesses, but for individuals it depends. He covers some second-order consequences for the tax in general and the new state and local tax deduction limit specifically. It’s worth reading through.
The rest of the memo is spent reviewing things he’s repeated the last few years. So if you’ve read any Memos the last couple years, it will sound familiar:
For years my description of the factors characterizing the markets has been essentially unchanged:
- a large number of big-picture uncertainties,
- sub-par prospective returns,
- above average valuations, and
- pro-risk investor behavior.
For as long as I have been discussing this view, no one has ever taken issue with any of these observations. Do you? That’s the key question. And if not, what will you do about it?
You could have made the above four points a year ago, and two years ago, and three years ago, etc. And in general I did. Thus it was possible to argue for raising some cash at a variety of times over the last few years. However, going meaningfully to cash would have been a big mistake – certainly based on how markets performed, but also on the merits – and I think it still would be wrong today.
He goes deeper into the positives and negatives in the market today. What he’s doing is what every investor should be doing – weighing the pros against the cons as it pertains to their strategy, goals, etc. and deciding on an allocation they’re comfortable with based on the level of risk in the market.
For Marks, when risk is high he’s more comfortable accepting a lower return today, in order to avoid the higher potential of a big loss tomorrow. That big loss may not happen, but to him, it’s not worth taking the risk.
This is something every investor needs to square with themselves.
Where investors get into trouble is focusing too much on the positive (negative) and, in turn, taking more risk (less risk) than they normally would. One thing that helps to avoid this is by understanding where we are in the market cycle. Mark’s concludes the Memo by explaining why this is so important:
Why do cycles occur? Why doesn’t the U.S. economy just grow at the average rate of 2-3% every year? And since the average return on the S&P 500 is in the range of 9-11%, why isn’t the return between 9% and 11% every year (and, in fact, why does the yearly return fall between 9% and 11% so infrequently)?
The simple explanation is that because of the involvement of people, economies and markets – as well as other cyclical phenomena – tend first to overshoot in one direction (and given how people are wired, usually to the upside) and then they are bound to correct in the opposite direction.
I think that description is highly relevant to the two topics discussed above.
- When markets do too well for a while – that is, when equity returns far exceed the growth rate of companies’ profits, and when bonds return more than their promised yield to maturity – it usually means they’ve become overpriced and will correct sooner or later.
- And when an economy expands faster than the potential growth rate determined by its population growth and increases in productivity – usually because companies or consumers borrow, invest or spend to excess – it’s likely to contract eventually. This happens either because the excesses are unsustainable in and of themselves or because central bankers take steps to cool things off in order to avert hyperinflation.
That’s the common thread here: markets that may have been doing too well, and an economy that may be in the process of being overstimulated. Both feel good right now, but each has potential negative consequences.
You can read the entire memo at the link below.
Marks Memo: Latest Thinking
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