I guess it’s Howard Marks week (the earlier post this week was totally unintentional). The latest Marks Memo made an appearance two days ago. To top that, Marks appeared on the Tim Ferris podcast.
The timing of the two conveniently fits with his soon to be released book Mastering the Market Cycle, which comes out next week. My copy is pre-ordered, which I’ll report on once I finish it.
Reading through the memo, I didn’t see anything new that Marks hasn’t already said. Market valuation is still high but not excessively expensive, the cycle is long in the tooth, and memories of 2008 are fleeting. The talk today has less to do with the pain of the past, but how long will good times last. It’s not euphoria, but there is an aversion to safety.
Marks offers multiple examples on the debt side of higher risk-taking. Businesses looking to borrow will find higher rates today than a year ago (the 2-year Treasury rate has doubled in the past year, from 1.4% to 2.8%…corporate high yield is just over 6%, triple-C rated is above 9%).
Businesses are dealing with higher borrowing costs yet lenders are loosening lending standards because there’s “too much money chasing too few deals.” There’s a lower margin for error on both sides. When things have to go perfectly in order to make money, you’re taking a huge risk.
This time around, it’s mainly public and private debt that’s the subject of highly increased popularity, the hunt by investors for return without commensurate risk, and the aggressive behavior described above. Thus it appears to be debt instruments that will be found at ground zero when things next go wrong. As often, Grant’s Interest Rate Observer puts it well:
Naturally, the lowest interest rates in 3,000 years have made their mark on the way people lend and borrow. Corporate credit, as [Wells Fargo Securities analyst David] Preston observes, is “lower-rated and higher-levered. This is true of investment grade corporate debt. This is true in the loan market. This is true in private credit.”
So corporate debt is a soft spot, perhaps the soft spot of the cycle. It is vulnerable not in spite of, but because of, resurgent prosperity. The greater the prosperity (and the lower the interest rates), the weaker the vigilance. It’s the vigilance deficit that crystalizes the errors that lead to a crisis of confidence.
Conditions overall aren’t nearly as bad as they were in 2007, when banks were levered 32-to-1; highly levered investment products were being invented (and swallowed) daily; and financial institutions were investing heavily in investment vehicles built out of sub-prime mortgages totally lacking in substance. Thus I’m not describing a credit bubble or predicting a resulting crash. But I do think this is the kind of environment — marked by too much money chasing too few deals — in which investors should emphasize caution over aggressiveness.
The time to be less cautious, to take chances, was 10 years ago. Because if the world actually ended, as many believed was possible, what did it matter? Of course, the world didn’t end and there’s been no significant downturn since.
So does it make sense to start taking chances 10 years later or should now be a time to take less risk? My take is the odds are against a long continuation of the current cycle. The time to plan for the next downturn is before it happens, not after.
Go read the memo and decide for yourself — Marks Memo: The Seven Worst Words in the World (pdf).
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The Tim Ferris interview is a great listen if you haven’t already. Some questions are the same one’s Marks always gets, so the responses are repetitive. But Ferris does ask some great questions that just don’t get asked very often. Those are worth it (not that the repetitive answers aren’t).
I jotted down a few highlights below from the my listen yesterday. Otherwise, go check it out.
The question of when is one of the hardest ones in our business. And I always say that we may have an idea of what’s gonna happen but we never know when it’s gonna happen. You can’t call these things. As one of my partners says, “If you name a price, don’t name a date. And if you name a date, don’t name a price. And then you can’t be wrong.”
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I think that the two most important things are where we stand in the cycle and the broad subject of risk. And, in fact, where we stand in the cycle is the primary determinant of risk.
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One of the keys to successful investing is to either be unemotional or at minimum act like you are. The great investors I know behave in an unemotional fashion… It’s not easy… I absolutely don’t want to give the impression that it’s easy. It’s terrifying. Others are terrified. That’s why they’re selling. That’s why they’re saying, “I don’t care what the price is, just get me out.” That’s when you want to buy. But the things that terrify them into selling, will also terrify you. You have to overcome it.
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To teach yourself to be unemotional is to counter human nature. And by definition, it can’t be easy.
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People should wake up in the morning and start the day by practicing, “I don’t know. I don’t know.” It’s a great thing to say and not enough people say it.
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Nobody ever says, “You know, my opinion is X and I think I’m wrong.” We all think that our opinions are correct… It’s one thing to have an opinion. It’s another to believe and act as if it’s right. And if you just say, “Maybe I’m wrong,” the world gets easier… The most important single thing is to not have the same degree of conviction about all of our opinions.
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There is nothing more dangerous in life than being sure you know something you don’t know. If you have excess certitude, you will do things boldly, in dangerous ways, and to dangerous extents, that have the ability to get you into trouble, to get you killed. But a sentence that starts off “I’m not sure, but” is unlikely to lead to fatal action. The distinction to me is so clear and so unarguable, that I think this is one of the most important things for life. Know your limitations.
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There is no rule that will ever work in every case… There can’t be a rule that always works. One day, just before the publication of my other book, I had lunch with Charlie Munger. And at the end of the lunch, when I got up to go, he said, “Now just remember, none of this is meant to be easy. Anybody who thinks it’s easy is stupid.” These things cannot be reduced to a rule. The market operates so as to confound rule makers.
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One of the most important things in investing is to make people comfortable. It’s a mistake to sit there and say, “You should do this, you should do that,” regardless of people’s comfort level. Because if you violate their comfort level, if you force them into things that are too risky them, and things go bad, their unlikely to do the right thing. They’re more likely to panic and sell on the lows, which is the cardinal sin of investing.
Last Call
- Winner Takes it All: How Markets Favor the Few at the Expense of the Many – Farnam Street
- Looking Past the Fed’s Next Rate Hike – Vanguard
- 3 Shades of Value – Morningstar
- Different Kinds of Smart – M. Housel
- Spicy Distributions – J. Catherwood
- Wall Street and the “Vampire Squid”: A Brief History – J. Zweig
- The Worst Takes on the Financial Crisis – Institutional Investor
- Q&A with Robert Frey Formerly of Renaissance Tech – Bloomberg
- Insider Trading’s Odd Couple: The Goldman Banker and the NFL Linebacker – Bloomberg
- Football is Changing. Bill Belichick Doesn’t Think the Keys to Winning Ever Will. – Washington Post
