Howard Marks: Equities are Under-owned and Un-loved
Howard Marks is the founder and chairman of Oaktree Capital Management, a Los Angeles-based firm with approximately $80 billion of primarily fixed-income and distressed assets under management. The “illuminated” edition of his, book, The Most Important Thing, was recently released. It contains comments from notable investors, including Christopher Davis, Joel Greenblatt, Paul Johnson and Seth Klarman.
I spoke with Mr. Marks on November 15 at the University of Virginia Investment Conference in Charlottesville, VA.
In your book you make the following observations about cycles: “Rule number one, most things will prove to be cyclical. Rule number two, some of the greatest opportunities for gains and loss come when people forget rule number one.” At this time, are people forgetting rule number one in either the equity or the bond market? Tied into that, in your last memo in August, The Role of Confidence, you wrote that we were in the middle ground of the valuation cycle. What has changed since then?
That is still true. Markets go up and down, and at the bottom they’re cheap, and then they rise to fair and then rich. We are in the middle range with regard to U.S. stocks. They have come a long way from the lower range a year and half ago. They are probably up 45% on the S&P from there. I thought they were very cheap at that time, and now they are at fair to full value. Full does not mean over-priced. I think they’re somewhere in the upper part of the fair territory.
All bonds are expensive since interest rates are being held artificially low by the Fed’s bond-buying program. One of these days, I hope, the government will stop holding interest rates down and rates will go up a moderate amount. If the 10-year today is 2.7%, my guess is it is going to go to 3.5% to 4%, but not to 6% right away. Bonds in general are rich. Credit spreads within the bond universe look okay.
You are a proponent of second-level thinking. Can you give a short explanation of what that means for the benefit of our readers?
It mainly means that you have to understand how securities are valued and how money is made. If you take a simplistic approach you can’t succeed. Second-level thinking says that you have to think different from and better than the crowd. If you think the same as the crowd you’ll have average results.
How is money made? If corporate profits grow 6% a year, it’ll be easy to make 6% a year in stock market. But to make more, or to outperform others, you have to think different and better. Money is made when the crowd’s expectation of the future turns out to have been too low, when reality exceeds perception. Obviously, if you are going to make money to an above average extent, you have to see when the crowd’s thinking is off. By definition, if you think like the crowd you can’t know when the crowd is off.
As I say in the book, the first-level thinker says, “This is a good company, you should buy the stock.” The second-level thinker says, “This is a good company, but not that good. You should sell it because it is up on expectations.”