In that memo he was speaking primarily about the bond markets, but he said investors’ “pro-risk behavior is having its normal dangerous impact on the markets.” What is your opinion? Are investors sufficiently heeding the risk that is now in the market?
Investors have plenty of things to worry about – and they are worried. Nevertheless, they are buying stocks and bonds despite their lack of confidence. Fed policy has had a positive impact on stocks, to some extent, and bonds, to an incredible extent. Sophisticated bond buyers have to know the arithmetic that dooms long-term bonds to poor results when interest rates (inevitably) rise, but apparently think they can be among the lucky that escape before bond prices collapse. We think this is like picking up quarters in front of a steamroller, and we have kept the duration of our bond portfolios extremely short.
For stock buyers, the long-term prospects of many good companies are very bright and we are comfortable holding stocks of those companies. However, many more short-term-oriented stock investors seem to be bearish and fearful yet also fully-invested, because they can’t bear to be left out of a rising market. These investors will probably be sellers at the first sign of trouble and bring us some welcome volatility.
Do you agree with Howard Marks’ assertion that the scramble for returns has brought elements of the pre-crisis behavior very much back to life?
Definitely. Bond investors are so desperate for yield that they are paying very high prices (receiving low yields) and buying bonds with very issuer-friendly terms and covenants. Junk – excuse me, “high-yield” – bonds are near record-low absolute yields and record-low spreads over Treasury yields. It is ironic that part of investors’ current interest in bonds is driven by their recent bad experience with stocks, yet they are forgetting about the recent mistakes they made in buying bonds.
Value investors had a particularly bad year in 2008, in many cases their worst year ever. Why didn't value investing do as good a job at protecting assets in the market decline as in previous bear markets? What did you learn from the 2008 bear market experience?
Value investing, done well, is very good at protecting investors against permanent losses, but in a full-scale panic, all stocks tend to go down together. Gordy Crawford, one of the all-time great media investors, said in a recent interview that in a market like 2008-09, there is no place to hide. Companies with strong balance sheets and good competitive positions came through the recent recession and bear market in good shape, and their stocks have recovered. There were some companies, though, that were caught in the brief liquidity crisis after Lehman’s failure and did not live to see the recovery. This was a good reminder that liquidity risk is to be avoided.