Howard Marks (02:55):
So, a pine away, but don’t put too much confidence in it. In the last six, seven years, I’ve been addicted to Mark Twain’s statement that it ain’t what you don’t know that gets you into trouble, it’s what you know for certain that just ain’t true. If you know a sentence that begins with, I don’t know, but, or I could be wrong, but ever got anybody into trouble.

Howard Marks (03:21):
The sentences that get people into trouble are, I’m sure that, or I’m confident that, or there’s no doubt that. And what I’m talking here, Trey is about a mindset. And when you’re in an area which is beset with uncertainty, variability, unpredictability, randomness, things like that, it just strikes me as folly to be confident that you know the future.

Howard Marks (03:53):
And I think it’s one of the most important things in life, any walk of life is to be realistic. And I think that realism in investing includes not being too confident about what you think you know.

Trey Lockerbie (04:07):
Well, let’s talk about another Mark Twain quote, which is history doesn’t repeat itself, but it does rhyme. And what I’m kind of curious to talk to you about, since you’re such an expert on market cycles, and have written one of my favorite books on market cycles, there’s always this hesitation to buy into the hype of a bubble, perhaps, and say this time is different.

Trey Lockerbie (04:27):
But what I’m really curious to know is, in your letter, you state that since 2008, we haven’t been operating in a free market. And so, is this time truly different?

Howard Marks (04:38):
Well, I think this is a very different time. And in fact, the events of the last year and a half, are the COVID, cyclical events occur for reasons that are endemic, internal to the market. And they usually have to do with excesses of optimism and then correction, which leads to excesses of pessimism, and then correction.

Howard Marks (05:07):
So, people think they know that things are going to be very good, but then they incorporate too much optimism, which means that they buy too much. They use too much leverage, they drop down in quality too much, they bet more than they should, et cetera. And when everybody does that, prices go too far on the upside to the point where they become precarious, and then they correct.

Howard Marks (05:33):
And then, on the downside, people sell, short, retreat to the sidelines, swear they’re never going to take the risk again. And eventually, things go to excess on the downside, but because everybody has sworn off risk-taking, they don’t get back in. So, what we’re all in this business to do, those of us who are active investors is buy low and sell high.

Howard Marks (05:58):
But everything in our nature conspires to make us buy high and sell low. And so, it is essential to combat those instincts. And this event of the last year and a half was not a cycle. It wasn’t born, I mean, the decline was not born out of excess optimism. And the recovery was not merely a bounce back from excessive pessimism.

Howard Marks (06:26):
This was like a meteor hitting the earth from outer space. The decline wasn’t the result of being out of business. It was it? This thing is called the pandemic, the Coronavirus. Then, the recovery was not merely a bounce back from excess pessimism, it was the result of the greatest economic rescue effort in history, which worked.

Howard Marks (06:49):
So, I think that there are relatively few lessons about cycles to be gained from last year and a half. And I think that maybe the greatest lesson to be gained is that it’s hard to estimate fully the things that are going to happen. And by the way, one of the things that’s worth noting is for those people who consider themselves forecasters. Who among us understood on March 23rd that from that date on the market would march up in a straight line to the point where it has now doubled?

Howard Marks (07:24):
From March 23, 2020, till today, August 21, the S&P 500 has doubled. Where are the people who thought that was the case? I certainly wouldn’t be one of them. And most of us under participated in the rally. Now, that’s a bit of an oxymoron, because if we under-participated, everybody under-participated, then how did the rally take place? And that shows you the folly of generalizations. But the point is, this was not a normal cyclical event. It was something very different.

Trey Lockerbie (07:55):
I’m glad you bring that up, actually, because there’s an old adage that you can’t time the market, right? And JPMorgan did this study back in 2015. It basically showed that by missing the best days in the market, which were essentially the days when the trend capitulated, it resulted in a massive difference in return.

Trey Lockerbie (08:13):
So, for example, staying fully invested from ’97 to 2016, resulted in an S&P return of 7.68%. Whereas by missing the 30 best days in the market, which were usually after a quick correction of source, your return would actually have been negative 0.5%. So, I know that Oakmark obviously has attended about not timing the market. So, what I’m more curious about is how you balance positions based on the cycle versus simply just investing through all fluctuations?

Howard Marks (08:46):
I think the answer, Trey, lies in the fact that while we invest through just about all situations. There have been times that we turn quiet, that doesn’t mean we behave equally in all situations. And sometimes we become more aggressive, and sometimes we become more defensive. And I think that’s a good thing to do, although clearly, it’s not easy to do it right.

Howard Marks (09:09):
And if we were to make the mistake that you just outlined in those 30 days, we would really have heard our clients. One thing I want to say before I move on is that in a way, the thing you pose is what we used to call in high school a trick question because those of us who are attentive to the market cycle and let’s say you’re good at doing it would be less likely to be out of the market on those 30 days.

Howard Marks (09:36):
What you’re saying is after the market gets killed, it usually bounces back. And if you missed that bounce day, you’re in trouble. Well, number one, if you missed the bounce day, you might have also missed the killing day, so they may offset. But if you’re a good timer and sensitive to excesses and able to weed them out, chances are you would not have dropped out of the market at the low ebb and missed the rally.

Trey Lockerbie (10:04):
Great point.

Howard Marks (10:04):
Yeah.

Trey Lockerbie (10:05):
You might have also missed the initial decline.

Howard Marks (10:07):
Well, exactly right. So, to me, though, we hear those things all the time, if you would have missed the best day, the best 10 days were 30 days. It’s like fun with numbers. Yes, if, but is it possible? I think the main import of your question is that the market does not perform smoothly. And there are huge updates and also big down days.

Howard Marks (10:31):
The updates, I think tend to be bigger than the down days, but the function of the market setting the appropriate price for assets, it’s not a smoothly operating one. And every once in a while, there’s a big boom. And we shouldn’t be surprised when that’s the case.

Trey Lockerbie (10:46):
I guess I’m asking mainly because, we recently had Jeremy Grantham on and he highlighted that although a lot of people were calling this market a bubble for a long time, in his mind, we’ve only recently seen bubble activity. Whereas before the pandemic hit, we were in this very slow growth. And as you highlighted, it was the slowest growth since World War II.

Trey Lockerbie (11:05):
And so, I’m just curious, I guess if you’re seeing similar bubble territory now in the recent market days? And if so, if it’s reminding you of, say 2006, when you begin, “planning for destruction,” when things weren’t operating right. Are you seeing any similarities to that time?

Howard Marks (11:24):
Well, there certainly are similarities. And they are the events that cause Jeremy and others to say, bubble territory, and to blow the whistle of caution. I think this concept of aggressive versus defensive is very important. I go on TV every once in a while, mostly after I just finished writing a memo. And they’re constantly trying to get me to say, buy or sell, in or out.

Howard Marks (11:49):
And in the last four or five years, I’ve gotten away from that kind of talk. And now, the way I say it is this, and by the way, short answers, especially in the investment business, are usually a mistake, because the concepts are complex, and not given too easy short answers. So, rather than say, buy or sell, what I say is this, every investor, especially everybody in your audience, should have, in my opinion, a view of what their normal risk posture should be.

Howard Marks (12:20):
And let’s say we’re talking about individuals, let’s say we’re talking about you, how should you set your normal risk posture? And in my opinion, the answer is, you look at your age, your income, your current earnings, the relationship between your current income and your needs, the amount of money that you have in the bank, or in a portfolio, the number of dependents you have, the level of your aspirations. And in particular, you have to make a judgment about your ability to live with volatility, mostly intestinal.

Howard Marks (12:57):
Do you have the ability to ride out the ups and downs? Or are you likely to panic at the low and sell out, which is the worst wealth killer in history? You think about all those things, you mesh them together. The way I say it is from zero to 60. Zero is all cash, 60 is maximum risk plunging into aggressive investments may be using leverage. Zero to 100, where should you be?

Howard Marks (13:27):
You should probably be about 75 or 80. One thing is when you’re older, if you think about the market cyclically, ups and downs, the younger you are, the more you can count on the long-term trend. And you have the freedom to if you have the intestinal strength. You have the freedom to ignore the short-term ups and downs. The older you get, the long-term trend becomes a bit academic, and the short-term trends might make a bigger difference, especially people who are, for example, retirees.

Howard Marks (13:59):
Retiree or someone is about to retire, who has just about enough money to retire and live shouldn’t be investing aggressively anymore, because while the trend line outlook for aggressive investments might be positive, they might come across some difficult periods in which their lives may be thrown into a tailspin. And one of my favorite sayings is never forgotten the man who was six feet tall, who drowned crossing the stream that was five feet deep on average.

Howard Marks (14:28):
In our business, survival on average is irrelevant. You can say, well, yes, he survived on average. You have to be able to survive on the bad days. And you have to survive all the time. But the challenge, of course, comes on the bad days. And so, anyway, the point is, you come up with a number and you say, Trey, okay, I’m on 80.

Howard Marks (14:51):
My next question is, will you change your risk posture from day-to-day or month-to-month, depend on what goes on in the market? Some people say no, I’m not going to change. I’m in the position, I have a good portfolio, I’m going to leave it alone. Some people say, yes, I’d like to change, because there when the market is too high, I’d like to cut back a little. And when the market is too low, I’d like to turn, put more oomph into my portfolio.

Howard Marks (15:15):
So, if you are interested in changing your posture as appropriate, then question number three, what about today? Today, do you think you should be more aggressive than your normal or more defensive than your normal? And I think that that’s a more useful way to think about this than buy and sell. And so, in the years leading up to the pandemic, we never had a bubble warning. We never turned highly defensive.

Howard Marks (15:44):
Our motto was to move forward but with caution. Move forward, make investments. We were making investments every day. We were trying to be fully invested, but with caution, since we’re a firm that takes a cautious approach to our investments. With caution meant more caution than you. And that’s what we did.

Howard Marks (15:59):
So, we had a portfolio that was biased toward caution. For several years, it didn’t help because it turned out that the period 09 through 19, for the most part, was a period when caution was your enemy, and aggressiveness was more helpful.

Trey Lockerbie (16:16):
Put the question on more caution. When you say more caution, are you referring to more of a cash position or just smaller position sizes in general? How do you think about caution?

Howard Marks (16:27):
That’s a great question. And most people throw that term around without asking that question. I think there are three ways to increase your caution. Number one, go to cash, in whole or in part. Very difficult, because number one, it’s a two-decision action. You have to get out, but then you have to get in at a more propitious time, or else it wasn’t worth it.

Howard Marks (16:52):
Charlie Munger says it’s actually a three-decision process because you have to get out, you have to get in, and while you’re out, you have to figure out what to do with the money. This is very difficult. And the other thing about, I try not to make decisions, which are going to be a disaster if things don’t break your way.

Howard Marks (17:08):
I think one of the important aspects of being a good investor is you try to set things up so that if things go your way, you do great. But if things don’t go your way, you still do okay.

Trey Lockerbie (17:20):
When you were referring back to the idea of as you age, getting more defensive, the typical routine or playbook for that would just be adding more and more to more allocation towards bonds. But given today’s environment with the yields being so low, and you’re guaranteed to lose money right now on a real basis, is that really the best move as you’re getting into your more defensive stage?

Howard Marks (17:45):
So, the first way is to raise cash. But that’s a real big problem because if you go to cash today, and the market doesn’t crap out for the next two years, let’s say it goes up 12% a year. Two years from now, you’re going to be behind the eight balls. You lost out on 24% of appreciation. You’ll never make that back. So, going to cash is problematic, we never do it.

Howard Marks (18:07):
The second, change your asset allocation. So, for example, we all know which asset classes are supposed to be more defensive than others. Bonds are supposed to be more defensive than stocks. Big stocks are more defensive than small stocks. Emerging markets are less defensive than developed markets. The U.S. is more defensive than Europe, et cetera.

Howard Marks (18:27):
So, you can move from aggressive assets into defensive assets. And the trouble with that is you have to really transform your portfolio. You have to do a lot of selling and a lot of buying. And if you’re in funds, it’s hard to get out and so forth. The third way of being defensive is the one I would suggest to most people. First of all, remember, most people don’t know when it’s time to get in and out. So, they shouldn’t be doing aggressive things.

Howard Marks (18:53):
What they should do, in my opinion, is at the margin, you’ve made changes in your portfolio that biases in a certain direction. So, let’s say you want to be more defensive. So, in every asset class, in high yield bonds, stocks, high-grade bonds, anything, there are ways to be defensive and ways to be aggressive within the asset class. So, for example, you say, well, I have a 30% commitment to, let’s say, high yield bonds.

Howard Marks (19:21):
There are high yield bond funds out there, which make the most in the good times, but lose the most in the bad times. There are other high yield bond funds that lose the least in the bad times but don’t keep up in the good times. So, you can switch managers within your high yield bond commitment, switching from aggressive managers to defensive managers. And that’s the one that I think most people should look at.

Howard Marks (19:46):
It’s just hard to get it right to justify major changes in your portfolio based on hunches, which is what I think they are, hunches about the macro.

Trey Lockerbie (19:58):
I’d like to tie back to the question right before that about, so as you’re thinking about entering a more defensive age for the retail investor, and it was most commonly going to bonds, I’m just wondering how you’re thinking about bonds. Ray Dalio recently said, he’d rather own Bitcoin than a bond, because you’re guaranteed to lose on a real basis. How are you thinking about bonds today?

Howard Marks (20:20):
No, I think that’s right. I think that, first of all, it’s in a way, it’s easy to say no bonds, it’s very tempting to say no bonds with yields where they are. But if you say no bonds, then I mean, bonds are, in absolute terms, they are the safe asset class. If you say, no, we’re not going to have bonds, then how are you going to implement safety in your portfolio?

Howard Marks (20:45):
So, Ray is certainly right that today’s bonds are very unattractive. But you may want to have. I would think of bonds today, look, in this day, when the Fed funds rate is zero to a quarter percent, and the U.S. Treasury pays less than the 10 Year pays less than one-and-a-half and so forth. I would think of bonds of that type, safe bonds like cash. A way to store money safely from which you don’t expect much.

Howard Marks (21:10):
Nobody who invests in the bond market today is going to make much, but hopefully, they’ll make a little income and their position will be steady if interest rates don’t go up much, which is an important caveat. But I sit on some nonprofit investment committees and have done over the years. Today, I’m pretty emphatic that there is no place in your portfolio for something like an endowment.

Howard Marks (21:34):
There’s no place in that portfolio for securities, whose only merit is that they’re not going to go up and down much. As you say, if you buy the 10 Year Treasury today, you guarantee yourself a return over 10 years of less than 1.5%, which doesn’t do much for anybody. Endowments typically need about a 7% annual return to accomplish their philanthropic mission.

Howard Marks (22:00):
And if you put many 1% bonds in the portfolio, it’s going to make it awfully hard to get to seven. And if you do so, and you still want the seven, that means with the rest of the money, you’re going to have to do things that are extremely aggressive. You try to offset, the money that’s invested in 1%, and that risk could bite you in the butt.

Howard Marks (22:21):
So, I think that certainly, Ray is right. In most portfolios today, there’s no place for safe bonds.

Trey Lockerbie (22:28):
I’m tempted to ask, I know you’ve been spending a lot of time with your son Andrew over the last year through the pandemic and talking a lot about Bitcoin. Any thoughts on that working its way into the portfolio at a time like this?

Howard Marks (22:40):
I came out very strongly against Bitcoin in 2017, which was the first time when it entered our consciousness. It probably had been around for seven or eight years before that, but that’s the year that went from one to 20 and everybody started… 1,000 to 20,000. And that’s the year that everybody started talking about it.

Howard Marks (22:58):
And I came up very negative because I said, there’s nothing behind it. It doesn’t produce any cash flow or any return. Intrinsically, the only return you’re going to get in Bitcoin is by selling it to somebody for a price higher than you paid. But you can’t value it, you can’t say what is the fair intrinsic value of a Bitcoin, and it doesn’t produce cash flow. I was extremely negative, I was extremely outspoken.

Howard Marks (23:23):
And as you say, I spent a good deal of the pandemic living with Andrew and his family. And we had to hash out some of these things because he’s on the other side. The first thing I was informed of by him is, and I accept this, is that at that time, and even today, I don’t know enough to have a strong opinion about Bitcoin.

Howard Marks (23:45):
Over the course of my life, I’ve been quite a skeptic. I’ve been successful in being skeptical of financial innovations. But that doesn’t mean that all financial innovations are not worth it. And so, I think that my reaction was a knee-jerk reaction to something new. And now, I prefer to say, I don’t know enough about it to have a strong opinion.

Howard Marks (24:07):
Andrew says to me, Andrew does on it, and obviously, it’s been a very good investment. And fortunately, he owns it for me because he manages money for our family. But he says to me, “Dad, are you ready to admit that I was right?” So, I said, “Well, let’s put it this way. I’m less emphatic that you are wrong.”

Howard Marks (24:23):
But I mean, Bitcoin has been around now for a dozen years. And if it’s a flash in the pan, it’s an awful long pan. Maybe it’s something there. And what I missed in 2017, looking for intrinsic value and cash flow production, I missed the supply-demand case. The supply-demand case is that the software limits the issuance of Bitcoin by the creation of Bitcoin to 21, I think 21.5 million, whereas the demand can grow for a long time.

Howard Marks (24:53):
People who live in places where you can’t get to a bank, where you don’t trust the banks, where you don’t trust the government, where you don’t trust the currency, a lot of these people are going to, maybe, turn to cryptocurrency. The other thing is that there’s a big argument that it’s, they call it digital gold, that it has some of the qualities of gold in the sense of being inflation resistant, and maybe crisis resistant.

Howard Marks (25:18):
But relative to gold, it has advantages, which is you don’t have to pay to store it, it’s not challenging to send it someplace, move it around, and you can spend it, which you can’t do with gold. So, those are the arguments in favor of Bitcoin. And certainly, in 2017, I wasn’t familiar with them. And the people who bought Bitcoin, let’s say, a year and a half or two years ago, have made a lot of money now.

Howard Marks (25:42):
We’ll see, we’re probably not finished learning all there is to learn about Bitcoin. And we’ll see in the future, whether it turns out to be a legit asset class and holds value. As the years go by, it gets harder to say there’s nothing to it.

Trey Lockerbie (25:57):
I asked, because after reading your latest memo, and while you do say you don’t understand enough of maybe about the technology, you certainly understand, I mean, you layout the perfect case for Bitcoin, in my opinion in your letter from the macro sense. And one of the other points I wanted to talk about that you’ve referred to recently, stems back to the cost of capital.

Trey Lockerbie (26:19):
And I’m wondering how you think through that, given that manipulated, maybe too strong a word, but that certainly seems to be the case. And I’m wondering how you think about the discount rates today and what you’re using in comparison to the interest rates at hand.

Howard Marks (26:35):
Great question, not an easy one. But I did say in the latest memo, that we haven’t had a free market in money for at least 12 years. And what I mean by that is that I’m sure that everybody who’s an investor has to believe in the free market system. We probably don’t have many socialists or communists investing in our stock market.

Howard Marks (26:53):
But if you believe in the free market, a lot of your belief is that in a free market, assets flow to their, what we call their highest and best use. And so, the free market does a very good job of allocating resources. Nobody’s going to work in job B if they can make much more money in job A. And the reason they can make more money in job A is that job A is working on a better product, which faces more demand, more people want it.

Howard Marks (27:24):
So, there should be a product, a company is more valuable, workers will go to work there. So, the resources migrate to their best use. And normally, the free market does a good job of incorporating considerations of risk and return. And when you’re operating in the free market, a lot of people say, well, on the one hand, I’d like to make a lot of money by doing XYZ. But on the other hand, I might lose money by doing XYZ.

Howard Marks (27:51):
So, I’m going to only put in a moderate amount, or I’m not going to do it or I’m going to hedge it or something like that. So, that’s how the pre-market incorporates intelligence. We don’t have a free market in money. The interest rate on certainly short-term funds, or ever since the global financial crisis of 09 has been set by the government.

Howard Marks (28:10):
And most people would argue that today’s interest rate is lower than it should be. And because we have a lower interest rate than might be appropriate, what does it mean? It means that borrowers are subsidized, lenders, or penalize. People who want to use leverage encourage, savings is discouraged. Savers, pensioners are penalized at the expense of borrowers and risk-takers.

Howard Marks (28:39):
So, the look, the Fed’s job is to manipulate the economy. And those manipulations have a, let’s say a price because they take money away from where it would naturally end up and they put it someplace where it actually wouldn’t end up, but they make it happen. So, you asked how we think about rates.

Howard Marks (29:00):
An asset value is in academic terms, but it turns out that it often works in the real world, it’s the discounted present value of the future cash flow. And if you’re a savant and if you can see the future, or if you’re an analyst trying to do a good job, you lay out the cash flows from that investment, year by year for the next x years, as far as you think you can see, and maybe you have a probability distribution, maybe you have a central point, then a range of high and low, but you lay out the future.

Howard Marks (29:32):
And then, you discount those cash flows back to the present to come up with the present value. What does it mean to discount? Well, if the interest rate today is 7%, and you’re going to get money in 10 years, then that money is worth half today, what it will be in 10 years. So, you come up with a present figure for what the future cash flows are worth, and the lower the rate at which you discount, the higher the present value of those cash flows.

Howard Marks (30:02):
So, the level of the interest rate you use in your analysis figures importantly, in setting the price. But the answer is, today, and so today, you could use a discount rate of 3%. And if you find something that’s going to pay off in 10 years, and you discount it back to the present at 3%, and you buy it, you think you’re doing a good thing. But maybe that means you make 3% a year, which is a very good return.

Howard Marks (30:27):
So, you have to discount at an interest rate, which is an attractive rate of return to you. You can’t succumb to using today’s interest rates. One of the things I said in the memo is that most assets appear to me to be fairly priced today, given the low level of interest rates. So, I just went through the way interest rates affect valuations. And today, we have the lowest interest rates in history that would simplistically argue for the highest asset valuations in history.

Howard Marks (30:58):
But if you buy at the highest asset valuations in history, there are lots of ways things can go wrong in the future as interest rates go up, people demand higher returns. That means that tomorrow’s values are not worth as much today, which means prices go down. One of the reasons the market has done so very well over the last 17 months is that by taking the Fed funds rate to essentially zero.

Howard Marks (31:24):
The Fed has, well, people say, well, I don’t want zero, high yield bonds look rated four. When the Fed funds rate was three, nobody thought high yield bonds were great at 4% yield. They said, no, I want nine. But today with the Fed funds rate of zero, they say, oh, that 4% looks pretty attractive. All judgments in investing are relative judgments.

Howard Marks (31:47):
Sid Cottle, who was the editor of Graham and Dodd and Cottle. Graham and Dodd are the Bible of, it’s called security analysis, their books, the Bible of our profession, although a little antiquated. Sid Cottle was the editor of the later editions, like the one I read in college. And Sid was a consultant to me at Citibank. And he said back around the early ’70s, investment is the discipline of relative selection.

Howard Marks (32:10):
All the decisions we make as investors are relative decisions. I think that based on return and based on the ratio of return to risk, I think, this is better than that. So, we buy this and we don’t buy that, or we buy this and we sell that. That’s the way we make our decisions. Today, we’re making relative decisions between two different assets, perhaps, relative to interest rates.

Howard Marks (32:32):
And we have to understand that if interest rates change, everything else changes. And so, the biggest mistake you could make today would be to discount at an ultra-low discount rate, because rates are low today, that’s a good way to get into trouble. In some way, you have to try to insist on a good absolute return. You have to insist on what we call the margin of safety.

Howard Marks (32:54):
That’s what permits you to do, okay, if things go against you, but it’s, it’s hard in a low-interest rate, environment. We’re living in, what I call a low return world. And it’s hard to make, for all the reasons I’ve been discussing, it’s very hard to make a good return in a low return world, an endowment that needs seven.

Howard Marks (33:13):
Most endowments, pension funds, insurance, et cetera, with fixed obligations have concluded that they can’t make the return they need in the stock and bond markets. So, they’ve moved to what is called alternative investments, which means private equity, hedge funds, press debt, real estate, all that kind of stuff. But that they go there to try to get the returns they can get safely in stocks and bonds, but that introduces other risks, the liquidity, leverage, manage your risk, you backed the wrong horse.

Howard Marks (33:45):
So, the point is, there is no safe and dependable way to get a high return in a low return world. Think about it. There can’t be. I mean, one of the most important things that every investor has to learn is that at some point in time, they may have to say, no, that’s too good to be true.

Howard Marks (34:01):
And if I say to you, Trey, I have found a way to make a high return with certainty today, you have to say, no, Howard, that’s too good to be true, because the world would not permit that to exist. If somebody comes into your office Trey and says, “I’ve been managing money for 30 years, I’ve never had a down month. I’ve made 11% a year. I’ve never had a down month.” Your job is to say, that’s too good to be true, Mr. Made Off.

Howard Marks (34:28):
And the reason Made Off got away with it for so long and hurt so many people so badly, is that when people think they’re making money, they never say, does it make sense that it’s so easy to make money safely? And it can’t be. So, I think that reasonable expectations are one of the most important things for any of us investors.

Trey Lockerbie (34:50):
Well, I’m glad you brought up security analysis because it touches on the point of how important price is, and while you’re saying that prices are appropriate relative to interest rates today. One of my favorite Buffett quotes is the price is what you pay, value is what you get. I’m curious about a couple of things around price and value. One is, let’s just start with what is your earliest memory that taught you the importance of price. And then, I want to lead into maybe where we go from there.

Howard Marks (35:21):
Malcolm Gladwell wrote the great book Outliers, which talked about the importance of what he calls demographic lock, what you and I might call right time, right place. And I was lucky in a perverse way, because I started my career as in the investment management business in 1969 at Citibank, as a security analyst.

Howard Marks (35:43):
And in those days, the banks did most of the investing. There were no boutiques, there were very few firms like Oaktree or the firms that are on everybody’s lips today. It was the banks. And most of the banks, what we call the money center banks. That’s the banks in New York, in Chicago and Boston, and places like that.

Howard Marks (36:04):
Most of the money center banks invested in what were called the NIFTY 50. And these were the 50 best and fastest-growing companies in America, companies that were considered so good that nothing could ever go wrong. And because they were so good, and nothing could ever go wrong, that meant there was no price too high.

Howard Marks (36:20):
And if you look in the index of my recent book, Mastering the Market Cycle, under no price too high, you’ll find, see there are lots of citations because that’s we talked before about a bubble. That’s one of the greatest indications of a bubble. If investors can think of an asset class and say, oh, you know what, for that, there’s no price too high. That’s a bubble, because, by definition, it’s irrational.

Howard Marks (36:42):
For everything, there’s a low price, a fair price, and a price too high. Anyway, so the banks invested in the NIFTY 50. That certainly included Citibank, we were the great leaders. That meant IBM, Xerox, Kodak, Polaroid, Merck, Lilly, Hewlett-Packard, Texas Instruments, PerkinElmer, Avon, Coca-Cola, and unlike that, great, great, great companies.

Howard Marks (37:04):
And if you would have invested in those companies that they have started work in September of ’69, and held them for five years, diligently, you would have lost almost all your money investing in the best companies in America. Why? Because people ignored price. And so, they didn’t get enough out, use Warren’s terminology.

Howard Marks (37:23):
And the answer is that price matters a great deal. And the shorter your time horizon is, the more it matters. The shorter your time horizon is, the more important it is that you’re not overpaying. So, anyway, the NIFTY 50 we’re selling at PE Ratio. Today, the average PE Ratio is in the low 20s. PE Ratio is between 60 and 90 on those days.

Howard Marks (37:46):
And for the most part, those PE Ratios have never been seen. And then, five years later, the PE Ratios were between eight and nine. And that’s a good way to lose 90% of the money, which most people did. So, that taught me an important lesson. And I concluded at the time, it’s not what you buy, it’s what you pay for that really matters.

Howard Marks (38:05):
Then, I was very fortunate, the break of my life came in 1978 when I was assigned to the bond department, I wanted to get into money management. My reign as Director of Research at Citibank involved as it was with the NIFTY 50 was not so successful. So, they said, I said, I want the management, they said, okay, we’ll put you in the bond department, started convertible bond fund, which I found very interesting. It was a backwater that nobody else was looking at.

Howard Marks (38:28):
And then, in August of ’78, I got the call that changed my life from the head of the bond department. He said, there’s some guy out in California and they milking or something, and he deals in something called high yield bonds, can you figure out what that means? Because a client had come in and they said, we want a high yield bond.

Howard Marks (38:44):
So now, I’m investing in the worst public companies in America. And I’m making money safely and steadily, whereas investing in the best companies in America had been really dangerous. So then, I concluded that good investing is not a matter of buying good things but buying things well. And if you don’t know the difference, then you shouldn’t be doing much investing.

Howard Marks (39:11):
So, that brush with the NIFTY 50 taught me the importance of paying a fair price. The real lesson is that there are no assets that are so good that they can become overpriced and dangerous. And there are a few assets that are so bad, which that at the right price, they can’t be barred. One of the things that Oaktree has done for the last 33 years with great success is investing in the debt of bankrupt or likely to be bankrupt companies. And we call it distressed debt investing.

Howard Marks (39:48):
And you might say, but Howard, how can you invest in the debt of bankrupt companies you know you’re not going to get repaid? And the answer is that if you buy the debt of a bankrupt company or soon to be the bankrupt company, it embodies, it gives you a claim on the value of the company as a creditor. If you buy it cheap enough, that maybe you’re paying a price for that claim, which is so low that it’s going to have a great return. And that’s what we try to do.

Howard Marks (40:17):
So, I think that price is extremely important. And as I said, in bubbles, basically what it means is they ignore the price. And that’s a terrible thing to do.

Trey Lockerbie (40:27):
A big difference between the late ’60s and now, it seems, is the IP involved, because I’m seeing similarities now, especially with the FAANG stocks and companies that are leading the S&P 500 that I start to worry about those who are big-time indexers. And I’m wondering if you see similar risks, these companies seemingly have no top because it seems almost impossible to put a price on their IP.

Trey Lockerbie (40:55):
So, do you look at the fact that the S&P 500 is market-weighted as a potential risk to a lot of retail investors?

Howard Marks (41:03):
Great question, very relevant question. In every market cycle, we get to the point where people say, you know what, this thing, whatever it is, whether it’s the NIFTY 50, 50 years ago, or internet 20 years ago, or tulip bulbs several 100 years ago, they get to the point where they will let, this is now it’s risen to the point where it’s a sure thing. This can’t, can’t lose. Why not?

Howard Marks (41:30):
Well, for example, you look at the tech or the FAANGs, they’re in the S&P heavily. Every time a dollar flows into, say, an S&P index fund, or even an active manager who secretly closet indexes, money is going to flow into these names, predominantly, because they are so heavily weighted in the index, which means that money has to keep flowing in, which means that they have to keep doing better, which means that they’ll never falter, which means that there is a sure thing.

Howard Marks (42:00):
Well, there are no sure things, and there’s nothing that can falter. My dad used to tell the story about a guy who was a habitual gambler. And every week he would go to the track and lose all his money. So, one day, he heard about a race with only one horse. So, he went out to the track and he put all his money down. And halfway around the track, the horse jumped over the fence and run.

Howard Marks (42:21):
The point is, there are no sure things. This goes back to Mark Twain if you find something that you think is a sure thing, and you bet disproportionately on it, because it’s a certainty, and it turns out not to be a certainty, that’s how you lose a lot of money. And so, you can construct this account or the FAANGs that I just described how the money has to keep flowing into them, and it’s self-perpetuating.

Howard Marks (42:48):
And when I was little, we used to talk about perpetual motion machines, which is a machine that can run forever with no fuel, because it generates its own energy. They’ve never come up with one yet. There was a cartoonist named Rube Goldberg who produced to design that was and we used to talk about Rube Goldberg devices. But the truth is, there is no perpetual motion machine. There’s nothing that goes on forever

Howard Marks (43:08):
And the way to lose a lot of money is to buy something on the presumption that it is a perpetual motion machine and then have a reawakening. I think that the, and by the way, the magic is off some of the FAANGs this year, they’re not necessarily having great year stock markets, S&P is up 18%. Many of them are underperforming. And Andrew would say that one year doesn’t matter.

Howard Marks (43:31):
But the thing is that I believe that if the market goes like this, and you have some asset, let’s say it’s a FAANG and it keeps going like this. If one asset outperforms the others, long enough, you have to flip it over. The clip outperforms, what you find underneath is becoming more expensive. That’s what outperformance is.

Howard Marks (43:54):
So, if asset A outperforms B, which is to say, does appreciate more than B, long enough disproportionate to the merits, eventually, it will become overpriced. And if it’s overpriced, it is then likely to run into some hiccups and a correction. So, I just don’t think that one asset can outperform all the others forever. And investors who hear that siren song of permanent outperformance are in trouble if they succumb.

Trey Lockerbie (44:29):
I want to touch on corporate debt as you did earlier because it seems like that game is shifting a little bit as well. The Fed now holds nearly 14 billion in corporate bonds themselves. How does the Feds’ recent involvement in these markets affect Oaktree’s investing playbook?

Howard Marks (44:47):
The most important thing about that, Trey, is what it did in the recent past. We were expecting something, a massive recession, something approaching the global depression if the Central Bank hadn’t come to the rescue. And in the first half of 2020, we raised the largest fund in history for distressed debt investing, $15 billion. The previous record was our await fund, which was $11 billion.

Howard Marks (45:18):
We started to invest that money and so forth. And in March and April, there were great bargains to be had. Then the Fed came in, cutting interest rates, giving out grants and loans, and starting to buy some corporate debt, which they had never done before. The Fed had never bought corporate debt before.

Howard Marks (45:36):
And the main effect of that was that it included the kind of meltdown that we had expected to occur and that we had expected to take advantage of. But that’s in the past, and there were lots of companies that would not have gotten through the pandemic in one piece, but they got through because the Fed kept loading them up with the money, making more money available to them, and buying their bonds.

Howard Marks (46:04):
Anyway, we are value investors. I don’t know if the Feds going to keep buying. By the way, the 14 billion they bought is something but it’s not a huge amount of money in bond market terms. And I assume they’re probably done buying corporate bonds now. It’s a very radical thing for the Fed to do, and they’ve probably done all they want to do for a while.

Howard Marks (46:26):
You said that one of the tenets of Oaktree’s investment philosophy is we don’t let market macro forecasts influence our investment decision. We don’t say, well, let’s say, should we buy that bond? Will the Fed be buying that bond on Thursday or not, that kind of thing. Or will they be cutting interest rates or raising them? We look at an asset, we say we think we can get a return of X percent under normal circumstances. And we think that X percent is a good return given the level of risk in that company.

Howard Marks (46:55):
And so, we make that decision on an internal basis. The company, the risks, and the possible return, without making guesses about what’s going to happen in the environment. It’s just too hard to get that in that environment part right.

Trey Lockerbie (47:11):
All right. Well, I want to be mindful of your time, but I do have one seemingly unfair question left, which I’m borrowing from Tony Robbins book, MONEY Master the Game, where he essentially asked Ray Dalio, if he could package together with a portfolio for his grandkids that they couldn’t touch for, say, 30 years, what allocations would make up a portfolio like that? I’m just posing the same question to you because I’m just incredibly curious.

Howard Marks (47:36):
This is what I want to say to your listeners, Trey. The most important thing is to start an investment program while you’re young, continue it as you grow, and don’t screw it up. That’s my most important recommendation. How do you screw it up? You tamper with it too much. And of course, as I mentioned, some time ago, the biggest screw-up you can do is to sell out at the bottom.

Howard Marks (48:03):
And so, most people are not really suited for getting in and out of the market. And I said that I think that that’s how you’re going to practice defense, it’s very problematic. If you look at the stock market, the stock market has returned about 10% a year for the last 90 years. And if you can make 10% a year, and if you can avoid paying any taxes, so don’t sell, your money will double every seven years.

Howard Marks (48:30):
When it compounds at 10% a year, it doubles in seven years. So, let’s say your grandchildren are by, they’re going to live to 75, got a 70-year program ahead of them. That means if you can do 10% a year and not pay taxes, both of which are heroic assumptions, then it’s going to double 10 times. So, you put in $1 today, the kid is five, two or eight, 16, 32, 64, 128, 256, 512, 1,024.

Howard Marks (49:04):
A $1 deposit when the kid is five will be $1,000 for 70 years. Just don’t screw that up. Don’t get in the way of the compounding machine. I think it was Mark Twain, maybe Albert Einstein, Einstein said the greatest invention in history is compound interest. Just get out of the way. Don’t screw it up. So, I think that, and by the way, my grandchildren should probably be at about 95 or 100 on my risk-return dial from zero to 100. Why? Because they have their whole lives ahead of them and their parents and their grandpa are probably going to backstop them anyway.

Howard Marks (49:43):
So, they should invest early, probably all in the stock market. You don’t have to get fancy with other things. And so, that what, and by the way, that means index funds, really, an S&P index fund a Russell 2000 index fund, you want to get to maybe emerging market funds, you might want to have some exposure to the emerging markets to smaller companies, certainly to China, which is probably going to… before those grandchildren become adults, China will be the biggest economy in the world.

Howard Marks (50:16):
So, you want to have exposure to China and perhaps the other emerging markets. So, I think my advice is a variety of equity index funds, which complement and round out each other, and then leave it alone. When automation began to make great inroads into employment as they did in the autonomous, especially the teens, they used to talk about the factory of the future.

Howard Marks (50:39):
In the factory of the future, there is one man and one dog. The dog’s job is to keep the man from touching the machinery. And the man’s job is to feed the dog. It’s the same with the grandchildren. My job is to create a portfolio for them and keep them from putting their hands on it. I think that that is a formula that is sure to work in the long run.

Howard Marks (51:01):
And anything you do in the short run, to try to outthink the market is probably going to reduce your likelihood of achieving your long-run goals.

Trey Lockerbie (51:11):
Well, I love the simplicity in that. And you mentioned Einstein. So, there’s another quote attributed to him that, everything should be made as simple as possible, but not simpler, but simply doesn’t always equal easy. And what you’re highlighting there is how hard that can be. The temptations are sometimes too great. So, I think it’s very wise and really great advice.

Trey Lockerbie (51:30):
Howard, this has been an incredible honor. I cannot thank you enough for coming on the show and providing all this wisdom for our audience. It’s a huge amount of value you’ve shared with us and you’ve been very generous with your time.

Howard Marks (51:42):
Thank you for your interest in my ideas. And thank you for sharing them with your listeners. I hope they’re helpful.

Trey Lockerbie (51:49):
I hope we can do it again sometime soon.

Howard Marks (51:51):
Absolutely.

Trey Lockerbie (51:53):
All right, everybody. That’s all we had for you this week. As I mentioned at the top of the show, be sure to go to oaktreecapital.com to find Howard’s free memos. I can’t believe these things are free. The wisdom is incredible. Also, definitely go check out Howard’s books. And if you enjoyed the episode, let me know on Twitter @TreyLockerbie. And for all things TIP, simply Google TIP or the Investor’s Podcast and find all the resources we have for you there. And with that, we’ll see you again next time.

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