[00:03:24] Howard Marks: The stock market, the S&P 500, has risen by about 10% a year on average for the last hundred years. Why doesn’t it just go up 10% every year? And in fact, Trey, why does it almost never return between eight and 12? If the average is 10, why don’t we see some eights, nines, elevens, and twelves? And the answer is that cycles, in my opinion, occur because people take things too far. When things are going well, they turn optimistic, and then they become too optimistic. And then they do things which are unsustainable. And so, eventually, the events become less optimistic, the people become less optimistic, and they kind of reverse their prior actions, whether it be the decision to build a factory or the decision to buy a stock, whatever it might be. And when the overly optimistic actions are reversed, cycles occur.

[00:04:23] Howard Marks: Very often the actions are too pessimistic. And so I concluded that we have a trend. Let’s say it’s the 2% of the economy, but then optimism takes over and we do above trend. But then people say, no, that’s unsustainable. And it corrects back toward the trend. But through the trend, because psychology goes too far to an excess on the negative side and that corrects back toward the trend, but goes through it toward an excess on the positive side.

[00:04:49] Howard Marks: So I think that cycles are very useful in thinking about excesses and. They are, for the most part, the operation of the traditional machine, be it the economy of the market with some novel events thrown in from exogenous territory, but just going too far and then correcting in both directions. Normal operation with normal excesses and normal corrections.

[00:05:17] Howard Marks: A Sea change in my way of thinking, is a change in the machine, in the fundamentals of the machine. People are going to do things differently post the Sea change than how they did it before. So in the memo I talk about the two important Sea changes that I feel I’ve lived through and worked through.

[00:05:37] Howard Marks: The first occurred in the late seventies. I started in this business in the late sixties, and at that time, a fiduciary was somebody who would buy high quality assets for the beneficiaries trust, whatever it is, and you could not be criticized for buying quality that was too high. You could be criticized for buying quality that was too low.

[00:06:02] Howard Marks: And in fact, under the right circumstances, if a fiduciary bought 10 risky assets, if 10, if nine of them were up 10 x and the 10th one lost 5%. The fiduciary could be surcharge for having bought a risky asset and made it. So the job of the fiduciary was to avoid low quality. Then around 77, 78, Michael Milken and others had the idea that the prohibition on issuing below investment grade debt was excessive, and rather than consist of a blanket prohibition, there should be an understanding that they’re risky.

[00:06:41] Howard Marks: Because they’re risky. They have to appear to offer a higher return as an inducement. But if the promised return seems adequate, so is the risk, then that’s a reasonable thing for a fiduciary to do. So this was a big change. This was a Sea change. You know, you go from, there are good assets and bad assets, and you can’t buy bad assets till you can buy any asset.

[00:07:02] Howard Marks: No matter how risky it is, as long as a prudent professional would say that the prospective return compensates for the risk. Big change. Risk return thinking. And I dare say that it’s risk-return thinking that governs everything we do today. And nobody declines to buy anything just because it’s low quality, but because it’s too risky for the return that seems to be offered.

[00:07:23] Howard Marks: Big change. Big change. And we wouldn’t have. Hedge funds, venture capital, private equity, and all the derivatives at the institutional level. If the old fiduciary rules were still in force. So shifting to thinking about risk and return together really has made the investment universe of today unrecognizable.

[00:07:46] Howard Marks: From 50 years ago, the other seed change I lived through came right around the same time, not connected, I don’t think by anything under underlying. But in 1980, I had a loan outstanding from a bank in Chicago, and they sent me a slip of paper as they did when rates changed. And they said the rate on your loan is now 22 and a quarter percent 1980.

[00:08:06] Howard Marks: December 40 years later, I was able to borrow at two and a quarter percent fixed for 15 years. Well, this is a major change. And first of all, declining interest rates have a number of very strong impacts. They stimulate the economy, they make it easier for companies to make money. They make assets worth more, and of course, they reduce the cost of borrowing.

[00:08:32] Howard Marks: So these events of those 40 years made it very, very attractive for asset owners and for borrowers. And people who borrowed money to buy assets got a double bonus, and this was the overwhelming Condit. Over this period, and it’s not a coincidence that this is when private equity in particular had its great success, because that’s what it does.

[00:09:00] Howard Marks: You borrow money to buy assets. The assets as it happened, turned out to be worth more than you thought they would, and the cost of borrowing to buy ’em turned out to be less than you thought it would be. That is a great combination. And so that, and I believe there’s a couple things worth noting. Number one, I think that this decline in interest rates was the biggest single event of the last 45 years in the financial world.

[00:09:24] Howard Marks: Most people wouldn’t say that. Why? Because it was very gradual over a long period of time. Kind of like the frog in the pot of water. You know, if you put a frog in a pot of boiling water, he’ll jump right out. But if you put them in a cool water and you turn on the heat, he’ll just sit there while it gets hot and eventually heals will come because he doesn’t notice that it’s taking place.

[00:09:43] Howard Marks: So gradually, and I think that’s what happened with rates, they change so gradually that people, I mean, if you sent out a questionnaire, what was the most important event that lasted 45 years in the world? I don’t think anybody would say derivatives, high yield bonds, private equity. Very few, I think, would say the decline in interest rates.

[00:10:01] Howard Marks: So a couple other things worth noting. Number one, that means that in order to have seen a more normal period, you had to be working in the seventies or maybe in the sixties. In the seventies, of course we had the battle against inflation, so that wasn’t a typical period. The sixties may have been something we would call normal, but that was obviously the sixties ended 53 years ago.

[00:10:23] Howard Marks: So not too many people who worked in the sixties are still working today, and I believe that the declining interest rates were responsible for the majority of all the money that’s been made in the last 45 years. So that’s pretty important. Those are my candidates for Sea changes, obviously, not just a normal cyclical up and down.

[00:10:45] Howard Marks: Not just an excess and a graduate, but a replumbing of the whole environment. 

[00:10:51] Trey Lockerbie: So the environment of borrowing money and buying assets from this low-interest rate period seems to be reversing. So what is the opposite of that? What is the Sea change we are entering into that you’re foreseeing?

[00:11:06] Howard Marks: Trey, I’d rather not say “reverse” because that implies that we’re saying rates went down and now they’re going to go up. I think I would say they went down and now they’re going to kind of hang around at this level. I’m not predicting that they’re going to go back up. And in fact, you know, you look at the Fed funds rate, which is four and three-quarters today, I’ll bet you in a year and a half it’ll be lower.

[00:11:39] Howard Marks: The rates are high today to fight inflation. I don’t think they’re going to stay this high or get. But if rates are coming down, well, two things. Number one, they’re through coming down in any major way, and number two, they’re through being ultra-low. You know, the Fed reduced the Fed funds rate to zero at the beginning of ’09 to rescue us from the global financial crisis.

[00:12:07] Howard Marks: And it worked and it was a strong move, and we should thank our stars. But interestingly, do you know how long they kept it at zero? The answer is seven years now. Zero rates are an emergency measure. An emergency measure was called for in late ’08 or early ’09. But clearly, we didn’t have an emergency for seven years.

[00:12:31] Howard Marks: Clearly, by ’12 or ’13 or ’14, the emergency was over. So why were rates left at zero? And the answer is, I’d rather think it was a mistake. But anyway, if rates aren’t going to be ultra-low and aren’t going to decline in the future, then the things that worked in recent years should not be the things that work best in that new environment. That’s the essence of the memo. Sea change.

[00:13:01] Trey Lockerbie: I’m tempted to ask if you think there’s a Volcker-like hammer needed here with this current inflationary environment, because you said they’re not going to stay low for long, they’re not going to go high for long, but inflation seems to be sticking around. You know that playbook exists.

[00:13:21] Trey Lockerbie: I’m just curious if you’re agreeing that maybe that’s not needed in this new environment.

[00:13:27] Howard Marks: Well, I think it’s not needed to the same extent. First of all, inflation today is probably roughly half of what it was in the seventies. So we, by definition, don’t need strong countermeasures. And secondly, some of the inflation that we have is kind of a one-off response to the post-pandemic measures that were enacted, distributing so much money to taxpayers and so forth, and also the little crimping of the supply chain. That, and those two things should work themselves out over time.

[00:14:01] Howard Marks: So I think that the level of interest inflation today is not so high, and it will abate naturally, which was not necessarily the case in the seventies. But we still need to wipe out inflation and inflationary psychology, which tends to get embedded and sticky. And I think that you asked whether we are going to have a Powell, a Volcker type treatment, and I think we are getting it from J Powell.

[00:14:31] Howard Marks: I think he’s being very reasoned, but he’s being resolute, and all the optimists who run the stock market would love him to say, ‘You know, we are probably going to think about bringing rates back down starting in December or something.’ But he hasn’t said it, and I don’t think he’s going to say it. And all he has said so far is we are going to keep raising rates. We may go slower than we were going. We may end up higher than we thought we were going to go, but we are going to keep vigilant.

[00:15:10] Howard Marks: And he hasn’t said a word. Well, he has, he has mostly said, ‘And we’re not going to be cutting rates anytime soon,’ which I think is very appropriate, so I’m optimistic that he’ll do the right thing here.

[00:15:26] Trey Lockerbie: Then they’ve been coming up with all kinds of tools that I think will kind of abate them needing to lower rates as well. When interest rates are low, corporate defaults are also low, and as rates rise, defaults also tend to rise. Right? So you’ve written about investing with caution in the past. While we’ve had this pandemic-infused uncertainty and this low return on cash environment, I’m curious how your opinion on investing with caution has changed in recent months. Is it the new definition of caution to a degree, or a different type of caution that you’re now investing with?

[00:16:07] Howard Marks: Well, there are lots of kinds of caution, and for me, caution means insisting on a margin of safety. You know, not many of us are so dumb that we will not make investments that would suffer if things stay the way they are. But if a cautious investor insists on a margin of safety or margin of error, or whatever you want to call it, what he’s saying is, ‘I want to make sure that if things get worse than I think they will, I’ll still be okay.’

[00:16:42] Howard Marks: And so I think that’s a very important part of being a cautious investor because, well, you know, from time to time, things will be worse than you had thought. How will you do? That’s a key question. Now, when the market’s flying high and valuations are stretched, and all opinions are loaded down with optimism, clearly you need a lot of caution because there’s so much potential for things to come in worse than expected.

[00:17:13] Howard Marks: When the market’s really low in its cycle, there’s not much risk of that. There’s no optimism in prices. Nobody thinks anything good is going to happen, so you’re not at risk of overestimating the situation and being disappointed to the same extent. So the thesis of mastering the market cycle is that your actions should be determined by where the market stands in its cycle.

[00:17:39] Howard Marks: To the extent you can figure that out, and when it’s high, you should be cautious. And when it’s low, you are aggressive and, you know, I still feel the same about that. At Oaktree, we have, I would say, a cautious bias. Every investor and every investment portfolio embodies a mix of aggressiveness and defensiveness.

[00:18:01] Howard Marks: Well, you say, ‘I want to be defensive so that if things go badly, I won’t suffer too much. But on the other hand, I don’t want to miss all the opportunities, so I’m going to have some aggressiveness.’ And the question of how you strike the balance between aggressiveness and defensiveness for me is question number one in the short or intermediate term.

[00:18:27] Howard Marks: And when the market is, I think the market’s in moderate territory. So I’d like to keep the same in their normal balance, which for oaktree means a cautious balance. And you know, we charted our course many years ago as saying that what we are going to deliver is lots of good years, maybe an occasional great year, but hopefully never a terrible one.

[00:18:48] Howard Marks: And if you can just do that combination, which I think we’ve done, and you can do it for 40 or 50 years, then I think you’ve really accomplished something. 

[00:18:58] Trey Lockerbie: So I want to talk about the current debt environment a little bit and just get your thoughts. Global debt is around nearly 350% of global GDP, and similar to how high rates can negatively affect corporate debt, and how zombie companies who spend more than they earn have sustained through this low-interest-rate environment. And they may be facing a reckoning. Our country, along with the rest of the world, has continued to accumulate debt, and there’s now a non-zero chance that our country could default on its debt. What are your general thoughts on how this new moderate interest rate environment will impact our country and its overall place in the world?

[00:19:43] Howard Marks: You know, late 2020, not so long ago when it looked like we were getting out of the pandemic and the related economic malaise unscathed. Stock market was high, interest rates were low, inflation was quiescent.

[00:19:57] Howard Marks: People started talking about something called the modern monetary theory and the belief that you could run as big a deficit as you like and take on as much debt as you like with no negative consequences, as long as quote, you’re in control of your currency. And that seemed to me what I said at the time was, it seems too good to be true.

[00:20:24] Howard Marks: I’m not smart enough to know why it’s too good to be true, but I think it’s too good to be true. And you know, it’s like, it would be like if somebody said, well, I’ll give you a credit card, and it has no maximum balance and it has no requirement to ever repay principal. Oh God, if you have one of those, you can buy anything you want and you don’t ever have to go out of pocket, although maybe you do for the interest, but maybe you can put the interest on the credit card.

[00:21:03] Howard Marks: And it’s the same thing as the way our country’s being run. Now, if somebody offered me that credit card or you, Trey, the first thing you would say is, well, what’s the catch? And when they say it about our country, I say, what’s the catch? I think there must be a catch, but I just don’t know what it is. So let’s say we’re at 350% of GDP.

[00:21:31] Howard Marks: Is that too much? No one can say, you know, I mean, we were very high at the end of 20, debt to GDP, but nothing bad seemed to be happening. At the end of, or mid 22, we concluded that the inflation was too high and was not going to be transient. So now we’ve concluded that the debt is too. So what’s the line in the sand where it becomes excessive?

[00:22:00] Howard Marks: No one can say. You know, Japan’s had heavy debt for a long time. It’s conservative, thought of it as a conservative country, but they may do. Other countries that we think are, you know, less stellar than we are, have higher debt ratios and they seem to do okay. It’s really very hard to come up, I think, with the statement of this is too, this is okay.

[00:22:28] Howard Marks: And that’s too. I just think we have to avoid having that thinking that, you know, I mean, one of the great, helpful things in life is that if it sounds too good to be true, it probably is. And I just think it’s too good to be true to think we can have a credit card we never have to pay the balance on.

[00:22:54] Trey Lockerbie: Well, speaking of Sea changes, Bill Gates wrote this new article. It says, “The Age of Artificial Intelligence has begun.” And during his lifetime, he has seen two revolutionary technologies: the graphical user interfaces that created Windows, and now AI. In his article, he writes that AI is as fundamental as a microprocessor, the personal computer, the internet, and the mobile phone. Prices tend to fluctuate more than company profits, right? And as a result of human psychology, markets are prone to be reflexive and have these reflexive swings, as you kind of outlined earlier, between hope and fear. And there have been funds driven by AI to date, but they’re kind of more akin to quant or algo trading, which you’ve written about in the past as well, and they’ve had these inconsistent or unimpressive returns that might be changing. I’m wondering if you’ve ever envisioned a world where either you use artificial intelligence in your decision making and AI investment funds eliminate the need for human investment managers altogether.

[00:24:02] Howard Marks: It’s a great story. He goes back to my days in grad school at University of Chicago, when the professor in the investment course told us that the vast majority of equity mutual funds do worse than the S&P. Many do worse before the imposition of fees, the vast majority do worse after the imposition of fees.

[00:24:25] Howard Marks: So you said, why don’t they just buy one share of every stock in the S&P? There was no such thing as an index fund at the time or of indexation. It started off as a kind of curiosity. In the Jackbot will introduce the first commercial index fund at Vanguard in ’74 and through the seventies and the eighties, maybe even into the nineties, people say, “Oh, yeah, yeah, no, I put, I put 3% in an index fund.” You know, that’s what I call da. They would put in a little bit to be able to say, “Yeah, we’re, we’re doing that,” but it wasn’t important.

[00:25:08] Howard Marks: Then over the next 10, 15 years, it came to be true that the majority of mutual fund equity capital was managed passively or by indexation. Why? Is it because indexation was so good? No, because active management was so bad. People buying things that would go down or that would go up less than the things they didn’t buy and charging high fees for the privilege.

[00:25:35] Howard Marks: So, you know, basically what happened in mutual fund equity is, to a large extent, the machine took over. Machine, not AI yet, but the machine of indexation or passive management, that is you establish a rule and you let the computer follow the rules. So what does a computer do? When I was in school, I hope they haven’t changed this ever since, but when I was in school, what we said, what we learned, that a computer can add, subtract, compare two numbers to see which is the bigger. Remember, those are the big things that computers can do.

[00:26:15] Howard Marks: And, but what it means is that they can process a lot of data. They can do it fast. They can do it without making arithmetic mistakes or emotional mistakes since they don’t have emotions. That sounds like a modest list. You know, process data, a lot of, no arithmetic mistakes, no emotional mistakes. Modest list, but better apparently than most people can do.

[00:26:39] Howard Marks: Because investing passively beat most of the people who were saying, well, what’s the market going to do? What’s the economy going to do? What a rate is going to do? What commodity price is going to do? What’s this company going to do? What’s that company going to do? What? Who’s going to win the battle between this company and that company?

[00:26:52] Howard Marks: It turns out that most people didn’t do a very good job of that, and so a lot of the work was turned over to indexation or passive investment. So it seems that those things can be done better. Indexation and passive can do better than most active. And I think that’s also going to be true of AI and machine learning.

[00:27:12] Howard Marks: When it gets fully implemented. Because obviously AI and machine learning should be able to do those same things even better and faster. And so I do believe that there’s a role. You know, if you look at the last 45 years or 55, the real upshot is that it became impossible for people to charge high fees for inferiority.

[00:27:33] Howard Marks: That makes a lot of sense, and I think that’ll continue to be true. So the point is that the machine can do better than most people, and we’re moving in that direction and AI will be the next step in that direction. Now, I wrote a memo 6, 7, 8 years ago called investing Without People, and I talked first about passive and indexation.

[00:27:54] Howard Marks: Secondly about systematic and algorithmic, and thirdly, about AI and machine learning. Remember, this is from a, from somebody who’s not an expert in any of those subjects, but what I said was that ai, just like passive AI and machine learning, even maybe to a greater extent, will knock out everybody who doesn’t add value.

[00:28:16] Howard Marks: It should be harder and harder and harder to run money and be paid highly for producing inferior. But hopefully there will still be a small group of people who can do something that the machine can’t do. And that is understanding subjective matters, qualitative matters and the future. Hopefully, you know, there will still be room for the best at that and hopefully Oaktree will be among them.

[00:28:43] Howard Marks: But, you know, can a computer, an AI computer enabled sit down with. CEOs and figure out which one is Steve Jobs? Can it sit down with five business plans and figure out which one is Amazon? I just don’t think so. This is an art form. We have thousands of people with high intelligence trying to do those things, and nobody does it consistently.

[00:29:10] Howard Marks: So that tells me. It’s not a matter of intelligence whether artificial or not. Some people get it. Some people have insight. Some people can make these qualitative subjective distinctions. Most people can’t, so I believe there will still be room left for the few people. Who can do these things demonstrably better.

[00:29:33] Trey Lockerbie: I hope so as well. In our last discussion, we were talking about the adoption of Bitcoin, and you were considering it to be a viable investment asset, although I think you were less convinced than your son. While the world of crypto has collapsed around Bitcoin, including Altcoins, FTX, Silvergate Bank, and even, etcetera.

[00:29:55] Trey Lockerbie: While those other cryptocurrencies have been collapsing, Bitcoin has continued to climb, and as of the time of this recording, it is up roughly 70% year to date. Have current events helped to highlight, in your eyes, the inherent differences between Bitcoin and other assets that claim to be cryptocurrencies?

[00:30:15] Howard Marks: I’m not necessarily close enough to the action, Trey, to be able to answer your question empirically. Clearly, as you say, Bitcoin has done less poorly, and in 2023, has done much better. It’s up 70%, albeit from a low. You know, it got down to the 15,000 level, and now it’s at the 27 level, I think. Of course, it was at the 75,000 levels for a moment. So it’s down almost two-thirds from the all-time high. But worth noting that, you know, I wrote a memo in January of ’21 called “Something of Value” about my time in captivity with my son, Andrew, during the pandemic. Our families lived together for three months, and we had some great discussions, as you can imagine. And it was around April, I think it was April when Andrew told me he had bought Bitcoin, and he, I think he paid five or 6,000. So clearly, it went up 15 or 1215 times, then it went down two thirds. But it still shows the five x gain from his purchase. And it, I guess the only thing I can say is that it hasn’t been disproved, and there are people who believe that when you have a bank crisis like we did with SVB and some of the others, that the weakness of the, I mean, it’s really, in many ways, it’s an anti-bank play, and the weakness of the bank shows up the strength of Bitcoin, and it’s done very, very well this year. And you know, for one thing, we can extrapolate from what we see in the United States. There are a lot of people who live in places where they don’t trust the financial system or have access to it, and they don’t exactly want everybody in authority to know how much money they have. So it does seem that there are good uses for some coins, and bitcoins seem to be so far the one in the lead.

[00:32:28] Trey Lockerbie: Speaking of some things overseas, I’d like to go there next. Well, I know that you minored in Japanese studies at Wharton, and I’d love it if you could share how that has influenced your investment philosophy.

[00:32:43] Howard Marks: First, I want to question confirmation bias, so it may have made me something that I wasn’t and otherwise wouldn’t have been, or it may have played to something about me, but you know what I’m getting at. But whatever the reason, it kind of meshed with a kind of, I would say, patience that I have. You know, I’m patient about expecting things to happen. I think I sometimes know what’s going to happen, but I’m prudent enough to know it’s not going to happen on my timetable, and I would say mature enough to know that things are always going to change. I may not know how, but you know, when people say, “well, we’ve reached a plateau and it’s a permanent plateau, and we’re never going to have the reversal,” you know, I think I’m mature enough to know that that’s not true.

[00:33:41] Howard Marks: So, in Japanese aesthetic terminology, for example, there’s a word called Mujo, literally translated as the turning of the will of the law. In other words, it’s about impermanence, about the things that change, in-cap. Change is uncontrollable. Change is often unpredictable. We have to accommodate ourselves to a world in which those things are true. The world is not going to accommodate us. The great Peter Bernstein once wrote me a letter, he said, “the world is not, the market is not an accommodative machine. It won’t give you high returns because you need them. The market and the environment will not accommodate you. You’ll have to accommodate them. You have to make adjustments,” and you know, I’m perfectly fine saying what I think will happen and then waiting for it to happen.

[00:34:35] Howard Marks: I don’t get frustrated. I don’t say, “well, it hasn’t happened in six months, so I guess it’s not going to happen.” I review my thesis, but if I still think it’s going to happen, then I’m perfectly happy waiting with patience, discipline, and humility. I think humility is a really important thing, especially in the market, which humbles us all. But you know, to think that you know everything that’s going on and everything that’s going to happen and you know when, and you know what the impact is going to be, if you can carry that belief for 20 or 30 years, then you must be really good at deluding yourself because we all run into surprises that we didn’t expect.

[00:35:24] Howard Marks: And you know, I think that humility, knowing how much we don’t know, knowing the importance of that, is a great way to stay out of trouble. You know, I believe that in our field, there is no room for certainty or for strong confidence in your views. You have to have confidence or else you won’t be able to act boldly and resolutely, but if you have too much confidence, that’s hubris and you’ll stick with a losing position even when all the reasons to stick with it are gone. So you have to strike a balance. But I think that intellectual humility is tremendously important. What is intellectual humility? It’s the admission to yourself that the other person could be right. And I think that anybody in a nonscientific field, in the field where there’s randomness and uncertainty and qualitative and subjective things are important, anybody who doesn’t allow for humility is riding for a fall.

[00:36:27] Trey Lockerbie: The reason I ask is there’s a potential Sea change of sorts appearing to be happening in Japan where a new guard is coming in and potentially removing what seemed to be a permanent yield curve control policy. And to your point about impermanence, I mean, nothing seems to last forever. What are your thoughts, if any, on Japan and the yield curve management today, and how that might affect their US Treasury holdings, the markets worldwide? Just any impact you might see from that change.

[00:37:01] Howard Marks: First of all, I’m not an expert on Japan or the Japanese market or economy. And secondly, I’m not an expert on yield curve control. I am basically skeptical of the power of governments to make things happen in the economy. Meaning, you can do it in the short run. And we’ve seen the Fed, for example, rescue us from the global financial crisis, and then again from the pandemic through quantitative easing and other measures. But I think of it, Trey, as kinda like a water spout in the ocean. I have often thought in terms of pictures – a water spout, a column of water, a big ball at the top, and the strength of the column of water keeps the ball up in the air a hundred feet above sea level. It only works as long as you’re pumping water, and the government, the Fed, cannot take us to a permanently higher level if they stopped taking their actions.

[00:38:06] Howard Marks: So I’m not crazy about a highly activist Fed and Treasury and so forth. And I think that, you know, we’re all, I’ll bet you that I’m a card-carrying capitalist. I imagine you are. And I imagine that people only listen to your podcast because they are. And what capitalists believe is that the free market is the best allocation of resources. And when we look around, governments, whether it be Cuba or Russia or Vietnam, we say the government can’t run an economy as well as an economy can run itself if left alone. Okay? So that means for me that I would rather see the regulators keep their hands off the economy. Now, once in a while, if the economy gets too hot, we have to cool it off with interest rate increases, among other things, to slow down the economy.

[00:39:03] Howard Marks: Cause the overheating economy is producing. Undesirable inflation and when it, when the economy goes too slow and it’s not creating jobs for Americans anymore, we have to give it some stimulus to get it back into job creation mode. When it’s too cold in between, I’d like to leave it alone. You know, I don’t think that there’s anything smart for me to do in, in the market every day or every week, or maybe even every month, and I don’t think there’s something smart for that.

[00:39:31] Howard Marks: To do every day, week, or month. So I’d rather keep my hands to myself. And you know, back when automation was being added to the picture in the states maybe 20 years ago in big ways, people used to talk about the factory of the future, which would have one man and one dog, and it was the dog’s job to keep the man from touching the equipment.

[00:39:53] Howard Marks: And it was the man’s job to feed the dog. And I think that’s kind of it. That I would like to have where the Fed keeps its hands off the machinery most of the time. And so back to Japan, you know, can they really make the economy or the interest, the yield curve, what they want it to be on a permanent basis?

[00:40:15] Howard Marks: I don’t know. But I like the old-fashioned China free markets better. 

[00:40:21] Trey Lockerbie: I’m with you there. Let’s go to China. You’ve been investing in non-performing loans in China with amazing results, with its leadership structure changing, and other recent events. Some have called China uninvestable. So as a contrarian, I imagine that might signal bullish to you, but have recent events changed your views on investing in China in any way? 

[00:40:43] Howard Marks: Obviously with the events of the last year or so, we have to be cautious. But, I’m naturally cautious, and the irony is that I’ve done some terrifying things in my life, investment-wise, cautiously. And they worked maybe because of the inclusion of caution. But here’s how I look at it. And by the way, when I go to China, they ask me, “What do you think about China?” I always say, “Well, why are you asking me? You live here, and I don’t claim to be an expert on China.” But what I think is this: China is nothing short of an economic miracle. From 1979, over the next 40, I think it was 40, maybe 41, 42 years, they increased the GDP a hundred x. It went from 177 billion to 17.8 trillion, a hundred x on GDP in a short period of time. It’s a miracle. They moved tens of millions of people from the farms to the cities and from subsistence agriculture to manufacturing, and I think they want to keep doing that. I don’t think they want to go back to eating grass like they did in the seventies when millions of people were dying of starvation every year. And in fact, I think that for Chairman Xi, he has to keep producing economic miracles to stay in power, and I haven’t figured out yet how China can perpetuate its economic progress and, you know, become the world’s largest economy, which most people think it will sometime in the 2030s or so, without selling a lot of goods to the rest of the world.

[00:42:31] Howard Marks: There’s just not enough consumption in China for enough goods to be produced and consumed. To produce the, the, with the growth we’re talking about, they have to keep selling to the rest of the world. And obviously they can’t do that if they have a hot war with the rest of the world. So I think they’re in a tough situation.

[00:42:57] Howard Marks: They don’t, that they have ideological differences from us to us as the enemy, which is. You know, symmetrical because we view them as the enemy, that there seems to be nothing that the two political parties in this country agree on more than that. China is the enemy and there seems to be no limit in badmouthing them.

[00:43:21] Howard Marks: But you know, the interesting thing, if you think about the last hundred years, until China came along, the US did not really have a serious economic r in a century. Now we do. And that rivalry’s going to be played out and you know, we don’t like some of the ways they undertake it. And everybody tells me the same thing, so they must be right.

[00:43:49] Howard Marks: They must be misbehaving in some ways, but I think they, I think they’re going to want to stay part of the world community, which means that they, I don’t think we’re going to have their worst. Confirmed. You mentioned that people describe China as uninvestable. I’ve done several things in my life that were uninvestable high yield bonds, 78 distress debt, 88, even emerging market equities in 98 were all considered uninvestable.

[00:44:17] Howard Marks: And you make the most money when you do something that other people refuse to do or everybody refuses to do, and it turns out to be the right thing. And so calling China uninvestable is, doesn’t give me a problem, doesn’t make me unwilling to invest in China. But guess what? We’re going to continue to do it, but we’re going to do it cautiously.

[00:44:44] Howard Marks: And I think there’s still a role for that in our portfolio

[00:44:49] Trey Lockerbie: In your book, the most important thing you highlight, risk management and being a contrarian when appropriate. And other investment tenants. Some people believe risk is controlled by position size, not only margin of safety, but you know, actual position size itself.

[00:45:05] Trey Lockerbie: How do you think through position sizing with your investments, especially as they kind of in the context of an overall portfolio? 

[00:45:13] Howard Marks: Position sizing is one way, insisting our margin of safety is another. Having certain minimal standards for interest rate coverage if it’s a bond, you know, there are lots of ways of having better foresight.

[00:45:27] Howard Marks: With regard to the future as something being more predictable by its nature is a way to control this risk. When you do things which are by nature, unpredictable, obviously you’re, you’re taking on more risk. So there are lots of ways to do it. Position sizing is important, but for me that goes, you know, it’s kind of like pornography, was it? Potter Stewart who said, I can’t define it for you, but I know it when I see it.

[00:46:00] Howard Marks: And I think that superior investors just have this feeling for certain investments, and for knowing. How great the uncertainty is and how great the potential reward is, and how the potential reward compares with the uncertainty and the possibility of loss. I don’t think it can necessarily be quantified. I don’t think quantification is an important criteria.

[00:46:23] Howard Marks: And in fact, if you think about the back to my answer about ai, if it could be quantified, then the machine could do it. So I’m talking about the fact that, hopefully there are some things that people can do that machines can’t do. Subjective, qualitative, future oriented. And so it doesn’t bother me to be unable to quantify the relationship between potential reward and potential risk.

[00:46:50] Howard Marks: I think it’s, I think you should ramp up your investments in things where you believe the potential reward is more than commensurate with the risk. It’s as simple as that. Now, a friend of mine in England wrote a book called Simple but Not Easy, and Richard Oldfield is his name. And I think it’s a great description of what we do.

[00:47:15] Howard Marks: We try to buy things that go. That’s not so hard to describe. The only thing is I can’t explain to you how you do it, you know, and I can’t make you able to do it. But some people have the ability, and in one of my books, I forget which one I say is the superior investor.

[00:47:38] Howard Marks: It is superior for the simple reason that he or she has a superior understanding of the probability of distribution that will govern the future events, and thus, for whether the potential return is more than enough to compensate for the uncertainty that lurks in the negative left-hand tail. That’s what we do. I use the word inference, I use the word, Sensitivity. That’s all it is. But that’s why I think that there’s creativity and the ability to deal with the unquantifiable in our job.

[00:48:14] Trey Lockerbie: That last point, or a point you threw in there, was reminding me of that Peter Lynch quote that I know Buffett’s borrowed, and it’s “selling your winners and holding your losers is like cutting the flowers and watering the weeds.” From what you said, I imagine that’s kind of the same philosophy you’re describing there to a degree, right? Going in on the things that you know are strong and not necessarily dollar-cost averaging down. Do you have a viewpoint on that?

[00:48:47] Howard Marks: Well, first of all, trade, nothing in our business can be turned into rules.

[00:48:52] Howard Marks: People who come up with rules all the time. You buy something, if it goes down 10%, sell it. Well, west Magic, about 10%. You might have a lot of things that are going to go 10 down 10, and then up 200, maybe it should be 20. Well maybe you’ll have a lot of things that’ll go down 20 and then up 400. So I don’t believe in rules.

[00:49:20] Howard Marks: And what you really have to do is you take your position, it’ll do what it’ll do, the market will do to you what it’ll. And then you have to reassess. You have to reassess. And the decision to sell, I think is better thought of as the decision to uny. So there’s a certain process that you apply, deciding whether you should buy something.

[00:49:46] Howard Marks: You should just reverse that process to decide whether you should buy something and that should be divorced from whether it shows a profit or a loss. You should not be any more willing, in my opinion. To sell your winners more than your losers or your losers than your winners, you should sell things. Let’s go back to the last definition.

[00:50:12] Howard Marks: You should sell things if the prospective return does not seem more than adequate to compensate for the risk of loss. You should hold things if it does. I wrote a memo not too long ago. I think it was in 2020, called Selling. And I had never written a memo on selling. You see almost nothing in our business about selling.

[00:50:38] Howard Marks: Everybody talks about when to buy, when to not buy it, etc. But I think that, and I said half tongue in cheek, that there are two reasons why people sell things because they go up or because they go down. If they go up, they sell them. Because they’re afraid that if they don’t sell them, they’ll go a bit down and they’ll kick themselves.

[00:51:04] Howard Marks: And if they go down, they sell them because they’re afraid that if they don’t sell them, they’ll go down more and they’ll kick themselves. So an amazing amount of energy is expended by investors trying to avoid having to kick yourself, which is to say, trying to avoid regret. And you know, a tremendous amount of investing is about avoiding regret, but, You shouldn’t sell things because they’re up and you shouldn’t sell things because they’re down.

[00:51:35] Howard Marks:  Well, there’s a couple good reasons. One is that you think the risks have increased. Another is you think that the return prospects are not as good as they had been. Another is that you think that the gains to date have been borrowed from the gains that remain in the future, but you shouldn’t sell anything for a numerical reason or because it’s up or because it’s down.

[00:52:04] Trey Lockerbie: What is the least important thing when it comes to investing? 

[00:52:09] Howard Marks: I’m glad you asked that. Very few people asked that, and I happened to have written a memo in November, I believe, entitled. What really matters. And first, I talk about a bunch of things that, in my opinion, don’t matter. Short-term events, short-term trading, short-term performance, volatility, hyperactivity, these are things that, that don’t matter, that don’t add to your long-term success and that you shouldn’t emphasize.

[00:52:36] Howard Marks: But of course, these are the things that most people spend all their time on. You go into a committee you know, I’ve been on a lot of investment committees for nonprofit. And you go into the meeting and they spend the first 45 minutes discussing the performance in the last quarter. Why? It’s over.

[00:52:58] Howard Marks: There’s nothing you can do about it. Well, you might say there, there’s stuff you can figure out to do in the future. Yeah. But you, you almost never see anybody taking any strong action based on what happened last quarter, changing their portfolio. Most people never change their portfolio wholesale. And you know, they spend 45 minutes because they think it’s their job.

[00:53:23] Howard Marks: Well, why is it your job? Well, I’m a fiduciary. You got to care. Well, yeah, but it’s. You know, and there was a great quote from a guy named Ian Wilson, who was head of GE, one of my favorites nowadays. He said something like, there is no degree of sophistication that you will get around the fact that all your knowledge is with regard to the past and all your decisions are with regard to the future.

[00:53:55] Howard Marks: So studying the past as a way of figuring out what you could do in the future has severe limitations, and I would rather go with fundamentals. I’d rather say, which companies can I buy a piece of that will become most valuable, more valuable over the years and decades, and which companies can I lend money to that have the highest probability of paying you.

[00:54:21] Howard Marks: And those things have nothing to do with GDP forecasts, interest rates recession and inflation. So, you know, I wrote that memo. Almost nobody said a word about it. I think it’s one of the most important ones I’ve written and I hope the readers will take a look. By the way, all the memos are available on the Oaktree website, Oaktree Capital website under the heading of something called Insights.

[00:54:51] Howard Marks: Hopefully they have insight. But the great thing is that the price is, Because they’re all free and I hope people will take a look.

[00:55:01] Trey Lockerbie: They’re also in audio format as well, which I’ve also been digesting. Right. I, so that last point reminds me of one of my favorite quotes from, you don’t judge a decision by its outcome.

[00:55:12] Trey Lockerbie: Right. Can you elaborate on what you mean by that? 

[00:55:15] Howard Marks: I talked about what we do. It’s not scientific, it’s not empirical, it’s not governed by rules. It can’t be quantified. We work in an area where there’s a lot of vagueness and it’s only appropriate, as I said, to view the future with trepidation and uncertainty.

[00:55:35] Howard Marks: And when I got to Wharton in September of 63, I remember the first book I read and It was called decision making under uncertainty, and it was about how oil and gas operators decide to drill wells, and it had a great impact on me, and especially the, the aspect that you cite Trey, because the, what I remember most strongly taking, taking away from that book.

[00:56:02] Howard Marks: What I most strongly remember is reading where it said, you can’t tell the quality of a decision from the outcome. And in our lifetimes, hopefully we get these things in. In Zen Buddhism in Japan, they have things called Koans riddles. And if you think about the brittle and you meditate on it, it can unlock.

[00:56:25] Howard Marks: A situation for you. Unlock it, understand, and I think that that line is similar. You can’t tell the quality of a decision from the outcome. We all know people who we say they’ve been successful despite themselves. Or they were right for the wrong reason. We also know people who were wrong for the wrong reason.

[00:56:49] Howard Marks: They did something. It made sense. It just didn’t work out. And lots of deserving people have not been successful because the ball bounced in the wrong direction for them. But I think that if you think about decisions we put into our decisions, everything we know about the past and everything we know about how we believe the machine works by, I say the machine, I mean the market or the.

[00:57:17] Howard Marks: But there’s obviously a lot we don’t know, which is what events will transpire in the future? Will tomorrow be sunny or cloudy? Will it rain or not? Who will be elected president? You know, there are so many things that are, that are some combination of unpredictable and random, that obviously it’s possible to work very hard and make a very well reasoned decision that doesn’t work for perfectly good reasons, or make a poorly thought.

[00:57:49] Howard Marks: Decision that is phenomenally successful. What that tells me is we shouldn’t assume that because that, because we’re making a, well, what we think is a well reasoned decision, it’s going to work. You got to leave plenty of room for error. They all, all these things come back and tie into each other. These are not random separate elements in one’s philosophy.

[00:58:14] Howard Marks: So you just, like I said, there’s no wrong for certainty. You have to assume that hopefully your better decisions will work more often than your worst decision or the better decision maker’s decision will work more often than the worst decision maker’s decisions, but it’s certainly not true that every correct decision or every well thought out decision is going to work or it’s going to work on your time.

[00:58:42] Howard Marks: A lot of these ideas come from a book called Fooled by Randomness, by Nassim Nicholas Taleb, and I found that book extremely thought provoking, or like decision making under uncertainty. You have to get at the truth of the environment that you work in.

[00:59:01] Trey Lockerbie: We’ve talked a little bit about the books you’ve written and the memos which have become required reading.

[00:59:07] Trey Lockerbie: I mean, even for Warren Buffett and some of the greatest investors. Every time you write a memo, they drop what they’re doing to read it. And if you haven’t done so and you’re listening to this, of course everyone needs to go read those things. What I am curious about is what you are reading, and I’d be curious to know either the book you’ve most enjoyed, say in the last year or so, or what you’re reading now.

[00:59:29] Howard Marks: I try not to read too many investment books because there’s so much more in them. And if you read on other topics, hopefully, you can generalize to investing. But I did get a lot from a book I read this summer called “Mistakes Were Made, but Not By Me” by Carol Tavris. And it’s basically a book about how people practice self-deception, self-delusion, and how cognitive dissonance can keep us from admitting valuable information that doesn’t square with our preconceptions.

[01:00:01] Howard Marks: And I think it’s really important for us to understand our cognitive biases and try to overcome them because, you know, common sense isn’t that common. And if you want to have common sense, you have to obviously get past the barriers that hold others back. And, you know, for example, I touched on this in a memo I wrote in October called “The Illusion of Knowledge.” I borrowed the quote from the historian Dan of Boston, who said that the enemy of knowledge is not ignorance, it’s the illusion of knowledge. When people believe that they or somebody else has knowledge, it ceases, it stops the quest.

[01:00:44] Howard Marks: But I think that people make forecasts all the time. I think GDP is going to do this. I think IBM’s going to do that. I think the interest rate will be this at the end of the year. They never write them down. They never compare their forecasts with what turned out to be true. In fact, when I was a kid, somebody once told me that an economist is a portfolio manager who never marks the market. In other words, they don’t keep a record. They don’t rigorously say, gee, are my forecasts any good? And in most people, forecasts are terrible, and they keep making forecasts. And how could they possibly be able to keep making forecasts if their record is so bad? And the answer is that they have these mechanisms which permit them to practice self-delusion. And that was the upshot of that book. I highly recommend it.

[01:01:46] Howard Marks: And then at the present time, I’m reading a novel, “The Unlikely Spy” by Daniel Silva because sometimes I like to read for enjoyment too.

[01:01:56] Trey Lockerbie: I just have to ask, you said you think in pictures, and I’m just curious if that has always been the case or if, from what you’ve read and where your mind takes you, you define that as sort of like the distillation of knowledge and simplifying things down to its essence and the way that you do that.

[01:02:19] Trey Lockerbie: Yeah, was that something you practiced and worked on, or is that something that came naturally?

[01:02:26] Howard Marks: It was not a conscious effort. Like you know, if I made a contribution to the body of investing, I hope it is my view of risk and my chart on which I superimpose some little L-shaped curves on the capital market line.

[01:02:43] Howard Marks: And you know, we all see this line, and it looks like that you have returned on the vertical axis and risk on the horizontal axis. The Y slopes up to the right, and we think that explains the fact that riskier assets have higher returns. And I think that’s a terrible way to render the subject. It can’t possibly be true that risky assets have higher returns because if risky assets could be accounted for to have higher returns, then they wouldn’t be risky.

[01:03:17] Howard Marks: So what does that relationship really mean? And I think it means that assets that are risky have to appear to offer higher returns, or nobody will make those investments. That makes perfect sense. But I had trouble just figuring out how to communicate that until I did my thing with the little bell-shaped curve.

[01:03:39] Howard Marks: And when you look at the curve, and it looks like this, you say, “As the risk increases, the return increases.” That’s a terrible distillation. It’s very dangerous to think that riskier assets are safe. But when you put on these little bell-shaped curves, and they progress in size as you move from left to right, then you say, “Aha, as the perceived risk increases, the expected return increases, but so does the range of possible outcomes. And so the bad outcomes in the range become worse.” That’s a pretty good description of risk. But it was my insistence on doing it through a picture, through a graphic, that led me to be able to communicate it.

[01:04:26] Howard Marks: So I have so much fun because I sit in my client’s office, and they ask me a question. I draw them and I do it over and over and over again. And to me, I get a lot out of it. And you know, if you just say the words, you can gloss over the weaknesses in your argument. But if you have to either write them down or create a graph which shows how things work, then I think you’re called to a higher standard.

[01:05:01] Trey Lockerbie: I would probably frame one of those drawings if you did that, so that’s really great. Howard, this is always such a pleasure. It’s one of the biggest privileges for me to get to speak with you, and I really admire you and what you’ve done and how, you know, you go back to humility. You’ve always been so warm and welcoming and giving with your knowledge.

[01:05:28] Trey Lockerbie: I know that our audience gets so much out of it, so I would just like to thank you for coming back on the show and doing this and getting the word out there about so many different resources that we’ll have listed on the links below. I just want to thank you.

[01:05:49] Howard Marks: Trey. You know, the stuff that we discussed today.

[01:05:52] Howard Marks: This isn’t glamorous stuff. This is not how I picked a stock that went up 10x, you know, or how I was able to afford my last yacht. This is interesting, provocative, and worth struggling over, and I’m very glad to come on the show and do it with you.

[01:06:12] Trey Lockerbie: I appreciate that so much. Thank you. 

[01:06:14] Howard Marks: Okay.

[01:06:16] Trey Lockerbie: All right, everybody, that’s all we had for you this week. If you’re loving the show, don’t forget to follow us on your favorite podcast app. And if you’d be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter @TreyLockerbie. And don’t forget to check out all of the amazing resources we’ve built for you at theinvestorspodcast.com. You can also simply Google TIP Finance, and it should pop right up. And with that, we’ll see you again next time. 

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