Howard Marks on the Stock Market

Howard Marks of Oaktree Capital is one of our leading investors. He focuses on the credit markets, or bond markets, and generally looks for distressed opportunities and mispriced bonds. He recently sat down with Morningstar for an interview to give his assessment of the markets. He says the stock markets still aren’t overheated, despite recent gains, because people aren’t invested in them as heavily as they were in the boom days. But he thinks bond markets generally are overheated and investors need to exercise caution. Marks is a value investor and also believes in the major tenets of behavioral economics. He thinks markets swing between extreme highs and lows, and smart investors need to understand which phase a market is in and do the opposite of what most investors are doing.

In the debt world, I think that the temperature became quite high, you might even say overheated, in the period 2012 and maybe into the first half of 2013; not so much because people were ravingly bullish in their attitudes or oblivious to risk, you mentioned the risk in Europe. There are lots of risks out there today, and everybody is pretty conscious of them. So why would the market become overheated if psychology was modest, and I think the reason is because, in the way I put it in one of my memos, even though people weren’t thinking bullish, they were acting bullish. They were going out the risk curve, talking greater risks to try to get greater returns, especially in the fixed-income world because they were forced to.

Why? Because when the Federal Reserve Bank and the other central banks took interest rates down to zero, what they basically said is you can’t get any kind of adequate return from Treasuries and high-grade bonds. If you want a good return, you’re going to have to go further out the risk curve. Of course, one of the goals of central banks in a crash or crisis, such as we were experiencing, is to rekindle risk-taking. I think they did a darn good job of it this time around by eliminating the return on safe instruments. This caused people to have to go out the risk curve and it caused prices for assets to become quite elevated, perhaps in the absence of bullish attitudes. I hope that’s clear, Jason.