Secrets of Legendary Investor Howard Marks (#219)
21:20 Share

As legendary investor Howard Marks says in his wonderful sea change memos, we went through an unusually long period of declining and ultra low interest rates from 2009 to 2021. The result was the longest economic recovery in history exceeding 10 years and the longest bull market in history also exceeding 10 years.

It was a great time to own assets. Is that period over? And how should investors invest now?

Hi, everyone. I'm Lynn Thoman, and this is Three Takeaways. On Three Takeaways, I talk with some of the world's best thinkers, business leaders, writers, politicians, newsmakers, and scientists. Each episode ends with three key takeaways to help us understand the world and maybe even ourselves a little better.

Today, I'm excited to be with Howard Marks. He founded and leads Oak Tree Capital, one of the largest investment firms in the world with around $200 billion of assets. He is also one of the world's best known investment commentators. His investment memos are very famous and his readers even include Warren Buffett. I am delighted to have Howard Marks as a guest on Three Takeaways for the second time.

Welcome, Howard, and thanks so much for joining Three Takeaways today. Thank you, Lynn. It's a pleasure to be with you. It is an honor for me. Howard, what do you think has been the most important event in the financial world in recent decades?

That's a great question, Lynn. And most people would say the bankruptcy of Lehman Brothers in 08 and the global financial crisis, the pandemic, the tech bubble bursting in 2000, Black Monday, 1987. That's what most people think of in terms of an event.

I think it was the decline of interest rates from 1980 when I had a personal loan at an interest rate of 22 and a quarter to 2020 when I was able to borrow personally at two and a quarter.

And the decline of interest rates over that period made everything easy. It made economies grow, businesses thrive, assets become more valuable, the cost of borrowing declined. It was easy to avoid bankruptcy and default. It was an easy period. It was great for people who owned assets because lower interest rates lead to higher asset prices.

It was great for borrowers because the cost of money came down. So people who owned assets on borrowed money got a double bonus and they really thrived. And this was very, very significant. I think that this shaped the entire financial condition over that period. Were there disadvantages?

There are. They're a little less obvious. But first of all, it was a very tough period for savers. The rate of interest on bank deposits went to zero. For people living on their income, because if they had their money in bonds or bank deposits, their income went way down. It was tough on insurance companies who take your money in

sit on it for a while and then pay their claims. Their profitability comes from deploying their money profitably in the meantime. That was tough in this low interest rate environment. The other thing is that low interest leads to unwise behavior. So there are downsides, but most people want lower interest rates because the downsides are kind of intellectual or academic.

The Fed has aggressively managed interest rates for decades, including keeping rates at near zero for over 10 years. As you mentioned, was that a mistake? And what do you think the best policy for interest rates is?

I think it was something of a mistake. It creates risky behavior. There's such a thing as moral hazard. And I believe it really started with Alan Greenspan in the late 90s. And they developed this thing called the Greenspan Put, which basically said that if we're going to have a recession or a crisis or a crash or something like that, the Fed will prevent it by squirting in a little extra liquidity, which will stimulate the economy and pull us out of it.

But if people believe that they can engage in risky behavior without penalty, that makes the financial system and the economy more precarious. And that's not a good thing. You know, I wrote in one of my memos once that fear of bankruptcy is to capitalism as fear of hell is to Catholicism. And fear of negative financial consequences presses people to make prudent decisions.

If they feel there's always somebody to backstop them and they don't have to be prudent, that's a bad thing for society overall. What kind of investing environment do you believe that we're now in?

I think we're in a decent investment environment, in part because interest rates are moderate. And by the way, my thesis, which is that rates aren't going to go down that much in the next 10 years, people say to me, oh, so you mean higher for longer? I say, no, these aren't high rates. They're higher than they were in the 09 to 21 period. That was the period of the lowest rates in our history, but they're not absolutely high. And in fact, I

until the other day when the Fed cut rates, the Fed funds rate was five and a quarter to five and a half. And if you look at a chart of the Fed funds rate over the last 70 years, the average was five. So no big change. But I think we're going to stay in this zip code for a while. I don't think we're going back down. So that should slow the tailwind, which has been supporting stocks,

slow, which means I'm not saying they're going to crash or go down. I'm just saying they're not going to go up as regularly or as rapidly. And it'll make leveraged investing, that is to say, engaging in investments with borrowed money, which is what private equity does and real estate operators do. It'll make that strategy a little less successful than it was in the low rate and declining rate period. But in general, I think that the US economy and the US markets, which is what I'm most familiar with, are

moderate. They're a little expensive in the context of history, but not crazy. And in my opinion, certainly not crazy enough to say to people, you should get out or reduce your holdings. You know, people should be invested most of the time.

Buffett always says, don't bet against the US economy. I think that's right. If you look at the Standard & Poor's 500 stock index, it's been up 10% a year for the last 100 years on average. That's pretty good. What that says is that you might have tried to enhance your performance by getting out and avoiding the crashes. Very tough.

But if you're not smart enough to do that, and 99% of the people aren't smart enough to do that, if you had been in for the last 100 years and made 10% a year for 100 years and turned a dollar in 1924 into $15,000 today, that would have been pretty good.

without any short-term trading jumping around in-out market timing. So I think we're in the zone of reasonableness today. And as I say, a little expensive, but not enough to warrant getting out and trying to be a mastermind. 10% a year return on the S&P 500 is pretty great. Do you find that forecasting is helpful for most people as they invest?

Not only would I say forecasting is not helpful for most people as they invest, I would say it's not helpful for almost anybody. When you look around, where are the people who got famous for being great investors because they could forecast the economy or the markets? You just don't find them. Everybody uses the example of Buffett. You mentioned his name earlier. Buffett conspicuously rejects economic forecasting.

And when he decides to make an investment, it has nothing to do with his forecast of what the economy or the markets are going to do over the next two, three, five years. And I think that's the right way. You know, he once said to me, for a piece of information to be valuable, it has to satisfy two criteria. It has to be important. And it's important to know what the economy is going to do. It would be great if we knew what the market was going to do. But he said, it has to be knowable. And it's not knowable.

which is to say it's not possible to achieve superior knowledge. It's easy to have average knowledge and to be about as right as the consensus about what's going to happen. But of course, everybody has average knowledge and average knowledge is already baked into the prices of things. So when you buy a stock today, it incorporates everybody's average forecast.

You can only outsmart the market if you have an above average forecast in terms of accuracy. And almost nobody does. So I'm not involved in macro forecasting. Buffett is not involved in macro forecasting. And none of the great investors that I know condition their investment decisions on what they think is going to happen in the macro future. You are known for saying always good, sometimes great.

Never terrible. Can you elaborate? Well, that's the Financial Times of London on Saturdays runs an article called Lunch with the FT. They take somebody out to lunch and they write an article about the person, the restaurant and the food. And they took me to lunch toward the end of 22. We went to my favorite Italian restaurant, which is right near my office in Midtown New York.

And I said to the writer, eating in this restaurant is like investing at Oak Tree. Always good, sometimes great, never terrible. Now, to me, that sounds like a modest description, but I think it's investment nirvana.

I've been doing this for 55 years. And I believe I can honestly say that about what Oaktree has produced. Oaktree has been in business 30 years. My colleagues have been with me another nine. So 39 years. That's basically what we've done. And if you can say that, always good, sometimes great, never terrible. That's a terrific career. And I think that's what I've been privileged to enjoy. How do you compare investing with sports?

I think they're very comparable in many ways. They are meritocracies. At the end of the game or at the end of a season, there's no debate about who is better. They're competitive. You try to do your best, but you're up against other people who are well-equipped, who are also trying to do their best. And there are many ways. And most sports require a combination, a blend of aggressiveness and defensiveness.

And so does investing. And the other thing is sports, like investing, involves luck. And, you know, sometimes the ball bounces funny. And when the ball bounces funny, sometimes the great athlete has a poor experience. And sometimes it works out great for the poor athlete. That's life, too. And that's investing, too.

I was watching Wimbledon and the US Open. And everybody who wants to invest, if they want to be above average, to be above average, you have to have more winners than the other person or less losers than the other person or both. And so when you play tennis or when you invest, you have to say, well, what's my strength? What's my strategy? Am I going to go for bigger and better winners?

And are we going to take a high risk path and strive for the, as my wife Nancy says, try to hit the fences? Or am I going to just be careful and try to drive out the losers? They're both legitimate.

Everybody needs a game plan and the ability to carry it out. But I think that the analogies between sports and investing are great. The one thing we know is that the people who don't invest are not going to make any money. You don't make money just for investing. You have to do some things right. But we know that if you don't invest, you're not going to make any money. That's the inescapable choice. How do you think about risk? Well, I think risk is inescapable.

And Will Rogers said, you have to climb out on the limb sometimes because that's where the fruit is. And you can't make money without taking risk. I wrote a memo. Most of my memos are about 12 pages. Some people tire of reading them. But I wrote one in, I think, April that was only three pages. And it was called The Indispensability of Risk. And you have to take some risk if you want financial success. How do you think about diversification?

Everybody believes it's prudent to diversify your portfolio. Because if you put it into one thing, I mean, somebody was telling me a story at lunch yesterday. Somebody put all his money into something and it turned out that it was a mistake and the guy operating was a fraud and now he's trying to get some money back. But none of us should put all our money into one thing, maybe two things. No, that's too few. Three, I don't know.

But if you have more money than you need to eat, the first purpose of your investment activities should be to make you comfortable. Nobody should make themselves uncomfortable to try to get more money than they need to eat. And if you're uncomfortable, you can't do the right thing. You can't hold on when it goes down, et cetera. Buffett always says, why risk what you have and need to get what you don't have and don't need?

So, comfort in part comes from prudence. Prudence insists on diversification. But everybody should bear in mind, we concentrate our portfolios to take advantage of what we know. We diversify our portfolios to protect against what we don't know. So, you have to look at it in that framework. Now, most people don't know much. So, they should be highly diversified. If you think you know something and you want to take a flyer, then you could diversify

Put a little of your money on a concentrated basis into that thing. But before you do, you should ask yourself that question. Do I really know anything? Investing is a tough field and it's hard to know anything. Again, like sports, you're playing against people who are pretty well equipped and highly motivated. So you say, I think I should buy some GM. You go into the market and you see it's 52%.

And you say, oh, you know, I'm pretty smart. I'm going to buy GM. I'm going to make a lot of money because I think it's worth 60. Just remember, somebody is willing to sell it to you at 52. They obviously think that it's fully priced at 52. Are you smarter than they are? That's the question you always have to ask. And most people never ask it. And you can play either a winner's game, which the greatest players play, or a loser's game. Can you talk about that?

If you watch Wimbledon and you see Alcaraz, he wins by hitting shots that his opponent can't return. Those are winners. If he doesn't try to hit winners, the others will eat him for lunch. When I go out to play, I'm not capable of hitting winners. So I try to avoid hitting losers.

And if I can just put it over the net 20 times in a row, my opponent is likely to only be able to do it 19 times, then I'll win. Not because I hit a winner, but because I didn't hit any losers. Every person has to decide for themselves which game plan they're going to try to operate. But isn't it folly for a novice duffer to try to hit winners when they don't have the skills, the conditioning, or the regularity?

Which comes back again to your always good, sometimes great and never terrible. There you have it. How can people diversify? Because when there are extreme moves in the market, it seems like everything is correlated and everything falls together. What is an effective diversification strategy or how should people think about diversification?

I once wrote a memo, late August, I guess it was, called Mr. Market Misbehaves, talking about the fact that the markets tanked in the first three trading days of April for no good reason, and people were jumping off buildings. And one of the things I mentioned in that memo is that there's an old saying in our business that in times of crisis, all correlations go to one. That is to say, everything moves together.

And things are different. They shouldn't move together. But one psychological mania takes over, causing everybody to treat everything the same. So if they treat everything the same, they dump everything at the same time. And clearly, there's nothing that's going to hold up. And in the extreme, there's no such thing as diversification, other than to hold some cash. But cash is very suboptimal most of the time, which means that you have to just hang in there, tighten your seatbelt, and you have to have a strong stomach, because

Because there will be times when no matter, even if you have a diversified portfolio, everything will go down together. And you might recall, and I'm sure you do, in that memo, I showed a picture of my phone on a particularly bad day. Every asset went down, every stock, every bond, the equity indexes in every country, all the commodities. Why? Were they all troubled? No, because people flipped out and they all applied a kind of monotonic psychology, which

So you can't think that diversification is going to save you on the worst days, and you just need a strong stomach. Before I ask for the three takeaways you'd like to leave the audience with today, is there anything else you'd like to mention that you haven't talked about yet? What should I have asked you, Howard, that I did not? I think that your questions have led me into most of the really important topics that confront most people.

And it's important to invest early, a lot, steadily, hold for the long run. Don't overtrade. Don't think you're a genius. Don't feel any pressure to trade because your friends are doing it because they're not geniuses either. And just go for the long run. Go for always good, sometimes great, never terrible. That is wonderful advice. Howard, what are the three takeaways you'd like to leave the audience with today? Number one.

Bear in mind, in investing, it's really easy to be average. We have index funds that'll make you average and it'll cost you very little. And it absolutely precludes the possibility of being below average. And it's very hard to be above average because to be above average, you have to be smarter than the average of everybody else. And the other people are morons. So for most people, an averaging strategy firmly adhered to over a long period of time without jitters is the best you can do.

Number two, this obsession with macro forecasting. When will the Fed raise rates? How much will they raise rates? How long will they raise rates? When will they stop? Will we have a recession? Will it be a bad one or a good one? Nobody knows. Almost nobody knows better than anybody else. It's almost impossible to profit from these things. Give it up.

and accept that from time to time, you'll be buffeted by events beyond your knowledge or control. That's life. Don't let that deter you. And finally, I wrote a memo, October 22, with the title, What Really Matters. So I hope your listeners will keep track of what really matters. And it's not short-term trading.

It's not hyperactivity. It's buying the stocks of companies that are likely to grow over time and lending money to companies that are likely to pay you back. That's what matters. Thank you, Howard. This has been wonderful. I always look forward to your memos. Thank you. And thanks for your great questions.

If you're enjoying the podcast, and I really hope you are, please review us on Apple Podcasts or Spotify or wherever you get your podcasts. It really helps get the word out. If you're interested, you can also sign up for the Three Takeaways newsletter at threetakeaways.com, where you can also listen to previous episodes. You can also follow us on LinkedIn, X, Instagram, and Facebook.

I'm Lynn Thoman, and this is Three Takeaways. Thanks for listening.