You may have heard of Howard Marks, co-chairman of hedge fund Oak Tree Capital. He cut his teeth investing in high yield bonds and convertible securities when they were still very esoteric investments.
He established Oaktree in 1995, with a focus on this area of the market — more commonly known now as ‘credit’. During the 2008 financial crisis, the firm raised a massive $10.9 billion to invest in distressed debt, a decision that paid off handsomely for his investors.
Marks has a philosophy similar to Warren Buffett. That is, he likes to be greedy when others are fearful, and fearful when others are greedy.
Marks is best known in investment circles for his investment ‘memos’, commentary about the mood of the market and the psychology of investors.
His latest effort, titled ‘There They Go Again…Again’, is a long and cautionary note about the risks building in this market.
It’s not the first time Marks has warned investors. Throughout his career, such warnings have been a common theme. Some have been prescient, while others have been so early that they have been wrong.
Who knows where this latest effort will rank?
Still, I thought it worth mentioning. As Marks says:
‘Since I’m convinced “they” are at it again — engaging in willing risk taking, funding risky deals and creating risky market conditions — it’s time for yet another cautionary memo. Too soon? I hope so; we’d rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains.’
And he has plenty of evidence to support his cautious stance. He says the ‘Buffett Yardstick’ — which measures total US stock market capitalisation as a percentage of GDP — hit an all-time high last month of around 145. That compares to the 1995–2017 median of about 100.
Marks then mentions volatility, or the lack of it. The VIX index is a market measure of volatility. Recently, the VIX hit its lowest level in history. You can see that in the chart below.
This is an indication that the market sees little need for concern right now. The market may be right. But history tells you that sooner or later, there is always something for the market to worry about. Getting the timing right is the difficult thing.
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As you can see in the chart, the trend over the past few years has been towards less worry. Betting on rising volatility has been a losing trade. Maybe it will continue to be one for a while yet.
After all, central banks have played a pretty good role in making sure investors ‘have nothing to worry about’.
Although I would argue that when there’s nothing to worry about, that’s precisely a reason to worry. Because when there are no worries, investors tend to factor that into share prices. The slightest increase on the worry spectrum then, will lead to a share market correction.
My favourite part of Marks’ memo relates to his thoughts on ‘Super Stocks’. I’m biased though, as I wrote about this yesterday and it confirms my thinking.
Investors love nothing more than to read about what they already think. It makes them feel smart. I’m no different. So let’s get into it…
‘Bull markets are often marked by the anointment of a single group of stocks as “the greatest” and the attractive legend surrounding this group is among the factors that support the bull move.
‘In the current iteration, these attributes are being applied to a small group of tech based companies, which are typified by “the FAANGs”: Facebook, Amazon, Apple, Netflix and Google (now renamed Alphabet). They all sport great business models and unchallenged leadership in their markets. Most importantly, they’re viewed as having captured the future and thus as sure to be winners in the years to come.
‘True as far as it goes…just as it appeared to be true of the Nifty-Fifty in the 1960s, oil stocks in the ‘70s, disk drive companies in the ‘80s, and tech/media/telecom in the late ‘90s. But in each of those cases:
- the environment changed in unforseen ways
- it turned out that the newness of the business model had hidden its flaws,
- competition arose,
- excellence in the concept gave rise to weaknesses in execution, and/or
- it was shown that even great fundamentals can become overpriced and thus give way to massive losses.’
Who knows how this will all play out?
Maybe we’re at the equivalent of a 1996 in the dot com boom? That is, there still may be a long way to go. Or maybe there is no comparison. I really have no idea.
The investment conference I was at last week kicked off with a video presentation from tech evangelist (and founder of fund manager Magellan) Hamish Douglass.
It was all about how the world would look in 10 years’ time. While entertaining, it was also slightly worrying that a multibillion dollar fund manager is so sure about what the future holds.
I mean, the iPhone has transformed the way the world works over the past 10 years. Who knows if there is another such device in our future that will transform things yet again?
Humility, and an admission of ignorance about what the future holds, are signs of a focused and grounded investor. The VIX, the FAANGs and the vision of an evangelist investor tell me markets aren’t particularly well grounded right now.
That’s why I’m concerned about a looming correction — especially in the tech space.