Master of the market, Howard Marks, has issued a cautious memo stating: “I think it’s better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses.” Livewire has pulled out nine key points from the memo for you, and link to it in full below.
On the four most noteworthy components of current conditions:
- The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.
- In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.
- Asset prices are high across the board. Almost nothing can be bought below its intrinsic value, and there are few bargains. In general the best we can do is look for things that are less over-priced than others.
- Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.”
Elevated Buffett yardstick
“The “Buffett Yardstick” – total U.S. stock market capitalization as a percentage of GDP – is immune to company-level accounting issues (although it isn’t perfect either). It hit a new all-time high last month of around 145, as opposed to a 1970-95 norm of about 60 and a 1995-2017 median of about 100.”
Record low for the VIX when risk is high
“The bottom line is that last week’s VIX was the lowest in its 27-year history – matching a level seen only once before. The index was last this low when Bill Clinton took office in 1993, at a time when there was peace in the world, faster economic growth and a much smaller deficit. Should people really be as complacent now as they were then?”
Concern over tech stocks
“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 unforeseen 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.”
When ETF's have to sell in a crunch
“As a product of the last several years, ETFs’ promise of liquidity has yet to be tested in a major bear market, particularly in less-liquid fields like high yield bonds. The large positions occupied by the top recent performers – with their swollen market caps – mean that as ETFs attract capital, they have to buy large amounts of these stocks, further fueling their rise. Thus, in the current up-cycle, over-weighted, liquid, large-cap stocks have benefitted from forced buying on the part of passive vehicles, which don’t have the option to refrain from buying a stock just because its overpriced. Like the tech stocks in 2000, this seeming perpetual motion machine is unlikely to work forever. If funds ever flow out of equities and thus ETFs, what has been disproportionately bought will have to be disproportionately sold. It’s not clear where index funds and ETFs will find buyers for their over-weighted, highly appreciated holdings if they have to sell in a crunch. “
EM debt a worry
“For only the third time in history, emerging market debt is selling at yields below those on U.S. high yield bonds. Is Argentina, a country that defaulted five times in the last hundred years (and once in the last five), likely to get through the next hundred without a rerun? “
What about private equity?
“In today’s low-return world, it’s clear that institutional investors needing 7-8% a year aren’t likely to get it from Treasurys yielding 1-2%, high grades at 3-4%, or mainstream stocks that most people expect to return 5-6%. Heck, you can’t even get it from Ivory Coast bonds! Where is one to turn? I’m not saying private equity isn’t a solution, or even that it’s not the best solution. It’s just that its record fund-raising is yet one more sign of the willingness of investors to trust in the future.”
Looking at the big picture
“As I said, most of the phenomena described above seem reasonable given the rest of what’s going on in today’s economic and financial world. But step back for perspective and put them together, and what do we see?
- Some of the highest equity valuations in history.
- The so-called complacency index at an all-time high.
- The elevation of a can’t-lose group of stocks.
- The movement of more than a trillion dollars into value-agnostic investing.
- The lowest yields in history on low-rated bonds and loans.
- Yields on emerging market debt that are lower still.
- The most fundraising in history for private equity.
- The biggest fund of all time raised for levered tech investing.
- Billions in digital currencies whose value has multiplied dramatically.
Try to think of the things that could knock today’s market off kilter, like a surprising spike in inflation, a significant slowdown in growth, central banks losing control, or the big tech stocks running into trouble. “
How to be a long-term survivor
“The keys to avoiding the classic mistakes also recur, and I listed them in There they go again:
- awareness of history,
- belief in cycles rather than unabated, unidirectional trends,
- skepticism regarding the free lunch, and
- insistence on low purchase prices that provide lots of room for error.
Adherence to these things – all parts of the canon of defensive investing – invariably will cause you to miss the most exciting part of bull markets, when trends reach irrational extremes and prices go from fair to excessive. But they’ll also make you a long-term survivor.
I can’t help thinking that’s a prerequisite for investment success.”
You can read the full memo from Howard Marks here: (VIEW LINK)
Quote: 'Thus, in the current up-cycle, over-weighted, liquid, large-cap stocks have benefited from forced buying on the part of passive vehicles, which don’t have the option to refrain from buying a stock just because its overpriced... If funds ever flow out of equities and thus ETFs, what has been disproportionately bought will have to be disproportionately sold.' Unquote. Implicit in this statement is an assumption of inefficient markets. Is this really true of large cap stocks ? This is a typical mantra of active managers. If you assume this then it follows that buying broad index equity ETF s will be irrational and there will be a day of reckoning. If you believe in inefficient markets then you should not be in market cap ETFs and should use active Fund Managers. Clearly, given the that the flow of funds into ETFs broadly equals the loss of funds by Active Managers, there is a loss of faith in active management by investors and most investors still believe that the major Western markets are largely efficient price wise.