Howard Marks: How I Mastered the Markets - My Advice From 50 Years of Investing

0:00Buffett says the less prudence with which others conduct their affairs the greater the prudence with which we must conduct our own affairs. And I would say that prudence is not in the ascendancy at the moment. Risk-taking is. Not grievously, but it is. And so we should be careful. Well, the Mag-7 are highly valued. Those don't trouble me. Because they're some of the greatest companies we've ever seen, the Mag-7. But I think that the other 493 companies in the S &P 500 are selling at a P.E. ratio. I don't know if it's 19 today or 20 or 21, something like that. Why should the other 493, which are much more mortal, be selling at P.E.

0:50ratios above the historic average for the S &P over the last 80 years? So this is why I say that I think that the S &P is valued highly. We sometimes know what's going to happen, but we never know when. And anybody says this is the time or this is not the time is talking through their hat. Overpriced and going down tomorrow are far from synonymous. You know what they say, Wilfred, if you like what you do, you'll never work a day in your life. And that applies to me. Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders and politicians in the world, giving you, our listeners, the edge.

1:38Please do remember that nothing you hear on the Master Investor Podcast should be considered direct financial advice. More on that in our show notes. My guest today is a legend of the investment world. He is co-founder and co-chairman of Oaktree Capital, which manages over$200 billion in assets under management. His track record there at Oaktree speaks for itself, but he's become a legend beyond that with his investment memos, which he writes a couple per year, where he shares his considerable investment wisdom and views on the current state of play. I am, of course, talking about the one and only Howard Marks.

2:17Howard, it is such a treat to have you on the Master Investor podcast. Welcome. Thank you, Wilfred. It's great to be back. And it's such great timing because you are celebrating 35 years of your memos this week. And there's a full e-book available for free on the Oaktree website, as well as your outline of the sort of best of of the memos over those 35 years. And what jumped out to me from your outline, which I love, is this is a part of your job that you adore. It makes you no money. They're free for all of us to read. But you love writing these memos. Well, you know what they say, Wilfred, if you like what you do, you'll never work a day in your life.

3:00And that applies to me. Well, that is a phrase that resonates with me because my late father used to say it to us a great deal. It's a big week as well because you've announced that Brookfield is buying the last minority stake in Oaktree that it didn't have yet this week. But I hope that doesn't mean you'll stop writing these memos. No, they'll pay me as well as I have been paid to date for the memos. Well, listen, we want to dive into them now because there's so much wisdom in there and we want to lean into all of that. And I've gone through all the memos, Howard, and I loved going back through them.

3:39And before we get on to sort of the current state of play and maybe the second half of this conversation, I wanted to dive into some of the ones that really jumped out to me today. And what was also striking, given that you've been writing these for 35 years, is the first 10 years or so, you said that people didn't really take that much note of them, which to me is a 40-year-old who's read these things eagerly for the last 20 years was very, very surprising. And the one that really changed all that for you was titled Bubble.com, January 2nd, year 2000. Talk me through just quickly that one. What was the central premise back then?

4:21In the fall of 99, there was a big bubble, one of the greatest bubbles we've ever seen in the stock market. It was called the TMT bubble, tech media telecom bubble, but nowadays we call it the internet bubble. And, you know, everybody assumed that the internet would change the world. They extrapolated that to mean that an internet stock or a stock with the name internet in its name was worth infinity. And, you know, that fall of 99, I was reading a book by Edward Chancellor, a financial historian called Devil Take the Hindmost, a history of financial speculation. And I was reading about, in particular, the South Sea bubble, in which England figured it would get rid of its national debt by creating a company, the South Sea Company, and giving it a monopoly to trade with the South Sea.

5:16And people went crazy over that stock, and they took off from their jobs to day trade in that stock and so forth. And as I read about people's behavior, I said, holy cow, that's exactly what's going on now in the tech stocks. And so, you know, that was the starting point. And I wrote a memo about the misbehavior that I saw taking place in the market for tech stocks. And as you say, it came out on the first day of 2000 and it had two advantages. Number one, it was correct. And number two, it was correct soon. Because if it takes a long time to be proved correct, people forget. But after 10 years, that memo made me an overnight success.

5:59And there's so much in it. I really strongly advise people go back and read that one amongst many others. But you quote Warren Buffett in that memo. And I know he then throughout his career quotes you back and loves reading your memos. This is a quote that jumped out to me from Warren Buffett in that particular memo that you quote. The key to investing is not assessing how much an industry is going to affect society or how much it will grow, but rather determining the competitive advantage of any given company and above all, the durability of that advantage. I wonder whether there's a big relevance of that today as well as there was back in 99-2000 because with this race of investment in the space of AI there are quite a few players competing out not hundreds but it's also not like the last decade where basically Google had a monopoly on search for example is that quote relevant today as it was in 99?

6:59Oh it's always relevant One of the most important sayings was from Mark Twain, American author, who said, history does not repeat, but it does rhyme. There are certain themes that rhyme from cycle to cycle or generation to generation. And what are the characteristics of bubbles? Number one, it invariably surrounds something new that triggers the excitement, gets people going. And since there's no history of it, there's no indication of what its limitations might be. and then people get excited about the new thing and they assume that it will change the world and then they assume that that will result in profitability, which is not always a strong assumption.

7:41And that was one of the comments I made in the memo about e-commerce. Then they assume that the incumbents will succeed, whereas they may be replaced. And in the extreme, they assume they'll all succeed, which may be unlikely. But, you know, the opportunity to buy the stock in each one looks like a lottery ticket that could pay off in millions. So these are some of the threads. And Buffett said 25 years ago about the internet, that the internet will certainly increase efficiency, but will it increase profitability? For example, what if all the companies in a given industry get AI? They compete to use it.

8:23They all put it to work. It increases efficiency for all of them, but they compete for business by cutting their prices, and that eliminates the unusual profitability of that industry. So, you know, what he's saying is change the world and make a lot of money don't necessarily mean the same. As you mentioned, the timing of that January 2000 note bubble.com was prescient. It made you a huge success. But in one of your later memos, November 2001, titled, You Can't Predict, You Can Prepare, you also outline, I guess I think it's fair to say, Howard, in that one, the central premise that it's impossible most of the time to correctly call the moment when something will come to an end, but that you do believe in cycles more broadly and you can try and establish where you are in a cycle.

9:22Is that fair? Exactly. I always hearken back to my way of saying things, but number one, there's not a word in bubble.com of prediction. It's only observation of what was going on at the time. And so what I say is we never know where we're going, but we sure as hell ought to know where we are. And where we are influences, or you might even say determines where we're going to go. But it's sufficient and maybe all you can do to say what's going on today, what are the implications for tomorrow, probably. Then the other thing, you mentioned timing. We sometimes know what's going to happen, but we never know when.

10:10And anybody says this is the time or this is not the time is talking through their hat. So the point is, what I call it is taking the temperature of the market, assessing what's going on, drawing inferences from that, and perhaps conclusions, assessing behavior, assessing the pricing of securities, and assessing the risk that's present. But we never know. I mean, one of the most important things for everybody to realize is that overpriced and going down tomorrow are far from synonymous because things can be overpriced and then become more overpriced and then highly overpriced and then extremely overpriced and then bubbles and it can take years.

10:52And if you see something that's overpriced and bet against it heavily enough, you can get carried out. And that's why your countryman, Lord Keynes, said the market can remain irrational longer than you can remain solvent because irrationality can go on more and more and more and to greater and greater extremes. And betting that rationality will prevail in the short run can be fatal, absolutely fatal. And in terms of the cycle right now, I wonder, particularly in the last couple of weeks, some of the big bank CEOs were commenting on this in their reports earlier this week. there have been a couple of quite high profile defaults, maybe not massive defaults in the US, trickle or and first brands.

11:42What do you think of that? Does that tell you we are late in this cycle one way or another or not? No, not at all. Not at all. There are defaults all the time. You know, I was one of my lucky breaks was being asked to start Citibank's high yield bond activities in 1978, which was the beginning of the high yield bond world. And one of the things about investing or life is that it's great to be in at the beginning. So I've been involved in high yield bonds. It'll be 47 years next month. There have been defaults every year. So the existence of defaults in itself is not a big deal. Now, in the case of those two, there is somewhat more significance than the usual default because they both probably, well, let's say, I'll try to stay out of jail here.

12:35They both may have had something to do with misbehavior on the part of the management, and they may have been examples of inadequate due diligence because somebody bought those bonds or those loans and held them. So that's significant. And one of my heroes, John Kenneth Galbraith, the American economist, used to talk about a good bezel. He was talking about embezzlement. He says, well, it's time for a good bezel. And the truth is that when the economy is doing well, the markets are flying high, The investors are optimistic when the investors are more afraid about missing out than they are about losing money.

13:21That's the climate in which a good bezel can take hold. And, you know, I spent my first 16 years at Citibank and the bankers have a saying that the worst of loans are made in the best of times for the reasons I described. And because the lenders compete to make loans, and when the going's good, they compete aggressively. That's when mistakes slip through. This is why I believe that it is the behavior of the participants who determine the level of risk in the markets. And, you know, today, I mean, look, we've had 16 positive years. There hasn't been a bad year in the last 16. There were two down years, but not too bad and easily recovered.

14:05There has not been a prolonged stretch of decline. So risk-taking has been rewarded. Caution has been penalized. I would say that it has made people feel that it's more dangerous to be out of the market than in, to turn down a loan could be dangerous than making a loan. These are all bad lessons. And it's not the worst I've ever seen. It's not as bad as February 07, for example. but it's certainly on the incautious side. You quote Buffett to me, I'll quote Buffett to you. Buffett says, the less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.

14:45And I would say that prudence is not in the ascendancy at the moment. Risk-taking is, not grievously, but it is. And so we should be careful. And when I say careful, you know, I try to always be careful. So when I say careful, I mean more careful than usual.

15:11I wanted to ask about the idea of being contrarian. And by, you know, reflecting on some of those notes, we are reminded of when you've taken clear contrarian positions to great reward. and you're well known as a contrarian, as an original thinker, can you always be contrarian? Or while you rightly point out no one can time the market perfectly, do you have to also then switch and buy into the momentum and the consensus at certain times or not? Well, you should never buy into momentum. You should never buy something because it's been going up or even because you think it will continue to go up.

15:54You should only buy it if you think it's good value. So that's number one. I don't believe in momentum. The great economist Herbert Stein said, if something cannot continue, it will stop. And I believe that firmly. So this business about it's going to continue, yes, it'll continue till it stops, but that's a hell of a thing to hang your hat on. And you certainly can't be a contrarian with good effect all the time. When I was working on my second book, which was called Mastering the Market Cycle, I was speaking with my son, Andrew, who is my collaborator. And I said, you know, Andrew, I think my market calls have been about right.

16:36And he said, yeah, Dad, that's because you did it five times in 50 years. Five times in 50 years, I found the market crazy high or crazy low. And when you find that, the logic can become compelling and the probability of being right can be high. But if you try to do it 50 times in 50 years or 500 times or 5 ,000 times, you know, my working career has spanned almost 20 ,000 days now. And so if you tried to do it 5 ,000 times in 20 ,000 days, if you're lucky, you'd be 50-50. Mm-hmm. So it's important to be contrarian at the extremes. It's not enough, and it's not a good idea to say, you know, if they say black, I say white.

17:30If they say buy, I say sell. If anybody who believes that simplistically or behaves that simplistically is going to go bankrupt fast, what you have to do is you have to say, what does the consensus believe? What do I believe? Why do they believe what they believe? Why do I believe what I believe? Which one is probably right? And if I bet against the consensus, what has to happen for me to be proved right? And so forth. So in my book, the most important thing is chapter one, and I call it second level thinking. You have to think different from the horde, but you have to think better. And there aren't that many times when the horde is that wrong that thinking different will be successful.

18:20That's such a great answer. And I guess what comes from that to me sounds like the importance of patience and conviction with these things. In terms of super long-term performance, you write about this in October 1990, a memo called The Route to Performance, which I guess, based on your earlier answer, people didn't read much at the time. First memo. Was that your first memo? Yes, because it's 35 years. There we go. It was 35 years on Sunday, by the way, Wilfred. I knew it was 35 years this week, exactly. Sorry, I've read a lot of memos this week, and I've noted the dates, but not the order. But anyway, in that memo, you outline a point which I think people overlook a lot, just the pure maths of it, which is 10 % down, 10 % up is a better return than 20 % down, 20 % up.

19:16And I guess central to that memo is it's as much about avoiding the bad years, the drawdown moments, as it is about chasing the up years. Well, you say it's as much. I would say it's more. And, you know, everybody who wants to be a successful investor has to choose their course. And so I wrote a memo, I guess it was in the summer of 24, watching the tennis, Wimbledon and so forth, which I love to do in the summer. And the title was... It's the best tennis tournament. We've still got that over here. It's certainly, as Churchill would say, of democracy, it's the best except for all the others. but you know I so I wrote this memo it's called fewer losers or more winners and every investor who wants to be superior has to basically choose one or the other the aggressive people among us will go for more winners the defensive people will go from fewer losers nobody really few people have the skill to do both you have to have a bias and and you have to explicitly choose that bias so that you can work conscientiously.

20:29So the first memo back, as you say, October of 90 was occasioned by a dinner I had with a client who was managing a pension fund for his corporation for 14 years. And he told me that in the 14 years, that company's equity portfolio had never been above the 27th percentile or below the 47th percentile. So solidly in the second quartile of performance every year in a row for 14 years in a row. So you would say, well, if they were between 27 and 47 every year for 14 years, where would they be for the whole time? Well, probably, let's say 37, right in the middle. Well, the answer was four. Well, how can that be?

21:09If you're in the second quartile every year for 14 years, how could you get up to the very top for the whole period? And the answer is most people eventually shoot themselves in the foot. And so if you can merely do that, avoid doing that, I think that's a great thing. You don't have to be a hero. You don't have to be a genius. You know, Buffett said someplace, if you have a 160 IQ, sell 30 points. You don't need them. And one of your newspapers, the FT, the great FT, has a column on Saturdays called Lunch with the FT. And they write an article about a person, a restaurant, and the food. And so in the late 22, they took me to lunch at my favorite Italian restaurant near the office here in New York.

21:51And I said to the writer, I said, eating in this restaurant is like investing at Oak Tree. And I hope this is true. Always good, sometimes great, never terrible. Now, that's not a huge boast. You know, that's not five stars. That's not the greatest restaurant in the world. But if you think about it, isn't that what we all want? And if you think about it in particular for investing, isn't that the best we can do? If you can be always good, occasionally great, and never terrible, you'll come out like my client at the very top. But this is an accomplishment that is compiled over decades, not days or months.

22:39But that's my goal. By the way, I'm going to read that column. I haven't read it. I'll also take note of where the Italian restaurant is. I also love Lunch with the FT as a column, and I'm always quite glad that they didn't make it a podcast, too, because it leaves space for conversations like this. Quick question on gold, then I want to get to some of your most recent memos in the current time. A great memo on gold. You wrote it in 2010, December. It's called All That Glitters. I was struck, actually, by you outlined the pros and the cons of it. It's very balanced, but my conclusion of you reading it is that you don't think it has a particularly long-term financial value.

23:20Correct me if I'm wrong, but my main question here for you is, what on earth is driving it to have quite such extraordinary performance of late? Well, Benjamin Graham, who was Warren Buffett's teacher at Columbia and first boss when Buffett worked at Graham Newman Hedge Fund, said that in the long run, the market is a weighing machine. It assesses merit. But in the short run, it's a voting machine. It reflects popularity. And gold is having its day in the sun now with great popularity. And so I think that's the main reason. Now, people would say, oh, no, no, that's not it. People are worried. They're worried.

24:04It's a flight to quality. People are terrified. And they're worried about the United States and the deficits and the debts. They're worried about China and Taiwan and rare earths. And they're worried about the Middle East. And they're worried about the quality of leadership in politics around the world, Russia, Ukraine. There are so many worries. That's why everybody's running to gold. Well, if that were true, then would the stock market be at an all-time high? And would the world's currencies be relatively stable. People are worried about the dollar. Is that why they're running to gold? Well, the dollar has been stable for six months.

24:42So I don't think you can make that point. And I'm happy with all the glitters from 2010 because I wrote everything that I thought about gold and 15 years later, I feel good about it. And basically what I said in there is that there There are two kinds of assets in the world, the ones that produce cash flow and the ones that don't. The ones that produce cash flow are stocks, bonds, companies, and buildings. And if an asset has cash flow, then you and I can intelligently discuss what it's worth. And if there's a building that I own that throws off a million a year in profit, and you want to buy it, you can say, well, I'll give you eight million for it because I'd like to have a 12 % return.

25:32And I'll say, no, no, that's not enough. It has many more merits than you think. I want 12 million because the profits will grow over time. But we're talking about an intrinsic value within a range. But if you talk about assets that don't produce cash flow, and we're talking about paintings, diamonds, furs, oil, gold, crypto. It doesn't produce cash flow. You can't talk about what the right price is. I mean, what's the right price for an ounce of gold? How do you derive it? How do you calculate it? and, you know, there is no intelligent way to assess the intrinsic value. These assets sell at a price, the term for which is what the market will bear, what the buyer will pay and the seller will take.

26:31That's where it sells, period. And the merits of gold at 4 ,000 were the same as when it was 2 ,000. If it was a buy at 2 ,000 based on those merits, is it still a buy at 4 ,000 based on those merits, etc. So the point of the memo, Wilfred, is that you can buy it because it historically has been a store of value and because you believe it will continue to be. But why should it be? And the reason you think it'll continue to be a store of value is because it always has. But why has it? And you see, so it's a circular thing without reference to anything intrinsic or tangible. And so you can invest in gold because you're scared.

27:18You can invest in gold because you're aggressive and want to be in on it. Or you can invest in gold as a superstition. You just can't do it analytically because you can't tell me what the right price is. And I guess anybody who's listening who wants to tell me what the price will be in a year, I'll give them 10 to 1 odds that they're wrong. Well, certainly to pick a particular one, maybe you could offer them a bet if it's going to be higher or lower. No, there I'll give you 50-50. Yeah, fair enough. Fair enough. And I think after the recent run, your point earlier about needing prudence would apply strongly.

27:59I want to come to two of your most recent memos and the current state of play today. Of all of the ones I've read of late, I think SeaChange, December 22, is critical to read. And you talk there about how you value gold, how you value a company. Critical in that, obviously, is the discount rate you apply. And in SeaChange, you talk about a sea change during your career, your 40-year career in investing and how for most of that last 40 years up to 22, people had enjoyed falling interest rates. And you raised the question in that memo about whether that's changed and rates rise for the next couple of decades afterwards.

28:45Do you still think that sea change fully took place or are rates now falling again in enough of a meaningful way with short end cuts that in fact it was just a temporary change not a sea change well i hate to correct my host but i have to please do work number one my career is 56 years not 40 number two i didn't say rates are going to be rising for years to come. What I said was that from 1980, when I had a personal loan outstanding at a rate of 22 and a quarter to 2020, when I took out a new loan at two and a quarter, all people saw was declining or ultra low rates or both, and that it's over.

29:39I didn't say they're going up. I said they're not going down. And the Fed at the end of 21 concluded that it had to raise rates to fight inflation. It did so starting soon in 22. The Fed funds rate went from zero on that program to five and a quarter. And five and a quarter is pretty close to the average for the last 70 years. So I didn't say they're going up from there. I just said they're not going down. And, you know, from 09 to 21, which was an unusual period of fighting the global financial crisis, the Fed funds rate, our short term benchmark rate, was zero most of the time and averaged a half.

30:25And I merely said, we're not going back there. What I went on to say was that, you know, you talked about the discount rate, and that's the important thing. When rates go down, a given asset that proves his cash flow becomes more valuable. And that happened steadily over that 40-year period. And that meant it was a great time to own assets. And we know when we have easy money, people talk about asset bubbles. And we had a steady rise in asset values over that period. The other thing is, if you buy assets using borrowed money and rates go down, your cost of capital goes down. So if you bought assets with borrowed money and then rates went down for 40 years, you say, boy, I'm smart.