20VC Howard Marks on How COVID19 Impacts Our Economy, Liquidity and National Debt, Why The Theory of Falling Knives and Market Bottoms is Wrong & Why The Best Investors Are Fundamentally Unemotional



In a timely episode of "20 minutes VC," host Harry Stebbings interviews Howard Marks, cochairman and cofounder of Oaktree Capital Management, to discuss the economic impact of the COVID-19 pandemic. Marks emphasizes the unprecedented nature of the current crisis, marked by a combination of economic standstill and liquidity withdrawal, and the challenges it poses due to high leverage and low asset quality in businesses. He compares the situation to past financial crises, noting the unique health aspect and the lack of a preceding asset bubble. Marks also critiques the notion of waiting for market bottoms, advocating for value investing based on judgement and encourages embracing opportunities in times of fear. Additionally, he discusses the role of government intervention in mitigating economic damage and the importance of maintaining an unemotional approach to investing during volatile times.

Summary Notes

Introduction to the Podcast and Guest Howard Marks

  • "20 minutes VC" is a podcast hosted by Harry Stebbings.
  • Harry Stebbings introduces the episode during a time of market uncertainty.
  • Howard Marks is the featured guest, known as the master of market cycles.
  • Howard Marks is the cochairman and cofounder of Oaktree Capital Management.
  • Oaktree Capital Management has over $120 billion in assets.
  • Howard Marks has an extensive background in investments, particularly in distressed debt, high yield bonds, and convertible securities.
  • He has also authored memos and books, including "Mastering the Market Cycle: Getting the Odds on Your Side."
  • Warren Buffett has praised Howard Marks' memos as highly informative.

"He's the master of market cycles. He's a personal hero of mine, and I couldn't be happier to welcome Howard Marks back to the hot seat today."

This quote emphasizes Howard Marks' expertise in understanding and navigating market cycles, and the host's admiration for him.

Howard Marks' Background and Oaktree's Anniversary

  • Howard Marks initially intended to be an accountant but switched to finance.
  • He earned a graduate degree at the University of Chicago.
  • His career in finance began with a summer job at Citibank's investment research department.
  • His roles at Citibank included equity analyst, unit head, and director of research.
  • In 1978, Marks was tasked with starting a high yield bond fund, which became a significant area in finance.
  • Howard Marks and Bruce Karsh initiated the distressed debt investing activity at TCW.
  • In 1995, Howard Marks, Bruce Karsh, and three colleagues founded Oaktree Capital Management.
  • Oaktree Capital Management is nearing its 25th anniversary at the time of the podcast.

"In 95, Bruce and I and three other colleagues left to start Oaktree. So we are within a couple of weeks of Oaktree's 25th anniversary, and that's the short version."

This quote provides a succinct overview of Howard Marks' journey in finance and the founding of Oaktree Capital Management, highlighting the significance of its upcoming 25th anniversary.

Current Economic Crisis

  • The current economic situation is characterized by a "total stoppage" of the economy due to the pandemic.
  • Key sectors like retail, hospitality, and travel are experiencing unprecedented declines.
  • The economy is described as being in a "deep freeze."
  • Prior to the crisis, companies and investment entities increased their leverage and invested in lower quality assets.
  • The combination of high leverage and low asset quality is problematic, with many companies over-leveraged.
  • Liquidity is being withdrawn by lenders, exacerbating the economic freeze.

"So the economy is in a deep freeze. And then in addition to that, given the fact that we had eleven years of prosperity and declining interest rates in the world, people used more and more debt to buy assets of lower and lower quality to lever them into palatable returns."

This quote outlines the two-fold nature of the crisis: an economic standstill caused by the pandemic and pre-existing financial vulnerabilities due to high leverage and asset quality issues.

Comparisons to Past Economic Events

  • Howard Marks compares the current crisis to the 2008 financial crisis.
  • The main difference is that the current crisis is a health crisis with life-and-death implications, whereas 2008 was a financial crisis.
  • Another distinction is that the 2008 crisis followed a bubble, with banks heavily leveraged, while the current situation does not involve a preceding bubble.
  • Banks are less leveraged now than they were during the 2008 crisis.

"Well, it's similar in some ways to eight, and it's different in some ways. The main difference is that this is life and death. This is a health crisis. That was a financial crisis."

This quote compares the current economic situation to the 2008 crisis, highlighting the unique life-threatening aspect of the current health crisis and differing financial conditions leading up to it.

Financial Problems for Highly Levered Entities

  • Highly levered entities are experiencing financial problems due to assets declining in price.
  • The current situation is compared to past financial issues, with the note that there is no analog as deficient in substance as the subprime mortgage crisis.

"So those are the differences. The similarities are that it's a financial problem for highly levered entities which own assets that are declining in price."

The quote explains that while there are differences between the current financial issues and past crises, the common thread is the financial strain on entities with high leverage owning depreciating assets.

Fiscal and Monetary Policy Concerns

  • Concerns exist about the effectiveness of fiscal and monetary policies after their extensive use in the past 7-10 years.
  • The main tools for economic stimulation, interest rate cuts, and deficit spending, are limited in their current capacity to reinvigorate the economy.

"The main areas in which we have exhausted our resources are interest rates, which historically, interest rate cuts have been the central bank's main tool for stimulating economies."

This quote highlights the concern that traditional tools like interest rate cuts are less effective because rates were already low before the current crisis.

Government Stimulus and Unemployment

  • Unprecedented levels of government stimulus, such as paying a significant portion of salaries, are being implemented.
  • The potential for high levels of unemployment over the next 12-24 months is a concern for the impact on markets.

"Given the potential levels of unemployment and the unprecedented levels of government spending, how does that impact and affect markets for the next 15 years, in your mind?"

This question from Bill Gurley to Howard Marks addresses the long-term effects of government spending and high unemployment on market behavior.

National Debt and Economic Function

  • There is uncertainty regarding the acceptable level of national debt and its impact on the economy.
  • Modern Monetary Theory, which suggests that the level of national debt may not be important, is hard for some to accept.

"We're going to be going through the next years saddled with an enormous national debt that we'll never repay."

The quote reflects the concern over the growing national debt and the uncertainty about its long-term implications for the economy.

Inflation Concerns

  • There is a risk that the current economic measures could lead to inflation after decades of low or absent inflation rates.
  • The return of inflation is seen as a potentially negative outcome for the economy.

"Deficits and money printing to service them seem inherently inflationary."

This quote indicates that the methods used to manage the national debt and stimulate the economy could result in inflation, which has been largely absent in recent decades.

Managing Uncertainty

  • Unique crises require unique approaches, as historical analogies may not apply.
  • Oaktree's strategy focuses on investing in companies that are expected to remain viable and in senior debt.

"All we try to do is figure out what companies will stay in business, some idea of what they're worth, and then invest in them on a senior level."

Howard Marks explains Oaktree's approach to managing investments during times of uncertainty, focusing on the viability and value of companies.

Valuation Adjustments

  • The public stock market has seen significant valuation adjustments due to the crisis.
  • There is uncertainty about how long it will take for valuations in other markets, such as real estate and private companies, to reflect the crisis.

"I wouldn't agree with your premise that valuations haven't been affected."

Howard Marks disagrees with the notion that valuations have not yet been impacted by the crisis, at least in the context of the public stock market.

Potential for a Great Depression-like Scenario

  • There is a fear of the crisis escalating to a level akin to the Great Depression.
  • The severity of the current situation is acknowledged, but specific outcomes are not predicted.

"You know what, my partner, Bruce Garsch and I talking, I would say, middle of last week, were afraid of"

Although the quote is incomplete, it suggests that Howard Marks and his partner are concerned about the potential for the crisis to worsen significantly, evoking fears of a depression-like environment.

Probability of a Depression

  • Howard Marks discusses the reduced likelihood of a depression due to government actions.
  • Uncertainty remains because economies are complex and unpredictable.
  • Historical context is important; few people have lived through a depression.
  • Government action is believed to have prevented a global depression.

"Now, I think with the government having done as much as they've announced, it feels like the probability of a depression is down."

This quote suggests that government interventions have lowered the risk of a depression, highlighting the influence of policy on economic stability.

"But since the last one started 90 years ago, and very few people who are alive today were there, and since the circumstances for every episode are different, I don't think we can be cavalier about that."

Marks notes the rarity of depressions and the difficulty in predicting them due to changing circumstances and the lack of living memory of past depressions.

Policy Changes for Economic Healing

  • Howard Marks compares economic healing to medical comas, suggesting a "freeze" on economic activities like evictions and debt collections.
  • Discusses potential consequences of freezes, such as landlords losing income.
  • Emphasizes the need for temporary measures to mitigate short-term economic damage.
  • Suggests possible extensions to unemployment insurance.

"And I think we need a freeze on certain things so that the economy can heal."

Marks advocates for temporary economic measures to allow recovery, akin to medical practices that give the body time to heal.

"So the solutions aren't easy, but I think the answer is that there have to be temporary actions to mitigate the short term damage."

This quote acknowledges the complexity of economic solutions while emphasizing the necessity of temporary actions to alleviate immediate economic harm.

Impact of Market Conditions on Oaktree Operations

  • Oaktree has been defensive in recent years due to undisciplined financial practices.
  • The firm is now becoming more aggressive as market prices have fallen and discipline has increased.
  • Marks references Warren Buffett's quote on prudence in financial affairs.
  • Oaktree tends to invest when others are fearful and step back from the market.

"When there's a lot of money in everybody's hands and they're all eager to put it to work, then everybody bids for assets, and they bid for opportunities to provide financing."

Marks explains the dangers of a market saturated with eager investors, leading to inflated prices and increased risk.

"But on the other hand, when other people are terrified, we should turn aggressive."

This quote captures Oaktree's contrarian investment philosophy of being aggressive when the market is fearful.

Identifying Market Bottoms and Investment Timing

  • Howard Marks emphasizes judgment in determining when assets are cheap enough to invest in.
  • There is no formula or algorithm for detecting market bottoms; it relies on personal judgment.
  • Investing when markets are falling can offer great value, but there are risks such as redemptions for hedge funds.
  • Oaktree's closed-end funds give them the advantage of not worrying about redemptions and the ability to invest during market downturns.

"Well, in answer to your last question, it's fallen enough to engage when it's cheap, when it is selling at a discount to its intrinsic value, and offering a high perspective return with the risk under control."

Marks defines the right time to engage in the market as when assets are undervalued and offer a favorable risk-return profile.

"I believe it is our job as professionals to catch falling knives carefully."

This quote emphasizes the professional responsibility to invest during market downturns while being cautious.

"So we can catch falling knives. And most of the time, Harry, when you catch a falling knife, it goes further."

Marks acknowledges the risk of investing during a downturn, as prices may continue to fall even after an initial purchase.

Understanding Market Bottoms

  • Oaktree rejects the concept of waiting for the market to hit the bottom before investing.
  • Howard Marks emphasizes that it's impossible to know when the market has reached its lowest point, as the bottom is only evident in hindsight.
  • The concept of waiting for the bottom is critiqued as an excuse for inaction during a crisis.

"Oaktree rejects the concept of waiting for the bottom. It's impossible intellectually to know when you're at the bottom."

This quote by Howard Marks highlights the difficulty in timing the market and the Oaktree's investment philosophy which does not focus on attempting to predict market bottoms.

Managing Investment Psychology

  • Howard Marks discusses the importance of being unemotional in investment decisions.
  • He credits mutual support between himself and Bruce Karsh in resisting emotional responses to market fluctuations.
  • Marks outlines the typical investor psychology that leads to buying high and selling low, which is contrary to the ideal investment strategy.
  • To achieve above-average investment results, one must resist the average psychological responses and instead buy low and sell high.

"The average investor gets excited when things go well and prices rise and wants to buy more, and the average investor gets depressed when things go poorly and prices fall and wants to sell."

Howard Marks describes the common psychological pitfalls that investors face, highlighting the tendency to make decisions based on emotion rather than strategic thinking.

Misconceptions About Economic Predictions

  • Howard Marks dispels the misconception that it's possible to predict the future of economic conditions.
  • He stresses the importance of investing without reliance on predicting future events, acknowledging that investment must proceed in the absence of foreknowledge.

"The important misconception is always the same, which is that it's possible, sitting here, to know what the future holds."

This quote emphasizes Howard Marks' view on the unpredictability of the future and the impracticality of basing investment decisions on attempts to forecast economic outcomes.

US vs. Europe Economic Prospects

  • Howard Marks compares the economic vitality and growth rates of the US and Europe.
  • He notes the US's higher underlying growth rate but also points out the current lack of national leadership.
  • Marks speculates that Europe might fare better in the current economic situation, despite the US's advantages.

"My guess is that the... Well, in this little instance here, I'm going to guess that Europe will do better."

Howard Marks cautiously provides his perspective on the relative economic performance of the US and Europe, indicating a slight leaning towards Europe due to current circumstances.

Advice for First-time Recession Experiencers

  • Howard Marks advises not to be discouraged by the current economic downturn, as it is atypical and exacerbated by unique factors.
  • He reassures that not all recessions will be as severe as the current one and that past recessions have been milder.
  • Marks suggests that future downturns may not follow the same pattern as the current crisis.

"This one is particularly exacerbated because, number one, the disease, and number two, it comes on the heels of such a long and unmitigated period of prosperity and market rise."

In this quote, Howard Marks explains the specific circumstances that have made the current economic downturn particularly severe, pointing out that it should not be seen as a standard for all future recessions.

Show Appreciation and Recommendations

  • Howard Marks expresses hope that the discussion is helpful to listeners.
  • Harry Stebbings endorses Howard Marks' book "Mastering the Market Cycle" and shares additional resources and sponsors related to the podcast.

"I hope it's helpful to you and your listeners."

Howard Marks concludes his participation by expressing a desire that the information shared will be beneficial to the audience, emphasizing the educational intent of the conversation.

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