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.
So writes, Howard Marks of Oaktree Capital (memo here). Marks is a billionaire investor (wiki here) with long experience of markets. Short video clip on it, above (from Oaktree)
Part of Marks' investment philosophy is “Superior investment performance is not our primary goal, but rather superior performance with less-than-commensurate risk. Above average gains in good times are not proof of a manager's skill; it takes superior performance in bad times to prove that those good-time gains were earned through skill, not simply the acceptance of above average risk. Thus, rather than merely searching for prospective profits, we place the highest priority on preventing losses. It is our overriding belief that, especially in the opportunistic markets in which we work, "if we avoid the losers, the winners will take care of themselves."
In his latest Memo, Marks suggests:
- 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.
… He also has this list on the seeds of a boom/bubble…"My son Andrew worked extensively with me in preparing this memo. We particularly enjoyed making a list of the elements that typically form the foundation for a bull market, boom or bubble. We concluded that some or all of the following are necessary conditions. A few will give us a bull market. All of them together will deliver a boom or bubble"
- A benign environment – good results lull investors into complacency, as they get used to having their positive expectations rewarded.Gains in the recent past encourage the heated pursuit of further gains in the future (rather than suggest that past gains might have borrowed from future gains).
- A grain of truth – the story supporting a boom isn’t created out of whole cloth; it generally coalesces around something real.The seed usually isn’t imaginary, just eventually overblown.
- Early success – the gains enjoyed by the “wise man in the beginning” – the first to seize upon the grain of truth – tends to attract “the fool in the end” who jumps in too late.
- More money than ideas – when capital is in oversupply, it is inevitable that risk aversion dries up, gullibility expands, and investment standards are relaxed.
- Willing suspension of disbelief – the quest for gain overcomes prudence and deference to history.Everyone concludes “this time it’s different. “No story is too good to be true.
- Rejection of valuation norms – all we hear is, “the asset is so great: there’s no price too high. “Buying into a fad regardless of price is the absolute hallmark of a bubble.
- The pursuit of the new – old timers fare worst in a boom, with the gains going disproportionately to those who are untrammeled by knowledge of the past and thus able to buy into an entirely new future.
- The virtuous circle – no one can see any end to the potential of the underlying truth or how high it can push the prices of related assets. It’s broadly accepted that trees can grow to the sky: “It can only go up. Nothing can stop it. "Certainly no one can picture things taking a turn for the worse.
- Fear of missing out – when all the above becomes widespread, optimism prevails and no one can imagine a glitch. That causes most people to conclude that the greatest potential error lies in failing to participate in the current market darling.
And he has this to say about The FAANGs (Facebook, Amazon, Apple, Netflix and Google) are truly great companies, growing rapidly and trouncing the competition (where it exists). But some are doing so without much profitability, and for others profits are growing slower than revenues. Some of them doubtless will be the great companies of tomorrow. But will they all? Are they invincible, and is their success truly inevitable?
The prices investors are paying for these stocks generally represent 30 or more years of the companies' current earnings. There are clear reasons to be excited about their growth in the near term, but what about the durability of earnings over the long term, where much of the value in a high-multiple stock necessarily lies? Andrew points out that the iPhone is just ten years old, and twenty years ago the Internet wasn't in widespread use. That raises the question of whether investors in technology can really see the future, and thus how happy they should be paying prices that incorporate optimistic assumptions regarding long-term earnings power. Of course, this may just mean the best is yet to come for these fairly young companies.
Here’s a passage from one company’s 1997 letter to shareholders:
We established long-term relationships with many important strategic partners, including America Online, Yahoo!, Excite, Netscape, GeoCities, AltaVista, @Home, and Prodigy.
How many of these “important strategic partners” still exist in a meaningful way today (leaving aside the question of whether they’re important or strategic)? The answer is zero (unless you believe Yahoo! satisfies the criteria, in which case the answer is one). The source of the citation is Amazon’s 1997 annual report, and the bottom line is that the future is unpredictable, and nothing and no company is immune to glitches.
It’s a long memo with many other interesting points. Worth reading in full (plus the archives if you haven’t come across them).
This cautionary memo joins the chimes of Ray Dalio (post here), John Hussman (post here) along with Albert Edwards (currently at SocGen (with Andrew Lapthorne, his recent chart here), and to some extent James Montier (who also worked alongside Albert at DK previously, but has a behavioural economist streak to his work; now at GMO) and Jeremy Grantham (at GMO) have tended to put quite some weight on these type of metrics and valuation discipline, at least for long cycle returns (around 7 years). It's interesting that most of this group are chiming quite loudly, with the possible exception of Grantham who is ringing in a slightly different key (suggesting much slower reversions to the mean than before).
The world of macro has so many cross currents (I shall try and put forward the optimists view in later posts). One reason I prefer micro - bottom up company fundamentals (as does Marks).
There is another interesting chime with Nassim Taleb's thinking from his pop risk books. This idea that we do not handle "fat tails" or "Black Swan" events very well. That models do not account for these events well (real world is not "normal" or "gaussian"). This dovetails well with Hyman Minsky's observation/theory on why we have and will always have boom/bust cycles.