We were fortunate enough to find the time to read Howard Marks’ latest letter. As a refresher, Howard Marks is the person about whom Warren Buffett once said that anything that Howard writes goes straight to the top of his reading list. While Marks’ letter is probably his longest in years, it may also be one of his best. It is full of investing gems that should be made required reading at any graduate program. Here are some highlights, but do yourself a favor and give it a read. The link is below. It is long but a very easy read and well worth the time. Marks opines that this time seems very similar to 2000 and 2007. It is hard to disagree.
Latest memo from Howard Marks: There They Go Again… Again
Here’s how I summed up on this topic in “There They Go Again” (May 2005):
You want to take risk when others are fleeing from it, not when they’re competing with you to do so.
This combination of elements presents today’s investors with a highly challenging environment. The result is a world in which assets have appreciated significantly, risk aversion is low, and propositions are accepted that would be questioned if investors were more wary.
Not a nonsensical bubble – just high and therefore risky.
The usual consequences of the conditions I describe – like an eventual increase in risk aversion – should happen, but they don’t have to happen.
And they certainly don’t have to happen soon.
I’m never sure of my market observations.
As a natural worrier, I tend to be early with warnings
… the easy money in this cycle has been made.
Oaktree will continue to follow its 2012 mantra: “move forward, but with caution” – and, given today’s conditions, with even more caution than in the recent past. If one is going to invest at times like this, investment professionalism – knowing how to bear risk intelligently, striving for return while keeping an eagle-eye on the potential adverse consequences – is the absolute sine qua non.
But there is one course of action – one classic mistake – that I most strongly feel is wrong: reaching for return.
The basic proposition is simple: Investors make the most and the safest money when they do things other people don’t want to do.
By way of Arthur Cashin comes research from Keene Little of Option Investor. Little emphasizes that while earnings for US companies have increased 265% since 2009, which is in line with the 271% spike in the S&P 500, sales for those companies have increased only 32%!!! How is that possible? Corporate buybacks. Buybacks reduce the number of shares outstanding, which pumps up Earnings Per Share (and corporate executives’ pockets). Our blog last week pointed out that one of the unintended consequences of QE and too low interest rates has been the fear of investing in plant and equipment. Why build the factory when the economy is in the doldrums and interest rates are going nowhere? There was no impetus to take a chance and build. Corporations were incentivized to borrow at all-time low rates and take the low-risk approach of buying back their own stock. Little goes on to ask: Who will do the buying when corporations stop?
Here is a quote from our blog last week.
The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen.
– Dr. Ben Hunt, Epsilon Theory
There were more research notes out this week from some of the quants on Wall Street, and the subject is, again, volatility. This is a crowded trade. It feels as though this trade is building and building. This trade has the potential to crush markets, as it will feed a vicious spiral. If volatility were to increase quickly, then funds will be forced to sell and de-lever. That selling and deleveraging will force more into the market to be sellers as buyers step aside. It was compared to portfolio insurance this week by Marko Kolanovic at JPMorgan. Just a reminder, it was portfolio insurance that was blamed for the 1987 stock market crash that took the market down 20% in one day. 1987. There is that year again.
We are in the midst of our first extended period since the financial crisis began that the market is rallying while the Fed’s balance sheet is holding steady. In the 2014-16 period, the market treaded water, while the Fed’s balance sheet did the same. Now the market is leaving the central bank balance sheet in the dust. Right when the Feds are talking about decreasing the balance sheet.
September looms large as the tapering of the Fed’s balance sheet looks to be still on schedule to start after the FOMC meeting on September 20th. The next ECB meeting is September 7th, with the Bank of Japan stepping to the plate on September 21st. Shale companies like Anadarko (NYSE:APC) are slashing CAPEX. The growth in rigs seems to have stabilized. Could that be an oil bottom? West Texas Crude is up 8.5% for the week to close just below $50 a barrel. The biggest week of 2017.
The debt ceiling is scheduled to be hit in mid-October. For now, we see support at 2400 on the S&P 500, with 2475 providing resistance. If they break through resistance, then we are off to a new range of 2475-2550. The path of least resistance is higher for now, but September/October loom.
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing, consider the risk. Everyone’s financial situation is different. Consult your financial advisor.