Howard Marks has helped build Oaktree Capital into one of the biggest alternative investors in the world, with around $122 billion of assets under management as of June. Once dubbed 'Wall Street's favourite guru", the American is also an author with his latest book, Mastering the Market Cycle, examining how to understand, track, and react to the ups and downs of market cycles, released last month. In an interview with The National in Dubai, he explains how to read market fluctuations so the odds stack in your favour, and why people should be adopting a cautious approach right now.
What are your top tips for investors?
The job of the professional investor is to control risk. It’s easy to make money – the challenge is to do it with risk under control. Risk is a function of where we stand in the cycle. When we’re low in the cycle, the risk is low; when we’re high in the cycle, the risk is high, and it’s harder to make money.
Everything an investor does to improve results falls under two headings. The first is asset selection, which is trying to hold more of the things that do better and less of the things that do worse. The second is cycle positioning, which is having more invested more aggressively, at the right time, and less invested, more defensively, when the times are not so right.
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How do you know when the market is overvalued?
The evidence comes in two forms. One is quantitative. We look at the PE ratio on stocks [price divided by earnings per share], the yield on bonds, the capitalisation ratio on real estate and transaction multiples on private equity, and so on.
Then there’s the qualitative, behavioural element. With experience, insight, training and emotional control, you can understand how events around you imply where we are. When we’re high in the cycle, it’s usually characterised by optimism, enthusiasm, greed, risk tolerance and credulousness. It makes the market a risky place. If there’s a lot of optimism baked in to securities prices and you buy then, you’re likely to pay a high price relative to the ‘intrinsic value’ and that makes it dangerous.
We want to buy at a low intrinsic value. So what causes that? Pessimism, fear, risk aversion, scepticism, recent bad performance, negative media stories – those kind of things.
Given all of that, where are we now?
We are at an elevated part of the cycle in which there is considerable risk – meaning a lot of [stocks] are overpriced above their intrinsic value. It’s time to invest carefully. The market is characterised by optimism, faith in the future, and desire to make money rather than fear of losing money; this suggests there is some kind of hot air underneath the market, which could dissipate with negative consequences. Maybe the lending terms have been weak, or there are no covenants, which happens in heady times when banks are unworried or competing to provide financing.
That said, if we take the US stock market and leave out the Fangs (Facebook, Apple, Amazon, Netflix, and Google), most stocks are not terribly overpriced. The PE ratio on the average stock is a little above normal, but not grievous.
In some sectors of the credit market, however, where Oaktree operates, there is a strong desire to put money to work, demand outstrips supply, so prices are going up. It’s time for caution.
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How do you exercise caution?
You can do this in three main ways. One is go to cash (exit your investments), which is extreme and I do not advocate that. If you hold cash you can’t lose money, but you also can’t make money.
Two, switch into conservative asset classes. Bonds are generally more secure than stocks, and the developed world is generally more secure than the developing world. Also, so-called ‘value investing’, such as gold stocks, which are valued for their present earnings and assets, is generally safer than ‘growth investing’, in stocks that are highly valued because they have a robust future in, say, 10 years.
Three, within an asset class, there are more aggressive and more defensive things you can do. Now is the time for defence. You can invest in bigger companies, which are generally safer, or companies in more stable fields like food, rather than risky fields like technology.
Some people are aggressive in nature and make a lot of money when the market booms; others are worriers and their strength is they protect their client when the market falls. Now is the time for the latter.
What macro-trends are driving this optimism?
Every year the economy does well and the market rises, people become more optimistic, because of the accumulation of good news. But in my country [the US], there has never been an economic recovery longer than 10 years. And we are 10 years since Lehman. So as things get better for longer, people get more excited, just when they should be turning cautious.
The good news is I don’t perceive euphoria. There has been an accumulation of sources of uncertainty - trade wars, Brexit, [political drama] in Italy, the rise of US populism, which would be bad for business, and military activities around the world.
However, because interest rates are so low, nobody wants to invest in cash or treasuries or money markets. So they are investing in risk markets anyway to get a decent return.
What are the key opportunities right now?
Investing smartly is about understanding the popularity of various assets. The way you make big money, relatively cheaply, is to buy something that is unpopular – which by definition means cheap – and it goes from unpopular to popular. In the last six months, this was emerging markets. While the US stock market was chugging ahead, EM markets were declining.
To clarify, we don’t buy things just because they’re cheap, but when we see something that’s fallen in price that’s a good starting point for an investigation. In most walks of life, people would rather buy at 50 per cent than 100 per cent. But in the stock market, people like to buy at 100 not 50, and if it falls they say something is wrong. So wise investing calls for scepticism - and contrary behaviour.
