Wednesday, January 25, 2012

Howard Marks (OakTree): “What Can We Do For You?”

Howard Mark's latest memo to his clients is a frank admission that investment managers, including Oaktree, don't have crystal balls and shouldn't act as though they do:

"The main thing we can’t do is see the future, and particularly the macro future. That simple statement has serious ramifications. It means a lot that we’d love to know is beyond us:
- we can’t know what the economies of the world will do,
- we can’t know whether markets will go up or down, and by how much and when,
- we can’t know which market or sub-market will do best, and
- we can’t know which securities in a given market will be the top performers.

And what does the fact that we can’t know these things mean for our portfolio management? Simple: it means we mustn’t act as if we can."

In fact,

"The more you acknowledge you don’t know what the future holds:
- the more you should diversify, spreading your bets to make sure you don’t miss the winners or, more importantly, overload on the losers,
- the less you should attempt to augment performance through adroit short-term market timing, and
- the less you should employ leverage."

Marks thinks US equities are cheap:

"U.S. stocks are much cheaper than usual, selling at low absolute p/e ratios. The S&P 500 has failed to appreciate over the last twelve years, while corporate earnings have grown substantially. Thus its p/e ratio has tumbled. The average p/e in the postwar era was 15 or 16, and in 1999 it reached 30. Today it’s about 12 ... [Despite caveats] the one thing I know for sure, however, is that U.S. stocks are cheap versus historic norms ... In 1999, sky-high valuations and investor ardor positioned stocks for a “lost decade.” Today, low valuations and investor indifference just might mean they’re poised to surprise on the upside."

He also thinks junk bonds are cheap:
"History shows that if you invest in the high yield bond indices when spreads go above 550 b.p., you usually outperform Treasurys by a wide margin over the next few years. Thus it’s clear that with spreads at 700 b.p., they’re priced to outperform. High yield bonds – like stocks – could turn out not to have been cheap enough, but there’s no arguing with the fact that they (and senior leveraged loans) are relatively very cheap."

"At the risk of oversimplifying, I see a long list of macro risks on one side of the scale, and low valuations and joyless investors on the other. Prices are neither so high that we must be hyper-cautious nor so low as to call for aggressiveness. Thus I think it’s time to balance defense and offense, and to move forward, albeit with caution."

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