Episode #124: “It’s Not What You Buy, It’s What You Pay for It That Determines Whether Something Is a Good Investment”

 

 

 

 

 

 

Guest: Howard Marks. Howard is the founder and co-chairman of Oaktree Capital. Since the formation of Oaktree in 1995, Howard has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction.

Date Recorded: 9/26/18

Run-Time: 42:50

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Summary: In Episode 124, we welcome legendary investor, Howard Marks. Meb begins with a quote from Howard’s new book, Mastering the Market Cycle, and asks him to expound. Howard gives us his top-line take on market cycles, ending with the idea that if you understand them, you can profit from them.

Meb follows up by asking about Howard’s framework for evaluating where we are in the cycle. Rather than look at every input as individual, Howard looks at overall patterns. What is the collective mood? Or is it depressed, sad, and people don’t want to buy? Or is it buoyant? Second, are investors optimistic and thrilled with their portfolios and eager to add more, therein increasing risk? Or are investors regretful and hesitant, burned by recent experience? Then there are quantitative aspects – valuations, yield spreads, cap rates, multiples, and so on. All of these variables help give Howard a feel for whether assets are high- or low-priced.

Next, Meb asks Howard to use Oaktree’s actions during the Financial Crisis as a real-world example of how an investor could act upon cycles. Howard tells us there are two parts to what happened during the Crisis – what Oaktree did during the run-up to the meltdown, and then what it did during the event itself. In short, Oaktree was cautious during the lead-up. They raised their standards for investments. Why? Howard notes that they didn’t know ahead of time how bad things would be. Rather, they were hesitant because they looked at the securities being issued, and it seemed that every day, something was coming out that didn’t deserve to be issued. This was a tip-off.

Then the event happened, culminating in Lehman bankruptcy, and that’s when Oaktree became very aggressive, buying half a billion dollars each week for 15 weeks. Howard tells us that, yes, our job as investors is to be skeptical, but sometimes that skepticism needs to be applied to our own fears. In other words, skepticism also might appear like “no, that scenario is too bad to actually be true.”

Meb notes that the challenge is investors want precision, picking the exact top and bottom. But this isn’t really how it works. Meb asks if there a time when Howard felt he misinterpreted a point in the market cycle.

Before answering Meb’s questions, Howard agrees that trying to find the bottom or top is a huge mistake. He notes that trying to find the perfect day upon which to buy or sell is impossible. In terms of potentially misreading the cycle, Howard tells us that Oaktree has been perhaps too conservative over the last few years, so they haven’t realized all the gains of the market. That said, he stands by his decision telling us, “anybody who buys or holds because of the belief that something that’s fully valued will become overvalued…is embarking on a dangerous course.”

Meb asks how Howard sees the world today.

Howard tells us we’re in the 8^th inning of this bull market. Assets are highly priced relative to history. People are bullish. Risk aversion is low. He notes it’s a time for caution – but – we have no idea how many innings there will be in this game.

What follows is a great conversation about bull markets, what ends bull markets, and how to implement market cycles into an investment approach. The guys touch on investor exuberance… whether markets need to be exuberant for a bull market to end… bullish action despite bullish temperament… the need to “calibrate” your portfolio… and the average investor’s ability to live with pain.

There’s so much more in this episode: How Howard’s market approach has evolved over the years… how “it’s not what you buy, it’s what you pay for it that determines whether something is a good investment or bad investment”… Howard’s thoughts on contrarian investing… and, of course, his most memorable trade. This one yielded him 23x.

What are the details? Find out in Episode 124.

Links from the Episode:

• 0:50 – Welcome and introduction
• 1:17 – How Howard feels about market cycles
• 2:56 – Howard’s framework for evaluating where we are in a cycle
• 5:05 – Using the Global Financial Crisis to illustrate how to respond in a cycle
• 5:37 – Triumph of the Optimists: 101 Years of Global Investment Returns – Dimson, Marsh, Staunton
• 10:43 – When Howard might have misinterpreted a market cycle, and the fallacy of striving for perfect market timing
• 16:28 – Factors that would impact the way Howard views the current market cycle
• 19:08 – Is exuberance required for bull markets to end or can they just fizzle out?
• 22:35 – When markets lose track of reality
• 25:09 – Practical advice for calibrating your strategy
• 30:34 – Rob Arnott Podcast Episode
• 31:39 – How Howard’s investment approach has changed
• 36:04 – Any trends that make Howard curious or have him stressed right now
• 38:41 – Most memorable investment
• 40:56 – Best way to connect with Howard: read his memos at com/insights
• Howard’s new book: Mastering the Market Cycle

Transcript of Episode 124:

Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Welcome, podcast listeners. Today we have a fantastic show for you with another market legend. He’s worked in distressed debt, high-yield bonds, convertibles, you name it. You probably recognize him as the co-founder of Oaktree Capital which now has well over a $100 billion dollars in assets. He’s also an author of his famous chairmen memos and a couple of investing books, the most recent of which is called “Mastering the Market Cycle,” which we’ll talk a little bit about today. We’re thrilled he’s here joining us. Welcome to the show, Howard Marks.

Howard: Thank you very much, Meb.

Meb: So this is gonna be a lot of fun and I thought we’d start out chatting a little bit some of the ideas from your recent book and we can veer off and go down any rabbit holes we feel like it, but let’s talk about the book a little bit. I wanna read a quick quote as a jumping-off point and we can go from there and it says, “And that brings us to the payoff from understanding cycles. The average investor doesn’t know much about it. He doesn’t fully understand the nature and importance of cycles. He hasn’t been around long enough to have lived through many cycles. He hasn’t read financial history and thus learn the lessons of past cycles. He sees the environment primarily in terms of isolated events rather than taking note of recurring patterns and the reasons behind them. Most important, he doesn’t understand the significance of cycles and what they can tell him about how to act.” So let’s use this as a jumping-off point. Maybe give us a little overview of kinda how you think about market cycles, why it’s important and what investors are missing out about them.

Howard: I think that, you know, you have two choices in life. You can say every day is a different day, every event is different from the last, or you can say that there are recurring patterns, learn those patterns, understand them and that makes life a lot easier. I’ve been in the investment business 50 years this summer. You know, I’m convinced that there are patterns that recur in our business and I think by this point in time I understand them. If you understand them, I think you can profit from them. The goal is to buy low and sell high. I think that an understanding of cycles allows you to understand when we’re high and when we’re low, and the key in understanding that is to understand why we’re high and why we’re low. That’s what, you know, a lot of my work is about and that’s really what the book’s about.

Meb: It’s interesting because a lot of people, I think, think about where we are in the market cycle. Of course, they’re almost always talking about equities, but they think about market cycles. But I feel like kind of what…well, you mentioned they think about it in a one-off way. Maybe what’s your framework to sort of evaluate exactly where we are because I know there’s a lot of anecdotal evidence where you say, “Hey, maybe there’s the famous business week cover in the early ’80’s ‘the Death of Equities.’” But what’s kind of the framework for analysing cycles? How do you kind of take a look at them?

Howard: Rather than look at every event or input as individual I tend to look for patterns in the things that happen in the world. You know, what are the things you wanna know to evaluate the investment environment? What is the mood? Is the mood optimistic and bullish and positive which tends to lead to high prices which we don’t wanna buy in? Is it depressed? Is it sad? Is it full of regret? In which case prices may be low and that’s really, of course, where we wanna be active. So one is mood. Number two is invest. Are they up? Are they positive? Are they happy with what they’ve done? Are they thrilled with the investment portfolios that they hold and eager to add to them, happy to increase their risk and so forth? Well, these are the things that lead markets to be high. Are investors sad? Are they terrified? Are they regretful? Are they hesitant to make new investments? Are they so chastened by recent events they stick to the side-lines? Again, these are the things that create bargains, we wanna know that. There are, of course, quantitative things we could look at, valuations, price earnings ratios on stocks, yields and yields spreads on bonds, transactions multiples on private equity, capitalization rates on real estate. All of these things tell us whether assets are high-priced or low priced in the context of history.

The point is that a cycle is an up and down oscillation around essential midpoint. We wanna know if the midpoint, for example, is the intrinsic value of the stock. We wanna know when we’re above it and when we’re below it. And that’s really what this is all about. So if you could evaluate the mood and people’s behaviour and attitudes and asset pricing relative to history, you can have a good starting point on understanding where we are.

Meb: One of my favourite passages in the book was recounting a conversation that was actually from one of your memos in ’07. It was about Henry Kissinger and it said, “He was a member of TCW’s board when I worked there and a few times each year I was privileged to hear him hold forth on world affairs.” Someone had asked, “Henry, can you explain yesterday’s events in Bosnia?” And he’d say, “Well, in 1722…” And the point is that chain-reaction-type events can only be understood in the context of what went before. I think it’s really important…you know, we talk a lot on this podcast about being students of history and understanding what’s happening in markets. My favourite investing book is “Triumph of the Optimists.” It walks, you know, people through a lot of the histories of stock markets and bonds and bills, but for the listeners on here, you know, we probably have some millennials listening who have only been in one market environment for the past 10 years and probably only think that that’s the way the world always works. Maybe let’s use a real-world example because I think you guys did a pretty masterful job in financial crisis. So maybe kind of use ’06, ’07, ’08 post-financial-crisis, walk us through some of the framework of how that transpired and how you guys kind of thought about it at the time and just as a general framework to how to think about a cycle in sort of the not real-time but looking back on kind of how that went down.

Howard: The global financial crisis of ’07-’08 was the biggest market event since the great crash of ’29 and the depression that followed. It was a major event and we think we did a good job in that environment. And, of course, there are two parts to it. What did you do in the run-up to it and then what did you do in the event? In the years ’05 and ’06, we were very leery of the market environment. We sold a lot of assets. We wound down some of our larger distressed debt funds and liquidated them and replaced them with smaller funds and we avoided the high-yield bonds of the most highly-leveraged LBOs and we generally raised our standards for making new investment. Why? Did we know that the great recession was coming? No. Did we know that mortgage-backed securities were fallacious and were going to jeopardize the future of the world’s banks? No. Why did we do it? We did it primarily…I talked about the mood. I talked about the environment. We looked at the securities that were being issued and it seemed that almost everyday something was being issued that didn’t deserve to get issued. We want markets to be safe and sane. We want investors to be balancing fear and greed, to be balancing optimism and pessimism, and most importantly, and this receives a chapter in the book, we want them to be appropriately risk-averse. We don’t want to buy at a time when other investors are oblivious to risk, disregarding risk, bidding assets up regardless of the risk because clearly that’s an environment in which we can’t get any bargain. So we wanna see balanced psychology and a decent level of risk-aversion, and we looked at what was happening near every day. You know, and I would go into my partner, Bruce Karsh’s office, or he would go into mine, and he’d say, “Look at this piece of junk that got issued yesterday. There’s something wrong with the market if junk like this can get issued.” It’s really almost as simple as that.

And Buffet has a great quote, “The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.” So when others are acting in such a carefree manner as to not exert a filter on the markets and not demand safety and quality, then we really should amp up our caution and we did and that’s what turned us negative on the environment in ’05 and ’06. Then of course, the subprime mortgages had their problems. The financial system looked like it was on the verge of melting down. This all culminated September 15th of ’08 in the bankruptcy of Lehman Brothers. Understanding again what we thought was going on in the environment and with other investors, we were able to become very aggressive starting on September 16th to invest over half a billion a week over the balance of ’08 over the next 15 weeks.

So half a billion a week for 15 weeks is a lot of money. It was close to 10 billion in total. What enabled us to do that? There were many things. There was, number one, I say you can’t ignore the quantitative and the point is that we were able to buy, for example, the senior debt of buy-out companies at prices which assumed that they were worth a third or a quarter of what some great LBO firms had paid for them one or two years earlier, and they don’t usually overestimate by that much. And we were able to buy from funds that were melting down and being liquidated, and you wanna buy in liquidations, especially when there aren’t many other buyers and we thought there weren’t many, or if any. And then finally, our experience, and I recount a great conversation in the book that I had with a pension manager, our experience told us that no matter what we said to people, no matter how conservative our assumptions were, all they said was, “Yeah, but it might be worse than that.” I reached this conclusion, it was almost in the form of an epiphany, that our job as investors is to be sceptical, and everybody knows that scepticism consists when they hear some fly-by-night scheme that promises profit without risk. We know that scepticism consists of saying, “No, no, no. That’s too good to be true.” What I realized at the depths of October of ’08 is that scepticism also consists sometimes of saying, “No, that’s too bad to be true.” When we can’t possibly come up with an account that satisfies people’s pessimism in the extreme, then we know that psychology unreasonably depressed. That means prices are probably unreasonably depressed and we should go to work, and that’s what we did. Buying in the fourth quarter of ’08 worked out very well.

Meb: Taking you back to the crisis, there was a famous investment saying that says, “Investing is the only business when things go on sale, everyone runs out of the store.” And it’s funny to think back to that time and it’s hard to kind of relate it to particularly our younger investor friends about what a experience that’s like without having been through it. So trying to explain to someone a lot of the booms and manias in busts and cycles historically, even when you talk about Japan in the, you know, ’80s or the breaks in the mid-2000s, without living through it it’s fun to read it, but for a lot of people until they actually go through it, I think, maybe our millennials are now with some of the cryptos, it’s hard to explain. The challenge I think for a lot of investors is they want precision. They wanna be able to pick the top of a cycle and pick the bottom exactly and that’s not really how this works. It was what the takeaway is from your book is where you see signs on both sides to where you think about. And over the, you know, your career is there an example on the flipside where you misinterpreted a point in the market cycle where you said, “Man, it just feels really crazy to me,” but it actually wasn’t. A lot of the signs are lining up for a good buying opportunity, but things proceeded to get worse. Every cycle is different. You know, different times, different links, different asset classes. Any thoughts there?

Howard: You mentioned that investing is the only place where people buy less when things go on sale, and I think this is really important for investors and especially new investors to realize. Normally, look, even Buffet says, “I like hamburgers. And when the hamburgers go on sale, I eat more hamburgers.” Everybody crowds the stores when the sales take place and we all know about this. Investing is a place which runs contrary to the laws of supply and demand. Normally, we demand more at low prices and less at high prices and that is, of course, makes sense should be. What goes on in the investment world? You buy a stock at $60. It goes to $80 and you say, “You know, I think I’m right. I’m gonna buy some more.” It goes to a $100. You say, “Now, I’m sure I’m right. I’m gonna double up.” So you increased the higher the price went. But what if you buy at $60 and it goes to $40. Most people say, “You know, maybe I screwed this one up. I better lighten up.” And if it goes to $20, they say, “I better get out now before it goes to zero.”

In investing, for the most part, people like them better at high prices and less well at low prices and that is the opposite of what it should be. This idea of trying to find the bottom to buy or the top to sell is a huge mistake. There’s a great saying, “Perfect is the enemy of good.” And this is so true. Trying to find the perfect day to start buying or the perfect day to sell is impossible. We never know when we’re at the top. We never know when we’re at the bottom because, for example, what is a bottom? It’s the day when the price which has been falling stops falling. We never know on that day. We can only know it by going on a little further and then looking back and saying, “You know what? It didn’t go down anymore. It started going up.” That was the bottom, but we never know it contemporaneous, and if we say, “Is today the last day it’s gonna go down?” Well, maybe not. I don’t think so. You know, remember it’s been going down because the news and the interpretation and the mood and the sentiment has been so bad it’s almost impossible on that day when mood and sentiment and negativism reach their nadir. It’s almost impossible to say, “Okay, this is the day we’re gonna start in.” I don’t even try to do that. At Oaktree, we don’t talk about starting to buy at bottoms or starting to sell at tops. We buy when the price is much less than the value in our opinion and we sell when the price is much more than the value. And I think that makes sense. It doesn’t matter if this is the best it’s ever gonna get. It’s still a good time to buy and a good time to sell.

So now, I’m gonna get around to your question. What have we done wrong? And I think that the last few years have been a good example. We’ve been conservative for the last few years. Our mantra has been move forward but with caution. We’ve insisted on a high degree of caution in the things that we did. Of course, when you’re cautious, you don’t go up as much as the market when it rises and that’s what happened. The market has risen more than we expected. We have been cautious, so even though we’ve been essentially fully invested over this period, we haven’t got a 100% of the rise because of our caution. I still think it was the right thing to do. Nobody could’ve predicted that this recovery was gonna go on 10 years in the economy or that the bull market would go on 10 years or that the market would respond so positively to the Trump administration, or the Trump administration would get this degree of a tax cut passed and so forth. And by the way, if you think about it, nobody can predict, and nobody should try to predict that securities that are fairly valued are gonna become overvalued. Anybody who buys or holds because of the belief that something that’s fully-valued will become overvalued is probably making a mistake or at least embarking on a dangerous course. I think that the extent and longevity of the gains of the last few years have been beyond anticipation. I think that our holding caution was the right thing. It just didn’t work in the last few years.

So in some of our portfolios perhaps rather than getting a 100% of the rise, maybe we only got 95%. But I think that’s okay especially because we had a conservative portfolio that would’ve protected us had things gone against us, and that’s the case.

Meb: How do you see the world today? Is it that you start to see that, “Hey, we’re kind of in the later innings of potentially this cycle?” Is that how you’re feeling today? Are there any indicators out there that would argue either for that or against it or what are your general thoughts?

Howard: I think we’re in the eighth inning. Saying we’re in the eighth inning has certain connotations with regard to where we think we are relative to the end of the game, where we are relative to the end of the up-cycle. Bear in mind, number one, I’m a conservative person. Number two, however, assets are highly-priced relative to history. Investor behaviour is bullish. Risk-aversion is low. People have had to drop their risk-aversion in order to make a high return in today’s low-return world, or I should say in order to strive for a high return in today’s low-return world. I feel comfortable saying that I think we’re in the eighth inning and that it’s a time for caution. What I realized about a year ago is that, you know, people ask about what inning are we in, we can say what we think. This isn’t baseball. We have no idea how many innings there will be in a game. In baseball, we know that if it’s not tied, a regulation game will go 9 innings, but in investing it can go 7 or 8 or 10 or 14. There’s no rule which says that this game has to end when we reach the ninth. So I think it’s important not to overdo the precision with which we can make these assessments. Go back to the way we started the discussion. When people are depressed and fearful and prices are below historic levels and the mood is negative, we wanna be buyers. When people are optimistic and aggressive, and prices are higher than historic levels and the mood is overwhelmingly positive, we want to reduce our risk, which is this. It’s really as simple as that. I’ll ask you, I’ll ask your listeners, I ask myself and my colleagues all the time, which is this? Is this a time when we’re probably in a depressed part of the cycle and the future of returns is bright, or is this a time when we’re in the elevated part of the cycle and the future for returns is limited. I have no problem saying it’s the latter, but if you say the latter and the downturn doesn’t come for a while, then you look wrong. And there’s a great saying in our business that being too far ahead of your time is indistinguishable from being wrong.

Meb: I love the baseball analogy, and I had a friend mention on Twitter the other day where they were talking about the ninth inning and they said, “We’re in the ninth inning, but have you ever been to a baseball game? You know how long the ninth inning can last?” And even that can go into extra innings. Well, it’s funny because, you know, if you look around you have a lot of kind of friendly quant shops out there that are kind of predicting really low returns for a lot of asset classes. Research affiliates came out yesterday and said, “The chance of people realizing a 5% real return which is about the historical real return of equities going forward over the next, I think 5, 10 years, the chance of that happening is 1%.” So pretty dour view of the world, but it’s funny because, you know, you look around and one of the things that people almost always expect at market peaks is sentiment. I wanted to ask you a little bit. Is exuberance something that is required for the cycle to end or can they just kind of fizzle out because it doesn’t feel like a lot of this bull market you’ve had over the past decade, it hasn’t really felt a lot of exuberance like other bull markets have ended in, so is that a requirement? How do you think about sentiment in general?

Howard: Let’s introduce a new word into our discussion. Let’s introduce the word excess. Remember that the midpoint, the trend…the midpoint of this fluctuation is what we call the midpoint, the fair value, the intrinsic value, the right value, that’s the midpoint. And the elevated parts of the cycle are when we’re above that. These are periods that are characterized by excesses. I think that what we’ve been talking about, euphoria. What was your word?

Meb: Exuberance.

Howard: Exuberance is a form of excess. I think it’s clear that we don’t wanna be buyers or holders in markets that are characterized by exuberance, but first of all I think we would agree that exuberance is a form of excess about which we wanna be very careful. Now, the question is, is exuberance a necessary condition for a high? I think it probably is. You may say, even that today we don’t have exuberance, I don’t think we do have exuberance. What we have today is people investing aggressively in risk assets for the main reason that risk-free assets pay so little. If we went back, let’s say, 10, 11, 12 years ago, you might have had a bunch of money in a money market fund that paid five, in five-year treasuries that paid six and a half, in high-grade bonds that paid eight. Those things don’t exist today. Instead of five, six and a half, and eight, the returns on those things are more like one, two, and four. All the money that 10, 11, 12 years ago might have wanted to be in those kinds of assets has flown out the risk curve to riskier assets including the stock market, including private equity, including private debt and so forth and driven up the prices to the point where the cycle is elevated. I would not say we have exuberance today or euphoria. We have people. I call these people handcuff volunteers. These are people who are reaching for more risk not because they want to but because they have to to make the returns they need. I think that even in the absence of euphoria today, one of the ways I say it is that people may not be thinking bullish but I think they’re acting bullish, and their bullish behaviour makes the market risky. And that’s what we have to focus on. And if it’s true that the market is risky because of that bullish behaviour, then we should cut our risk even though those people may not be described as euphoric or exuberant.

Meb: Yeah, we actually talk a lot about that with the equities where you have this scenario where we look at some of the sentiment survey is favourite stat is the AAII’s bullish, bearish survey showed the highest stock bullishness in December of 1999, the literal worst time ever to be bullish on stocks. And when were people most despondent was in March, 2009. You literally cannot come up with a more ridiculous possibility. So you’re not seeing the extremes yet, but if you look at some other indicators like percentage net worth, household assets that are in equities, it’s kind of do what I say, do what I do. Most people are highly exposed, they’re just not particularly excited about it. But you’re starting to see a little bit of the mania in some other areas, certainly with some of the Tilray stock last week in the cannabis space. I’m gonna read you, here’s a new data point for you. This is a pitch I got last Friday. Subject line in the email was how this model-turned entrepreneur created the cannabis tech company, and within this email it’s talking about I’d love to connect you with a CEO, a former model and is launching the world’s first cannabis co-working space in Hollywood, California, so pretty close to Oaktree HQ. Favourite part is it says the leader in this space with this company is…I’m not gonna mention the name, Blockchain Cannabis Solution. So within one company we have co-working, blockchain, cannabis and a model. I may send Jeff or a single producer to go meet this company, do a little due diligence.

Howard: That’s a good story and it’s an example of when markets lose track of reality. You know, back in 2017 in the height of the Bitcoin boom, there was a very banal company with an ordinary product. It was in financial trouble which put the word Bitcoin in its name and the stock soared, so I think that’s just a typical example.

Meb: And you can go back to learn the history. I mean nifty fifties and some of the early tech boom of the later part of the century with a lot of the electronic or computer-sort companies and adding things in their names, and the most obvious, of course, would be the dotcom in the ’90s and more recently blockchain, I guess, in cannabis. But yeah, you’re starting to see pockets of it in certain areas. In other areas, you know, we look at a lot of the global equity markets and I think that average global equity market is down to about 20% from peak, so there’s a lot of pain elsewhere in the world, just not the U.S. which is responsible. There was a great chart the other day, responsible for over a 100% of the equity returns globally this year because a lot of the rest of the world is down.

So shifting gears a little bit, favourite part about the book was…it was actually early in the book, was actually kind of the practical advice of how to put this to work. So a lot of people listening say, “Okay, I’m gonna become a student of history. I’m gonna study cycles. I’m gonna kind of try to implement this.” And I think some of the advice you have about how to do it, and I don’t wanna steal your thunder but I wanna read this, where you’re talking about how to kind of think about this and you said, “The key word is calibrate the amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive. When we’re getting value cheap, we should be aggressive. When we’re getting value expensive, we should pull back. Calibrating one’s portfolio’s position is what this book is mostly about.” Could you expand on that a little bit. I mean, I know we’ve touched on it during pieces. As far as the practical implementation for people listening to this, the kind of general thoughts on how to actually put this study of cycles into practice.

Howard: You mentioned a memo that I put out in July of 2017 about what was going on in the market in my opinion. It attracted a lot of attention. One TV investment analyst said, “Howard Marks says it’s time to get out.” And, you know, my reaction is there are two things I would never say. One is, “Get out,” and the other is, “It’s time.” I’m never that sure and I don’t think that anybody can be that sure that you should be out as opposed to in and that today is the time to do it. If your listeners don’t feel that degree of conviction and certitude, I think that’s the right thing not the wrong thing, thus I say calibrate. It’s not a matter of in or out, or today or tomorrow, all of which have so much precision and definiteness to them, but rather think of it as a speedometer from 0 to 100. And 0 is maximum defence all cash and 100 is maximum offense fully invested in aggressive and risky assets. My reference to calibrating is really saying, “Where should we be in between those extremes of 0 to 100?” Nobody should run his portfolio that today I’m 0 and two weeks I’m a 100 and then I go back to 0. We should adjust moderately within the range. First of all, I would encourage each of your readers to think about where, from 0 to a 100, they should normally be. Think about your age, think about your earnings, think about your future, think about how much assets you have, think about your circumstances, how much assets you might need in a pinch, think about your psychological makeup and your ability to live with risk. You might say, “You know what, I’m a young person. I have a bright future. I have a good income. I’m making more money than I need every day. I’m putting some aside into the market. I’ve been through this before. I can stand to live with fluctuations. I think I’m a 75 or an 80. My normal risk posture is 75 or 80.” So I think it’s important to do that. Of course, it’s really important to do it accurately. And one of the problems is that people, in good times, people overestimate their ability to live with pain. And I remember the people who back in ’97 when the tech stocks were booming, people saying, “Oh, you know what? I wouldn’t mind if I lost 30% of my 401k portfolio not so much, it’d be fine.” Believe me when they went down 40% they weren’t fine.

So I would encourage everybody who’s listening to try to think about what their normal risk posture should be and need to do it in the form of my speedometer from 0 to a 100. So we have a person who says, “I’m normally a 75.” Now the next question is, “Okay, then where should you be today?” Today are we in the depressed part of the cycle and are things undervalued relative to history and are people moping around and willing to take risk in which environment I would say you should amp up your risk because you’ll be getting a lot of bargains? Or are we in the elevated part of the cycle where everybody’s happy, nobody sees anything to worry about, everybody thinks risk is their friend, that the more risk they take, the more money they’ll make. And so securities are priced above their historic levels and the mood is very positive, which means that there’s probably a lot of optimism priced into every security. If you think you’re in the elevated portion of the cycle, then I think you wanna turn the speedometer down and maybe you wanna only be a 50 or a 60 at that time. You don’t have to have the certainty to go from your normal 75 to 0 in order to do a good job of managing our assets and adjustment within the range, I think, is all that most people can do.

Meb: I think it’s great advice. You know, I think the challenge so many people want to think in terms of binary outcomes. They either wanna be in or wanna be out. They wanna be cheering for the market or they wanna be cheering for it to go down, and there’s a great quote from Bogle who says, you know, he does a 50/50 stocks bond portfolio and when asked why, he says, “Well, I spend half the time worrying I have too much in stocks and half the time worrying I have too much in bonds.” But this concept of calibrate I think is so…I’m gonna steal it and certainly use it with conversations with clients. We had on Rob Arnott earlier in the year and he had a great quote that’s pretty similar, where he called it “over rebalancing.” So if you had a target portfolio and equities were down a lot, you may rebalance and you may rebalance a little bit more. So if you’re 60/40, you may say, “You know what? I’m gonna be 70/30 now because stocks are at a 5 P/E” Or maybe things are starting to get a little bubbly, take it down to 50/50 or 40/60. And I think one of the biggest challenges for a lot of investors, and this isn’t just individuals, this is almost every professional investor I talk to, and these institutions are a little different. So they tend to have a written investment plan, a policy portfolio, but most investors are kind of shooting from the hip. We try to encourage all the investors we talk to to actually at least write down the basics of how they’re gonna think about the world because it’s…as everyone knows with dieting and everything else, if you don’t have kind of a written plan and rules, it’s really easy to stray and do the dumb things behaviourally. So calibrate is my favourite phrase in the book, probably next to disprefer.

You know, so Howard, you’ve seen a lot of cycles and time tends to season an investor. I think most investors we have on this show have been through the agony as well as the ecstasy of making and losing money, but I’m curious to what extent, over the years, you’ve changed your investment approach. So you’ve been through a lot of different cycles and is there anything that the Howard of 10, 20, 30 years ago would’ve done that’s a lot different than the Howard of today?

Howard: I don’t think that I would say that I’ve changed that much. I have evolved because I now think about the environment in the systematic way that I’m encouraging you and your listeners to do. I didn’t always know these things. I didn’t always do these things, and as you say, I’ve lived through a lot of cycles and I’ve come to these conclusions. That’s a very important example. Another great example, and I tell this in the book, 50 years ago when I started I worked for a New York bank, and the bank practiced like all the other banks something nifty 50 investing and it bought the stocks of the 50 greatest, fastest, growing companies in America, IBM, Xerox, Kodak, Polaroid, Avon, Merck, Lilly, Texas Instruments, Hewlett-Packard. These companies were so adored and people were so sure that nothing could go wrong with them and people were so convinced that they would be fast growing in terms of profit that their prices just got too high. And if you had joined my bank when I did and bought these stocks and held them for five years, you would’ve lost almost all your money. And that’s an amazing thing. They were great companies and you could’ve lost, as I say, almost all your money, 80%, 90% in many cases.

Ten years later, I switched to high-yield bonds and I was asked to start the bank’s portfolio in high-yield bonds, which was one of the first from a financial institution. Now, I’m dealing with the worst companies in America. I say that a little bit Ironically but, you know, by definition, high-yield bond issuers are not gilt-edged companies and are making money steadily and safely. So what did that experience tell you? If you can lose a lot of money in the best company and make a lot of money steadily and safely in the worst companies, what are the lessons? The main lesson is it’s not what you buy, it’s what you pay for, that the term is whether something is a good investment or a bad investment. One of the ways I like to say it, good investing is not a function of buying good things, it’s a function of buying things well. People should think about that and they should think about it until they understand it because if you don’t know the difference between buying the good asset and making a good investment, then you’re not gonna be a successful investor. Good investing comes from buying things for less than their intrinsic value. As my own experience has shown, there is no asset which is so good that it can’t become overpriced and thus a bad investment. There are very few assets which are so terrible that they can’t become under-priced and that’s a good investment. You know, it’s a simple statement but I would emphasize this to your listeners without limitation. You have to understand the difference between a good asset and a good investment. I have made that evolution over these years. Right now, it has become second nature. That’s really my other example now.

Meb: Yeah, I think it’s important. You know, we talked about that quite a bit when we’re talking about global investing, you know, the average American, but also every country in the world tends to have a very large home country bias and the average American puts 70% in the U.S. for equities, also for bonds is even more and when it should only be say 50. And we see a lot of cases…you know, hey, look at a lot of these countries. They may seem scary, but the valuations tend to be a lot lower but one of the challenges for a lot of professionals is that the career risk creeps in. You can always justify a U.S. based 60/40, nifty 50, whatever it may be, but if you own a bunch of these other countries or do things that are uncomfortable, a lot of professionals that ends up being get hung out to dry and can get fired. We often tell people that that’s the challenge, whether it’s doing the right thing or trying to balance that. For a lot of people, it’s pretty tough.

A couple of more questions then we gotta wind it down. What are you thinking about these days? And I can pose this question with two outcomes. You can pick either one or both. Is there anything for someone who’s a student of history that’s got you particularly excited? Any topics, any ventures, any sort of ideas that you’re particularly curious about as we wind down 2018? And on the flipside, is there anything that’s got you really stressed out?

Howard: First of all, I sleep pretty well at night. There’s nothing keeping me up. Ironically, as a conservative investor, what I worry about most is being too conservative too soon. I think caution is the right thing now, but I’ve thought it for a while and it hasn’t worked. In the last several years, the highest returns have gone to the person who took the most risk. That’s only me when I think that the cycle is extremely depressed, and I haven’t thought that for several years. We have a cautious portfolio. We’ll continue to be cautious. Will that be the right thing or the wrong thing? We will find out. That’s one of the things, I guess, that keeps me up, that the market and the economy do better than I expect. What do you get excited about? The big easy exciting money is made in investing, and especially made safely, by doing the things that other people are unwilling to do. Being the contrarian is the essence of good investing. That doesn’t mean you necessarily do things that everybody refuses to do. You start looking at those things. But what are the things that have been catching the most grief lately and that people are most down on? China, emerging markets, in particular Argentine and Turkey maybe. You mentioned that things are doing less well abroad than they are in the States. Most markets are not up like the U.S. stock market is. That’s very much worth noting. The contrarian, the bargain hunter, the value investor right now is looking largely outside the U.S. We know that these things are cheaper than they are inside the U.S. Many of them are just down and down substantially, but of course, that in itself is not the buy signal. Is it down enough or the right amount or too little? Even though things are way down, we still have to put an intrinsic value on assets. We still have to know whether the price is more or less than the intrinsic value. The contrarian, the bargain hunter starts off by looking at the things that have been doing poorly.

Meb: I can sympathize because you just named all the countries in our largest fund. So we’ve been happy holders of a lot of those, but it’s been a little tougher this past quarter. The question we always ask our podcast guests, going back over your career, and this can be good, it can be bad, it can be anything, but what has been your most memorable investment. Has there been anything that really sticks out as the most memorable investment of your career, and that can be personal too?

Howard: We made an investment in ’09 in a packaged food company called Pierre Foods which was having a real tough time, which needed a restructuring. The debt was well under water. We bought the debt. We got control through the debt. We restructured the company financially, brought in new management, changed some of the strategies, made some ad-on acquisitions, took the company public, eventually did a transformative merger with a very large company, excellent company in the same field, were able to exit that just a couple of years ago, maybe it was…I think it was probably in ’17, so we probably were 8 years from start to finish and we made 23X on that investment. We’ve never made anything close to that before. It’s far from typical. It was an ideal situation, timed exactly right. Never thought we would make a return like that when we went in, clearly had a great outcome that we’re extremely happy with.

So some of my Oaktree colleagues pulled that off over that period of time and it’s very easy to remember a success like that.

Meb: That’s interesting and it’s funny too. There’s the challenge when you’re looking at your jobs as a value investor, and Buffet of course talks a lot about this when you’re seeing all these opportunities exciting and there’s still a little anxiety. For me, this is why I’m a qualm, by the way, because I have too many emotions. I have every single behavioural bias. Was the decision easy at the time? Was it something where you’re saying, “Man, this is easy to pull the trigger,” or was there still some element of the world’s still ending? This was a hard trigger to pull.

Howard: I don’t think it was a tough decision. We did take a very large position in debt which was sufficient to give us control, so by definition, we made a sizable financial commitment to a company that was troubled. We thought we had value, emotion, and the cycle on our side, and if you combine that with good analysis, which gives you positive signals, I think that’s the best you can have.

Meb: Howard, it’s been a blast today. I’ve had so much fun chatting with you. Where can everybody find more about you if they wanna keep up with your writings, everything else? What’s the best place?

Howard: We’ve been talking some of the memos I’ve written over the years. I started in ’90s. The newest one went out just today.

Meb: How many you up to in total?

Howard: You know, I don’t count but I’m sure it’s well over 100 at this point. Your listeners can find them all at the www.oaktreecapital.com/insights under the heading of chairman’s memos, they can read them for the last 29 years. They can sign up for a service that will notify them when one comes out. And as you mentioned, of course, Meb, the book is coming out, “Mastering the Market Cycle” and I like particularly the subtitle, “Getting the Odds on your Side.” We can’t be sure of success. We can’t be sure of avoiding bad outcomes, but we can, through diligence, attentiveness, insight, and especially understanding cycles, I think we can get the odds on our side. We can have more invested and at risk when we’re low in the cycle and less invested and at risk when we’re high in the cycle, and that’s about the best anybody can do.

Meb: Perfect way to end the podcast. I’m gonna add one more quote that Charlie…you related to Charlie Munger said to you, which is, “Investing is not supposed to be easy. Anyone who finds it easy is stupid.” Howard Marks, thanks for joining us.

Howard: It’s my pleasure. Thanks for having me on the podcast.

Meb: It’s been a blast. Readers, we will add show notes to the buy the book, to all Howard’s memos, everything else we talked about today on mebfaber.com/podcast, where you can also find all the archives. You can find the show on iTunes, Stitcher, Breaker which is our favourite. And of course, if you’re loving the show, hating the show, leave us a review. Thanks for listening friends and good investing.