Howard Marks Sea Change: How Markets Are Shifting

Howard Marks' Sea Change is a concept that highlights the shifting nature of markets and the importance of adapting to these changes. Markets are constantly evolving, and investors must be prepared to adjust their strategies accordingly.

In recent years, Marks has emphasized the need for investors to be more cautious and risk-averse in their approach. This is due in part to the increasing uncertainty and volatility of the market. As Marks notes, "The future is inherently uncertain, and the present is inherently unknowable."

Investors who fail to adapt to these changes risk being left behind. Marks warns that "the future is not what it used to be", and that investors must be willing to reassess their assumptions and adjust their strategies accordingly.

The shift in market dynamics is evident in the rise of value investing, which has been gaining popularity in recent years. Marks has been a long-time proponent of value investing, and his Oaktree Capital Management has been successful in implementing this strategy.

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The investing environment is undergoing a significant shift, as Howard Marks notes in his latest memo to clients. This "sea change" is characterized by higher interest rates, loftier inflation, and less risk-taking.

The benchmark interest rate is expected to stay in the 2% to 4% range for the next several years, a far cry from the below-2% standard of recent years. Highly stimulative rates are unlikely in the near future, unless a serious recession occurs.

A more pessimistic mindset has taken hold, with investors expecting a recession, risk aversion rising, and the Federal Reserve tightening its grip. The real fed funds rate, or inflation-adjusted rate, is currently negative, with the Consumer Price Index at 7.1% and the Fed's new rate benchmark at 4.25% to 4.5%.

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The investment landscape has undergone significant changes over the years, and understanding these shifts is crucial for making informed decisions. One notable sea change occurred in the 1970s with the arrival of non-investment-grade bonds in the primary markets.

Michael Marks discovered in 1978 that non-investment grade bonds could offer enviable returns, provided they offered sufficient interest to compensate for the risk of default. This was a major departure from the traditional approach of investing only in safe, investment-grade bonds.

Risk-return thinking is essential in investment decisions. In the 1970s, Marks explained that a B-rated bond was considered a bad investment by Moody's, but today we assess investments based on their prospective return and risk.

The OPEC oil embargo of 1973 and 1974 triggered a rapid increase in inflation, with the Consumer Price Index (CPI) rising to 11.0% in 1974 from 3.2% in 1972. This period of high inflation was eventually brought under control by Paul Volcker's actions as chair of the US Federal Reserve.

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Howard Marks has witnessed two previous "sea changes" in the investing environment, which significantly impacted the way investors think and approach the market. The first sea change was the introduction of non-investment-grade bonds in the primary markets in the 1970s.

In 1978, Marks discovered that "unsafe" non-investment-grade bonds could yield enviable returns, as they offered sufficient interest to compensate for their risk of default. This changed the way investors thought about risk and return, shifting from a binary view of good or bad investments to a more nuanced consideration of risk and potential return.

The second sea change was driven by macroeconomics and the OPEC oil embargo of 1973 and 1974, which led to rapid inflation and a decline in interest rates. As a result, the Federal Reserve, led by Paul Volcker, was able to reduce interest rates and bring inflation under control, ushering in a declining-interest-rate environment that prevailed for four decades.

A similar sea change is currently taking place, with higher interest rates, loftier inflation, and less risk-taking as the new trend. The benchmark interest rate will be in the 2% to 4% range for the next several years, compared to the below-2% standard of recent years.

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Howard Marks has made it clear that a "sea change" is taking place in the investing environment. Higher interest rates, loftier inflation, and less risk-taking are the new trends.

The benchmark interest rate will be in the 2% to 4% range for the next several years. This is a significant shift from the below-2% standard of recent years.

Investors can now potentially get solid returns from credit instruments. This means they no longer have to rely as heavily on riskier investments to achieve their overall return targets.

A much more pessimistic mindset rules today, with investors expecting a recession, risk aversion rising, and the Federal Reserve tightening. This is a far cry from the buoyant equities outlook that reigned from the financial crisis all the way through 2021.

The real fed funds rate is negative, and the Consumer Price Index is still high at 7.1%. This translates to a deficit of at least 2.6 percentage points.

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The introduction of risk management into conventional investment some 50 years ago was the first sea change Marks witnessed. This was followed by a four-decade run of low interest rates, which propelled risk-taking.

With the third sea change, things will be less rosy. However, the beneficiaries of this switch will be lenders and bargain hunters, which sounds like bondholders and value investors.