Investor Behavior Has Entered A Zone Of Imprudence

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Howard Marks on Equities www.purnartha.comHoward Marks, Chairman and founder of Oaktree Capital, warns that investor behavior has entered the zone of imprudence and thinks that China is the biggest threat for the US economy.

If you want to know from Howard Marks which stocks are going to do well next year, you’re going to be disappointed. The chairman of Oaktree Capital, one of the most successful investors on Wall Street, does not need to pretend that he can look into the future. Instead, he focusses on the things that are most important to investing for the long run: risk control, a good sense of market cycles and inspiration which, for example, he finds in the world of sports.

Mr.. Marks, we’re at an interesting point in time. For the first time since the financial crisis the Federal Reserve has raised the interest rate. How does the world look like from your perspective at this historical moment?

We’re in a very strange market. Most people are doing a good job of thinking and the consensus is not necessarily wrong today. On one side, the world is a very uncertain place and I think the average investor understands that. Most people are sober and sensitive to all the uncertainty. You don’t see many people who are massively bullish. Nobody is saying stocks are going to the moon. Back in 1999 there was a book published with the title “Dow 36’000” predicting that the Dow Jones Industrial would almost triple. Well, that book is not being re-published today.

And on the other side?

Security prices are not low. I wouldn’t say high, but full. So people are thinking cautiously but they’re acting bullish and they’re behaving in a pro-risk fashion. While investor behavior hasn’t sunk to the depths seen just before the crisis, in many ways I feel it has entered the zone of imprudence.

How do you explain this juxtaposition?

The answer is that they are forced to be buyers by the central banks. The rate on money markets is close to zero and treasuries yield between one and two percent or even negative in Europe. Most investors can’t live with that. They have to move out the risk curve in order to try to get five, six or seven percent. That has induced or forced risky behavior. To me, this is the most important thing that’s been going on over the last few years, and it still is here at the end of 2015.

There are a lot of risks lurking out there: Monetary policy divergence between the US and Europe, a high degree of stress in the emerging markets and the specter of further terrorist attacks. What’s the most important risk for investors?

Academics say risk equals volatility

and the nice thing about volatility is that it gives them a number they can manipulate and use in their formulas. But I don’t worry about volatility and I don’t think most investors are worried about volatility. We know prices will go up and down. But if something is going to be worth a lot more in the future than it is today we’re going to buy it regardless. So people don’t worry about volatility. What they worry about is the potential of losing money.

You wrote extensively about risk in one of your recent memos. What does risk mean to you?

Most people think that there is a positive relationship between risk and return: If you make riskier investments you can expect a higher return. That’s total nonsense! Because if riskier assets could be counted on for higher returns than they wouldn’t be riskier. The reality is that if you make riskier investments you have to perceive that there will be a higher return or else you have no motivation to make that investment. But it doesn’t have to happen: If you increase the riskiness of your investments the expected return rises. But at the same time the range of outcomes becomes greater and the bad outcomes become worse. That’s risk and that’s what people have to think about.

Where do you see potential for bad outcomes?

Investors are not doing what they want to do. They’re doing what they have to do. They are like “handcuff volunteers”. Today, if you want to make a decent return you have to take risks. And most people have been willing to do that. And because of that money has flown into high yield bonds and leveraged loans. For example, at one time there were ninety-five straight weeks of inflows into leveraged loans mutual funds.

Now, credit markets have become quite nervous. What goes through your mind when you look at the rising spreads on high yield bonds?

That’s a good thing. If you’re a buyer you would rather buy at a high risk premium than on a low one, everything else being equal. Maybe the onrush of money was too strong, maybe the attitudes were too optimistic. Now people are a little more worried, especially since they already had a little bad experience in Ukraine, in Greece and in China over the summer.

Then again, the consequences of a full blown crisis in high yield bonds could be severe.
The riskiest thing in the world is the belief that there is no risk. When people think there is no risk, they do risky things. By contrast, when people think there is risk than they behave in a safe manner and the world becomes a safer place. That’s why I welcome the recent developments. They remind us that today the risks are substantial and they should be undertaken only with considerable forethought. My dad used to tell the story of the gambler who went to the race track and said: “I hope I break even because I need the money.” The market is not an accommodating machine. It will not go where you want it to go just because you need it to go there. So if you’re talking about money that you can’t afford to lose then you can’t say: “Just give me the highest yield.”

Investors aren’t the only ones who behave riskily. The central banks themselves have placed venturous bets on unconventional policies like quantitative easing and negative interest rates. What’s the price we’re going to have to pay for that?

This is one of the factors that contributes to making the world a risky place today. In the United States, we had seven years of super low interest rates to try to stimulate. That has never happened before. What are the long term effects on the economy? What’s the effect on lending behavior? And, how will that go now that the Fed has started to raise rates? What will that do to the world? The answer is very simple: We don’t know. And anybody who thinks he knows is kidding himself.

Some kind of wild card is the steep fall in energy prices. Has oil reached a bottom now?
There is nothing intelligent to be said about the price of oil, as I wrote in a memo at the end of 2014. Oil prices have been controlled by OPEC (editor’s note: Organization of Petroleum Exporting Countries) for the last forty years. So clearly, the past doesn’t tell you anything about the free market price of oil. There are assets we feel we can value: stocks, bonds, companies and buildings. They all have in common that they deliver a stream of cash flows that can be valued through a proper discounting process. But how do you value an asset like a barrel of oil or an ounce of gold that doesn’t produce cash flow? You can’t!

Oil was one of the most important factors for the financial markets this year.. What’s your outlook on the eve of a new year?

Everybody would like to know what’s going to happen a year from now. What the economy, interest rates, exchange rates, earnings and all that stuff is going to. But it’s very, very hard to know. My favorite quotation on this subject comes from the economist John Kenneth Galbraith: “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

So how should investors prepare themselves for the next year?

The most important thing to do is to assess not the future but the present. Awareness and understanding of cycles is an essential tool for investment survival. That’s why I always say: “We may never know where we’re going, but we’d better have a good idea where we are.”

Where are we today?

The point is, we had a crisis in 2007-2008. The central banks all moved to stimulate the economies to get them going. But all around the world economies are growing slowly: Europe, America, Japan – and China is slowing down. That’s what’s happening today. The last six years have been slow and most people believe that the next ten or even twenty years will be slow compared to the ‘eighties and the nineties. And I must say, I am pretty convinced that they’re right. I happen to believe that the nineties especially, but maybe also the eighties, were in many ways the best of times and are not going to be duplicated. So in my opinion we’re not going back to a high growth environment.

As a matter of fact, some people fear that the US economy could even fall into a recession.
There will always be cycles and that means there will always be a recession coming. But is it one year away or five? That’s the question! I think we’re going to limp along in a slow growth mode. There is always a possibility of some acceleration. But there is no boom so there is no need for a bust. Booms usually create overexpansion and when it turns out that it was excessive it turns into a bust. Today, I don’t see boom and I don’t see bust. So I don’t see anything that could cause a recession in the short term, at least not in 2016 – and I’m not characterized an optimist.

And how about further down the road?

I don’t think the world has to worry about the US. But it has to worry about China. So if you’re asking me when the US will have a recession then the question is how long will China go without a recession?

How come?

China has been going for the last twentyfive years with superior growth and without a recession. It’s not going to grow 25 years in double digits again. China is going to grow in single digits and it may have ups and downs. And if China has a recession, that’s very significant for the whole world. Looking at the statistics you might say China is not too important for the US. For instance, the percentage of the profits of the S&P 500 (SP500 2053.13 -0.38%) companies that comes from China is just 1%. But a recession in China would have significant effects on other countries we sell to. The US would not be untouched. So if you need a culprit for a future recession in the US then it’s likely China will contribute.

Another concern are weak earnings. Yet US companies are paying out dividends and buying back shares at a record pace. How healthy is that for Corporate America?
One of the worst things is when a business behaves in a short term way. When the management does things which are not desirable just to please shareholders, either to make the stock go up or to hold on to their jobs. I’m not saying that all buybacks and dividends are wrong. But stock prices are on the high side of fair. The Price/Earnings ratio on the S&P 500 today is 19, whereas the post war average is 16. So if I wouldn’t buy the stock as an investor, why should the company be buying it? Don’t they have better use for their money?

Obviously, there seems to be a lack of good ideas.
There is an interesting book called “The Outsiders” by William Thorndike. He follows the careers of eight outstanding CEOs like Henry Singleton of Teledyne, Katharine Graham of the Washington Post, John Malone of Liberty Media and Warren Buffett of Berkshire Hathaway (BRK.A 199259.5 -0.93%). They all were outsiders because they behaved differently from the crowd. For example, when an industry would go through an acquisition wave these CEOs would not participate. They would think: “Everybody else is buying and that’s driving up the price of companies so we shouldn’t buy.” They were called capital allocators and they treated cash as a valuable resource. And today, with the average stock on the expensive side, these CEOs wouldn’t be buying their stocks back.

Those CEOs were also good at investing. What does it take to be successful in investing?
For me, the definition of a great investor is one who performs well in the good times and doesn’t get killed in the bad times. In other words: When the tide goes out he’s prepared because he has a margin of safety in his portfolio. It’s like in the world of sports: Pete Sampras for example, who is widely regarded as one of the greatest in tennis history wasn’t always an exciting player. His highlights were hard to distinguish from his low lights. But that means his worst moments were almost as good as his best moments. That would describe a terrific money manager: Consistent and not too much excitement, no big ups and downs – and that’s what we try to do at Oaktree Capital.

In your recent memo you worte about inspiration taken from the world of sports. What else can investors learn from top athletes?

If you want to be a superior player you have to have self confidence. The same is true for the superior investor. At some point you have to act boldly.. You have to say: “This is my conviction” and you have to act on it. You can’t have five hundred different stocks and expect to have a great return because you’ll be diversified into mediocrity. Also, you have to think different from the crowd because if you think the same you act the same and you perform the same. That’s what I call second level thinking. A first level thinker says: “It’s a great company so I should buy the stock”. In contrast, the second level thinker says: “It’s a great company. But it’s not as great as everybody thinks so the price is too high and I should sell.”

In your memo you also refer to the baseball star Yogi Berra. He was famous for saying things like “It’s too crowded, nobody goes there anymore”. What kind of trades are too crowded in today’s markets?
Today, I don’t see any glaring exceptions. Of course, I see some asset classes that are somewhat more attractive than others. But I don’t see things that are dirt cheap or crazy high, except the possibility of social media stocks and technology IPOs. But other than that I don’t see anything glaringly wrong. I just think the whole world is priced for a better future than we have.

So what’s your strategy in this kind of market?

We are living in a low return world caused by the central banks pulling down the risk-free rate to zero. And yet, even though the returns are low, the risks are substantial. That’s why at Oaktree our mantra for the past four and half years has been “move forward but with caution.” The outlook today is not so bad and prices are not so high that they demand complete caution and defensiveness. But at the same time prices are not so low and the outlook is not so good that we should be aggressive. So our strategy is not maximum defensiveness, not aggressive. It’s somewhere in between, but with a significant emphasis on caution. And that means you have to select your investments carefully.

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Japan’s Factory Output Falls

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Japan’s factory output fell for the first time in three months in November, data showed on Monday, a sign that weak emerging market demand continues to cloud prospects for a sustained recovery in the world’s third laJapan slows down visit www.purnartha.comrgest economy. But manufacturers expect to increase output in the coming months, offering some relief for the Bank of Japan as it struggles to jump-start growth and accelerate inflation toward its 2 per cent target. Industrial output fell 1.0 per cent in November from the previous month, more than a median market forecast for a 0.6 per cent decline, trade ministry data showed. Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute, said November output “was not good. I think factory output has stopped falling but it’s not strong enough to say it is rebounding.”
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RBI Unlikely to Hit Repo Rate

Rela Estate housing

The Reserve Bank of India (RBI) is likely to keep the repo rate unchanged in 2016 as consumer price index (CPI)-based inflation may remain above its target of five per cent by March 2017, says a report. With inflation expectations still elevated, we expect RBI to keep policy rates on hold in 2016 and instead focus on greater transmission, Nomura said in the report. As disinflationary forces stabilise oil, rural wages, negative output gap, minimum support price (MSP) the report expects underlying core retail inflation to remain above RBIs five per cent target in March 2017. Headline retail inflation should rise above six per cent due to higher housing allowances, it said. In the fifth bi-monthly monetary policy review last week, RBI kept the repo rate unchanged at 6.75 per cent.

“RBI will use the space for further accommodation, when available, while keeping the economy anchored to the projected disinflation path that should take inflation down to 5 per cent by March 2017,” it had said in the policy statement. According to a report by Bank of America Merrill Lynch, RBI will go for a 25-basis point cut at its February policy meet.
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Finance Minister Satisfied with Performance

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Voicing great satisfaction over performance of the Indian economy in a year of turmoil and volatility globally, Finance Minister Arun Jaitley today dismissed grumblings about the economy not having taken off as cynicism a way of life in India. Looking back at 2015, Jaitley said India has been the bright spot with growth prospects of 7-7.5 per cent despite global slowdown and adversities, and expressed optimism that the growth rate which is quite good would improve further in the months to come. India has responded well to the challenge posed by the slowdown in global economy, he said, but acknowledged that there are areas (in which) we have to respond faster. As the year ends, I look back with a sense of great satisfaction, Jaitley told PTI in an interview, during which he underlined that Indias fiscal fundamentals are extremely sound.
Outlining his priorities for the New Year, thFinance Minister on Economy www.purnartha.come Finance Minister said he would continue with structural reforms and the priorities would include GST, rationalising direct taxes, further easing the system of doing business. After having done that, I would like to concentrate essentially on three things more money for physical infrastructure, more money on social infrastructure and lastly more money on irrigation because that is a neglected sector.
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US Economy Grows

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US Economy Grows by www.purnartha.com Americans have a reason to cheer..US economy grew in the third quarter as strong consumer and business spending offset efforts by businesses to reduce an inventory glut, underscoring its resilience despite a raft of challenges. Gross domestic product grew at a 2 per cent annual pace, instead of the 2.1 per cent rate reported last month, the commerce department said on Tuesday. The GDP data backs up the Fed’s decision to lift-off this month and paves the way for more rate hikes early in 2016,” said Chris Rupkey, chief economist at MUFG Union Bank in New York. While other data on Tuesday showed a surprise 10.5 per cent plunge in home resales last month, economists cautioned against reading too much into the drop, noting that new mortgage disclosure rules had caused delays in closing contracts. The National Association of Realtors said existing home sales tumbled to an annual rate of 4.76 million units, the lowest level since April 2014. The drop is in stark contrast to robust housing starts, new home sales and bullish homebuilder sentiment.

Namo to Visit Russia

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Narendra to Visit Russia  www.purnartha.comPrime Minister Narendra Modi leaves for Russia today for a two-day visit that is part of the annual summit talks with President Vladimir Putin. After their meeting in Moscow on Thursday, the two leaders are expected to sign key agreements on defence and nuclear energy. We expect to sign a number of agreements covering a very broad range of fields. Final touches are being given on some of them,” Foreign Secretary Subrahmanyam Jaishankar told reporters. Last week, the Defence Ministry had cleared the purchase of Russian S-400 Triumf air defence missile systems at an estimated cost of Rs. 40,000 crore. “Russia has been a very major military and strategic partner of India. There will be a lot of discussions on that,” he said. Expanding economic ties is also top of the agenda, with CEOs from both sides meeting.

India’s Current Account Deficit Widens

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India’s current account deficit (CAD), or the difference in the value of goods and services exported and imported, widened from $6.2 billion in the first quarter (April-June) to $8.2 billion in the second quarter (July-September). However, on a year-on-year basis, the July-September CAD was lower than $10.9 billion, or 2.2 per cent of GDP. The contraction in CAD was primarily on account of lower trade deficit in second quarter compared with the same time last year,” RBI said in the second quarterly balance of payments data release. Referring to trade in services in the second quarter of FY16, RBI said net services receipts moderated marginally on a year-on-year basis, largely due to a fall in export receipts in transport, insurance and pension services. However, there has been some improvement over the preceding quarter. The private transfer receipts, mainly representing remittances by Indians employed overseas, amounted to $16.5 billion, a marginal decline from their level in the preceding as well as the corresponding quarter.
The widening deficit is something you’re going to have to live with for the next two quarters,” said Madan Sabnavis, chief economist at Credit Analysis & Research Ltd in Mumbai. However it’s narrowed from the previous year, indicating “there isn’t a real big problem here,” he said.

Sweeping Changes for Overburdened Bankruptcy System

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india bankrupt by www.purnartha.comThe government on Monday introduced a bill in parliament aimed at bringing sweeping changes to an outdated and overburdened bankruptcy system, setting deadlines for the first time for processing insolvency cases. At present, Asia’s third-largest economy has competing laws with unclear jurisdictions to deal with the liquidation or revival of companies. This often results in the process dragging on for years, inflating costs for investors and taxpayers. The bill, introduced by Finance Minister Arun Jaitley in the lower house, seeks to enact a single bankruptcy code. Under current rules, even deciding whether to save or liquidate an ailing company can take years, leaving it in the hands of managers who can – and do – strip assets with impunity. Foreign and domestic investors say the difficulty in exiting ventures is a deterrent in their investment decisions. Jaitley over the weekend told business leaders that the government was planning to pass the bankruptcy bill in the current parliament session that concludes on Wednesday.

Indian Economy Set to Triple

The size of the Indian economy will more than double to USD 5 trillion if 7 per cent growth rate is sustained for next 10 years, Minister of State for Finance Jayant Sinha said. If we grow at 7 per cent, we will double our economy in a decade. We are going to go from USD 2 trillion economy to USD 4 trillion economy, if the rupee strengthens, to may be USD 5 trillion economy. That’s going to happen, we just have to keep doing what we are doing,” Sinha said at the Ficci AGM here. “About USD 4 trillion GDP per capita will roughly double to USD 3,500 from about USD 1,600 per capita today. At USD 3,500, we are solidly middle income,” he added. On fiscal deficit, he said the government will meet the target for current as well as for the next fiscal. With regard to key legislations, Sinha said “on our side we are ready and prepared to introduce the bankruptcy legislation. If indeed we are able to bring in the bankruptcy legislation, it will be the second best relative to getting GST.”

China Economy Expected to Slow Down

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China’s economic growth is expected to slow slightly to 6.8 percent next year, the central bank said, adding that downward pressures would persist for a while. The figure given in a working paper from the People’s Bank of China is slightly lower than its forecast of 6.9-percent expansion for the current year, the official Xinhua news agency reported. The paper listed overcapacity, profit deceleration and rising non-performing loans as major drags on the economy. But it said a recovering property market, the lagging effects of macro and structural policies and small improvements in overseas demand would help bolster growth.

The world’s second largest economy grew 6.9 percent in the third quarter, the slowest pace since the global financial crisis. The central bank has cut interest rates six times since November 2014 and reduced banks’ reserve requirement ratio several times to try to stimulate growth.