WHEN: Today, Wednesday, July 18th
WHERE: CNBC’s “Power Lunch”
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Howard Marks, Oaktree Capital Co-Chairman, live from the CNBC Institutional Investor Delivering Alpha Conference in New York City on Wednesday, July 18th.
Following are links to the video of the interview on CNBC.com: https://www.cnbc.com/video/2018/07/18/oaktrees-marks-stocks-are-probably-fairly-priced-here.html.
Mandatory credit: CNBC Institutional Investor Delivering Alpha Conference.
SCOTT WAPNER: Thank you for being here, Howard. Always a great time to catch up with you, especially now, at kind of our midyear report, maybe we should call it, on where we are in the markets. And we've heard from some great and insightful people already today here, but most recently, others who have weighed in on the markets. And I'd like to get sort of your temperature, take the temperature on where we are. Guggenheim's Alan Schwartz said this week: We're in the 8th or 9th inning of the bull market, but there are tremendous storm clouds on the horizon. Jeffrey Gundlach, who I'm figuring you know well: We're getting closer to a recession, he said, looking at the spread between the 2-year and the 10-year. Larry Fink noted the narrow breadth in the market as being maybe concerning. What do you see?
HOWARD MARKS: You know, ever since the global crisis, which means ten years, people have been asking me what inning are we in. And now I would say we're in the 8th inning. I would agree with Alan. However, we have to notice that this isn't baseball, and we don't know how many innings there will be.
SCOTT WAPNER: We could go into extra innings.
HOWARD MARKS: Exactly. And so if it was a 9-inning game, we'd know what that means, but there could be 11, there could be 14. Of course, when you get to this point in the cycle, people start pushing out their horizons, you know. When it's been going on for five years, they say: Well, I think we could make it three more. When it's going on for ten years, they think, I could make it five more, which is counterintuitive. And people are doing that now. That shows optimism. It's somewhat dangerous. I mean, Jamie Dimon not that long ago said we're in the 6th inning. Warren Buffett seemed to agree with him. What do they see that you don't?
HOWARD MARKS: Well, first of all, the economic recovery, we're really driving blind now. We're in the tenth year of an economic recovery, and the record for -- since the war is ten years. So will we beat the record? It looks like we will, but is there something about ten years which calls this thing to a close?
SCOTT WAPNER: Well, I could say, well, maybe, you know, you throw history out the window and we've just extended the cycle because of tax reform, regs coming off, and other things that are going on fundamentally around the world that are pretty positive.
HOWARD MARKS: Exactly, but I've just finished a book on cycles called Mastering the Market Cycle, and it's going to the printers. And one of the things it says is that extended bull markets are usually greeted by four words: "It's different this time." And, you know, in every extended cycle that I've seen in my 50 years, when you are in the later stages, people started coming up with rationalizations for why it's not going to end. And, of course, usually it turns out not to be any different. So we'll see. Certainly, I heard David a minute ago and, you know, he said he doesn't see a recession this year or next year.
SCOTT WAPNER: No signs of a slowdown, he said.
HOWARD MARKS: Or next year. I don't see them, either. But, you know, when you're talking about being in the 10th year or 11th year of recovery and the 10th year of a bull market, how much do you want to push your chips out on the table? Or do you want to take a few off? That's really the key question.
SCOTT WAPNER: You said, in January, quote -- and it certainly got a lot of fodder -- The easy money has been made. And the market's changed a little bit, valuations have come in. Earnings certainly look strong. You still think -- is the market more attractive today than it was in January when you wrote that?
HOWARD MARKS: It is more attractive because the earnings estimates have gone up a lot. You know, if you went back, let's say, eight months ago, before the tax bill was passed, we were talking about a P/E ratio on the S&P about 23; and now, the earnings expectation, the growth projected for this year is so high, that now we're talking about a P/E of about 17. The market went from meaningfully overpriced, not a record, but overpriced, to average price today. That's a big change. However, it should be noted that even though earnings projections show growth in the 20s of percent this year, the market is only up a couple of percent. So in other words, a lot of the appreciation of the stock market was front-ended. It had happened by January, I think. And even though earnings are going like this, stock prices are not.
SCOTT WAPNER: It was pretty confounding how you had incredible earnings growth in the first quarter, all of the reasons for the stock market to do well, and it didn't, as you point out. We're assuming we're going to have good earnings, and we're in the midst of season now, and it seems to be good. Is this time different, or are we being held back by all of these other forces that are out there; geopolitics, trade, worries about rates, et cetera?
HOWARD MARKS: All those things are important. There are a lot of potential negatives out there. But I think the most important thing for me is, on the subject, is that people who do not understand how the markets work or haven't been around very long, tend to think, good news, appreciation. It doesn't necessarily work that way, because the good news could already have been anticipated, which means that even though the news is good, it's greeted with a yawn. And that seems to be what's going on this year. Plus, the progress is deterred by some of the negatives like sluggishness. You know, eight months ago, we were talking about a synchronized global recovery, and now we can see weakness in Europe, for example. And, of course, I think that the tariffs and trade war could be a real issue, whereas eight months ago, nobody had it down as a concern.
SCOTT WAPNER: When people suggest that we could be in a Goldilocks environment, do you scoff at that? Does it feel like that? Growth is expected to remain strong. Inflation is expected to remain same. Is that Goldilocks?
HOWARD MARKS: You know, look, the idea that things are good and are going to stay that way forever has always gotten people into trouble. I would love if it turned out to be true. But, you know, you referenced my statement that the easy money's been made. If you invested in the S&P at the bottom, you've quadrupled your money so far. That kind of appreciation is not in the cards anymore, I don't think. You know, the growth that's going to be reported in profits this year is not the trend line growth. It's a bump, a lot of it related to the tax bill. What is going to happen when growth drops back off next year? So I go back to saying -- you know, I don't say get in, I don't say get out. I never say this is the time.
SCOTT WAPNER: Sure.
HOWARD MARKS: I'm not that smart. But the question is: With the world configured as it is, with the recovery and the bull market at the age they are and with the question marks on the horizon, do you want to have as much risk as you had three years ago, same, or more? That's really the question.
SCOTT WAPNER: What cracks the bull market? What's it going to be?
HOWARD MARKS: I once wrote a memo maybe 15 years ago, and I said -- and this will help you date it. I said: Well, what could cause the bull market to stop? $100 oil, which of course was soon achieved; rising interest rates; dollar weakness, or something else. My money's always on the four, you know. One of the greatest oxymorons in the world is we're not expecting any surprises. It's surprises that knock the market down; and, by definition, surprises are not anticipated. If we had to specify today what it will be, I think you'd have to say rising interest rates, producing competition for stocks and making it harder for companies to service their debt. But I think it's folly to think you know, A, what the market's going to do; and, B, especially, why.
SCOTT WAPNER: You were sitting here a year ago, and now we're here today. And I said: Howard, would you have ever imagined that things would feel and be this good, and the ten-year note yield would be at 285, or wherever it currently sits today without looking at it right now; you would say what?
HOWARD MARKS: Well, I think that -- I think that things have turned out very well in the short run. Things have gone about as well as they could in most areas. I think that, you know, we have a President who I think fully intends to be a pro-business president and is perceived that way. That gives investors and corporate executives confidence. We have the tax bill, which is very pro-business, and stimulatives to the economy in the short-run. Now, there's a question about whether you should stimulate an economy when it's in the ninth year of a recovery. Doctors do not give adrenaline to healthy patients. But, certainly, it produced a big bang this year. You know, the second quarter is estimated to have risen 5%. At Oaktree, we are not macro forecasters or macro investors, but you have to look at that and say that's a heck of a number. I don't think it's going to extrapolate, but things are going extremely well. And by the way, eight years ago, people were saying, you know, it looks great for Europe and maybe, as David said, maybe the Euro will become a reserve currency. Nobody thinks that anymore, and the U.S. is pretty much back to being alone at the top of the heap.
SCOTT WAPNER: What, then, is the message in low rates? Why do we have rates as low as they are? Is it all Central Bank-related, the fact that you still have negative rates in parts of the world? What's the message?
HOWARD MARKS: Well, look, I think that a lot of it relates to the Central Banks. We have negative interest rates. We don't really know what that means. And the Central Banks, in running up their balance sheets in quantitative easing, have done something that's never been done before. We can't pretend we know how the unwind is going to go. So, you know, clearly we had artificially low rates -- well, we still do, I think, but we had them for nine, ten years. And the Fed is trying to back out of that now, and get back to normal. But, you know, exactly how it goes is unclear. And the lowness of long-term rates relative to short-term rates is something people are talking about; that a flatter inverted yield curve has been associated with recessions in the past. May be again. Not exactly clear why, but it is something that people are worried about.
SCOTT WAPNER: You said that the President and his policies have been good for the economy. If you had to write one of your famous memos and the title was "President Trump and the Markets," how would it start?
HOWARD MARKS: I think that it would start by saying that President Trump's election was one of the biggest surprises that anybody living has ever seen; and that how salutary he has been for the economy and for the market is another big surprise. And, you know, back just before the election, there were only two things that everybody was sure of. Number one, Hilary would win. And number two, if Trump lost, the market would tank. And, among other things, that shows the folly of forecasting. But I mean, life has been a big surprise ever since.
SCOTT WAPNER: How would the memo end?
HOWARD MARKS: I think what it would say is that a lot of the things that have been done have clearly been good in the short run, and the long-run impact remains to be seen.
SCOTT WAPNER: Worry about the deficit, like we've heard on this stage already today?
HOWARD MARKS: How can you not? How can you not? When I was a boy, there was a raging debate about whether it was okay for countries to have debt. Is national debt okay? You don't hear that much anymore. And, you know, as David said, you're going to add $1 trillion a year to the national debt for the next dozen years. Is there a number that matters? People don't seem concerned anymore. And, you know, people used to be prudish, by current standards; and now, in contrast, it seems that there is no prudence. There's certainly no concern. There's nobody worried, you know? And if you get up and pound the table for taking away the punch bowl, you're not going to get many votes. So, you know, everybody now has concluded that stimulating the economy, giving away tax breaks, stimulated earnings, this is the way to get votes. But -- and, you know, the Republicans historically have been the party of fiscal prudence, and they voted for the tax bill, knowing what it would do to the debt and the deficit.
SCOTT WAPNER: I thought of, you know, the risks that are so obvious, as we've already laid many of them out, geopolitical and domestic. Your most recent memo talked about a risk that has been mentioned on this stage for years, most notably perhaps from Carl Icahn, who sat here with me a few years back and worried about ETF, all of the money passively that has gone into ETFs and what happens when the dam breaks one day. You're worried about that as well.
HOWARD MARKS: Well, ETFs are just another investment technique; and like all the others, they have feet of clay. When I was a kid, we watched the Lone Ranger. His gun fired silver bullets, and he never missed. And everybody in the investment business is always looking for the next silver bullet, and people on the sell side promise it to them. There is no such thing as a silver bullet. There's nothing that delivers high returns without risk. And the question is, it's just an investment technique. Do people expect more from it than it can be delivered; and is that going to be a source of disappointment; and will that be an important factor in cracking the market? No investment vehicle can, in tough times, be more liquid than the underlying. So, for example, we have high-yield ETFs, which people assume they can sell any minute. But if they know that they had a portfolio of high-yield bonds, it would take them some time to work out. So they think that the ETF is much more liquid than the underlying. Where does that increment in liquidity come from? And the answer is, in tough times, it will be shown to be a loser, in my opinion. Now you look at ETFs, which are, let's say, smart beta. These are rule-based investment technologies. They are no better than their rules. If you have the right rules, it'll work. If you have the wrong rules, it won't work. And there's no way to set the rules with certainty that it will work. The rules are based on a continuation of the things that have worked, working, and they may continue or -- as David quoted Herb Stein, or they may stop working. And we'll see. But, you know, I keep going back to the fact that there is no silver bullet. The only thing that really can be depended on in the investment world to work is superior judgment, not any technique or algorithm.
SCOTT WAPNER: Do you think there's been a bubble in passive investing?
HOWARD MARKS: Well, I mean, there's certainly been a trend to it. I would have to -- in order to answer your question, I have to do research and find out what the buyers are expecting. I have a feeling they're expecting too much.
SCOTT WAPNER: Even just in the sheer volume of money that has flowed into ETFs and other forms of passive investment.
HOWARD MARKS: Merely saying that I'd rather own stock in an ETF than directly or in a mutual fund is not necessarily wrong, as long as you understand that if the market has a hiccup, your ETFs will get hurt and you may not be able to get out so close to the last price as you thought. Now, the one thing that probably should be highlighted about ETFs is that a conspicuous number of ETFs are concentrated in the same stocks, because many of them use momentum as a factor. Momentum favors, you know, a relatively short list of stocks, and, you know, the movement of money into ETFs which feature those particular stocks certainly has contributed to the increase in the prices of those stocks relative to other stocks.
SCOTT WAPNER: You're somewhat alluding, and maybe directly, to FANG stocks.
HOWARD MARKS: Yes, right.
SCOTT WAPNER: Right. You look at the appreciation of those stocks and say that ETFs have maybe artificially propped up some of these.
HOWARD MARKS: They're great companies, but the ETFs probably have accentuated the flow of capital into those stocks, and when things go cold and the person who expected instantaneous liquidity can't get it, he's going to turn around and he's going to look for somebody to sell that ETF to. Who's going to buy it?
SCOTT WAPNER: You write, "Like the tech stocks in 2000, this seeming perpetual motion machine is unlikely to work forever."
HOWARD MARKS: Nothing works forever, and things that are the most hyped and usually the things that are the most loved produce the most disappointment and the most pain.
SCOTT WAPNER: Is that what maybe causes the unwind? All of, you know, this -- we've talked, whether it's looking at ETF flow -- the FANG stocks alone have cost 70% of the -- amounted to 70% of the gains in the S&P?
HOWARD MARKS: Right.
SCOTT WAPNER: You add in a few other tech stocks and you're talking about 90-plus percent.
HOWARD MARKS: Well, when you --
SCOTT WAPNER: The danger area, the red lights are flashing there?
HOWARD MARKS: Well, but, you see, when something has worked for six, eight, ten years, people do tend to consider it a perpetual motion machine and think it'll go on forever; and people say, Well, is that what's going to crack it? And the answer is, well, what's going to change their mind? As long as they think that Amazon and ETFs are perpetual motion machines and they keep putting in capital, they won't crack. So clearly, when they crack, that could be something that hurts the market a lot. What's going to make them crack?
SCOTT WAPNER: So how, then, given everything we've discussed, are you trying to deliver alpha? Where are you finding it? Where are the best opportunities that Oaktree sees?
HOWARD MARKS: Well, at Oaktree, we have had a motto for some time now: Move forward, but with caution. We are investing every day. We're trying to be fully invested, but we are emphasizing caution. We're a cautious firm, so that means more caution than usual, even. So I think that the greatest achievement of alpha is to get, let's say, returns that are almost as good as the risk-taker with a lot less risk. And we're trying to do that. We've been very good at it in the past, and I think we will be able to do it in the future. That is our emphasis today. In a hot market, which is characterized by risk tolerance and optimism and a lack of skepticism and a lack of cynicism, it is a mistake to try to outperform the best performers. Because to do that, you have to take a hell of a lot of risk. And at Oaktree, that is not what we're trying to do. We're trying to have almost as good a return as the hottest performers, but with a lot less risk. And I think that's a single accomplishment, and that's where we are today. Having said that, Scott, there are specific markets that we like, and where Oaktree is active, and those would include emerging market equities, private lending, real estate lending and infrastructure, things along those lines. For the most part, one of my competitors, I forget exactly which one, one said that everything with a QSIP is overpriced. Public securities are basically priced higher than private securities today, and I think that a lot of the best opportunities are on the private side, which Oaktree emphasizes.
SCOTT WAPNER: It is interesting, though, that you like emerging market equities, and the question that we asked the audience before we walked out on the stage, the majority like emerging market equities, as well, versus the U.S.
HOWARD MARKS: That's right. Well, look, they've been hit. They have been significantly hit, and the pendulum of opinion swings radically with regard to emerging markets. And in the last, you know, months or year or so, it has been on the negative side. How many things can you find today that are down? How many things can you find that are unloved? These are the things that Oaktree likes to emphasize, and this category is one of them.
SCOTT WAPNER: How are you positioned as it relates to high-yield?
HOWARD MARKS: Well, high-yield, we're a so-called long-only investor. We don't go short. This summer celebrates my 40th year in high-yield bonds, and we are --
SCOTT WAPNER: No better person to ask that question.
HOWARD MARKS: We are primarily single B investors. We think that CCC introduces too much risk, and BB gives up too much yield. So we like the B. And rather than -- you know, we have a motto at Oaktree: If we avoid the losers, the winners take care of themselves. And that emerged primarily from my experience with high-yield bonds. So we try to buy a portfolio that yields almost as much as a nonselected portfolio, but with a lot less credit risk.
SCOTT WAPNER: At the end of the year, is the stock market going to be higher than it is today, or lower?
HOWARD MARKS: Even.
SCOTT WAPNER: Typical Howard Marks answer. So give me your riff. We have -- let's just say we have 30 seconds left before we go. What's your riff on Bitcoin? We've heard some conversation today, you're going to hear more of it later on some panels, as well.
HOWARD MARKS: Well, you know, I wrote some memos and touched on Bitcoin a year ago. And, as my dad used to tell the joke, Bitcoin is not an investing sardine, it's a trading sardine. And the people who are buying Bitcoin are buying it because they think that somebody else will buy it from them at a higher price; not because they can specify its intrinsic benefit, not because they can judge the intrinsic value, but only because they think it's going up. And why will somebody else pay them more than they paid for it? Well, because they think somebody will pay them more than they paid for it. This is what we called, when I was a kid, the greater fool theory. And I think that this is a trading -- a speculative medium, and I think that that's what Bitcoin is. And last year showed that it can have great years. But in the long run, I think it will be shown not to have any substance.
SCOTT WAPNER: Can't thank you enough for your time. It was great having you here at Delivering Alpha. Howard Marks.
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