Billionaire investor Howard Marks, co-founder of Oaktree Capital Management, shared a note with Oaktree clients this spring that was later published on the Oaktree website. In the memo “Further Thoughts on Sea Change,” Marks recommended “significant capital reallocation.”
Specifically, he’s suggesting investors shift their money toward bonds and out of the stock market.
First cautioning against using the rationale “this time it’s different” to justify poor investments or excessively high valuations, he conceded that this time, the economic landscape may really be different.
The phrasing refers to a New York Times article by Anise C. Wallace from 1987, when Sir John Templeton, the famed investment banker, “warned that when investors say times are different, it’s usually in an effort to rationalize valuations that appear high relative to history — and it’s usually done to investors’ ultimate detriment.”
“Given the pace of developments these days — especially in technology — I imagine things might genuinely be different more often than they were in Templeton’s day,” Marks wrote in his note.
Given that we may truly be living in “unprecedented times,” to borrow a pandemic-era phrase, what does Marks suggest to his clients?
Marks: Sell Equities, Buy High-Yield Bonds
In the note, he recommended selling some equities and buying bonds — specifically high-yield bonds. Today, high-yield bonds deliver returns greater than 8%. He added that such investments in the credit market are not dependent on market behaviors, providing another measure of security in the event of a recession or economic downturn.
Marks pointed out that today’s investors have become comfortable with the ultra-low interest rates we’ve seen in recent decades — most either didn’t experience or don’t remember the high inflation and high-interest-rate environment of the 1970s. Low interest rates drove market optimism, economic growth, and asset appreciation.
But these decades of low interest rates are poised to change, according to Marks. “For a number of reasons, ultra-low or declining interest rates are unlikely to be the norm in the decade ahead,” he wrote. “Thus, we’re likely to see tougher times for corporate profits, for asset appreciation, for borrowing, and for avoiding default.”
Since these factors, particularly asset appreciation and corporate profits, drive the stock market, it would be wise for investors looking for higher returns to diversify. In fact, CNN reported that the Dow Jones Industrial Average is flat for the year as of early October 2023.
“In early 2022, high yield bonds (for example) yielded in the 4% range — not a very useful return,” Marks wrote. “Today, they yield more than 8%, meaning these bonds have the potential to make a great contribution to portfolio results. The same is generally true across the entire spectrum of non-investment grade credit.”
Right now, according to CNN, bond prices are down and investors have been selling them en masse. Should investors take Marks’ advice and jump into the bond market rather than buying overvalued stocks?
Vanguard: Diversification Is Key
Most investment professionals would agree that diversification is key. An Oct. 9 blog post on the Vanguard website read: “Over the long term, bonds continue to be a great diversifier to equity stress.”
In years of negative equity returns, bonds have delivered benefits. According to Vanguard, bonds typically outperform cash in the three years following peak federal funds rates and have performed better than stocks and cash during recessions.
Marks, however, stated in his note that he’s not predicting a stock market collapse and he’s not suggested that people take a dramatically defensive stance toward investing. He wrote, “I have no reason to believe that the recession most people believe lies ahead will be severe or long-lasting.”
However, he remained steady in his recommendation to reallocate capital toward bonds for higher returns and greater financial security. “Unless there are serious holes in my logic,” he wrote, “I believe significant reallocation of capital toward credit is warranted.”
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