Thinking About Macro
Howard Marks writes one of the best investment memos in the investment industry and he just published his most recent memo on what is going on in macroeconomics today and how useless it is to try and make predictions based on the macro.
As per Investopedia, macroeconomics is a branch of economics that studies how an overall economy—the market or other systems that operate on a large scale—behaves. Macroeconomics studies economy-wide phenomena such as inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
The macro future isn’t knowable so Oaktree doesn’t base their investment decisions on it.
Howard Marks sees a different market before the year 2000 and after 2000. Pre 2000, he believes that the market responded more to events that surrounded individual companies. Post 2000, and more specifically post 2008, he sees a market that responds a lot more to macro themes that involve what the Federal Reserve is going to do or what world events are occurring.
Howard Marks writes that we all have views about the future but at Oaktree they say that it's one thing to have an opinion, but something very different to assume it's right and bet heavily on it. And one thing Oaktree doesn’t do is just assume that their view of the future is right and bet heavily on it.
Not much should be put into inflation predictions and Howard gives the following 3 examples why.
1. Howard mentions that two chief economists (Henry Kaufman and Al Wojnilower) during the 1970’s didn’t know how to stop the 5-15% annual inflation rates that lasted up until 1982. It was eventually Paul Volcker who figured out how to stop high inflation by raising interest rates to double digit rates very quickly which brought on a double dip recession from 1980-1982 which then succeeded in stopping the high annual inflation rates.
2. The US, Europe and Japan have been targeting 2% inflation targets through the 2010’s but fell short despite high budget deficits, continuous economic expansion and money supply expansion.
3. Despite the Phillips curve saying that there is an inverse relation between unemployment and inflation, the unemployment rate from 2010-2020 went down to 3.5% but inflation didn’t go higher.
Here are the following reasons that point to the possibility of a continued period of much higher inflation today: Labor shortages; April, May and June consumer price index readings; excessive money printing which decreases the value of the dollar making imports more expensive; rising commodity costs (cost push inflation); more money chasing fewer goods (demand pull inflation) and the prevalence of MMT theory that essentially says debts and deficits don’t matter.
Here are the following reasons that point to the inflation that we are experiencing today to being only temporary: cost push inflation resulting from shortages that is affecting finished goods and manufacturing inputs are a result of restarting reproduction, our psyche plays a part due to consumer expectations, COVID relief spending isn’t forever, enhanced unemployment benefits are ending, slower economic growth in the future and technology's deflationary effects.
But whether high inflation will continue or will be transitory is impossible to know according to Howard Marks.
The all-time high in gold was in August 2020 when the Fed injected several trillion dollars into the markets and the economy but when there were fears about inflation rising in June 2021, the price of gold was 14% below its all-time high set on August 2020. In response to this, Howard Marks writes, "Not only do the markets not know what's coming, but they often behave in ways that make little or no long-term sense."
Market forecasters from 2000 to 2020 were off by 12.9% points in trying to predict what the return of the S&P 500 would be for the upcoming year. In other words, market forecasters provide no value because they (nor does anyone else) know what return the market is going to have in the future.
The Fed has played a very active role in managing the economy starting in the 1990's under Fed Chairman Alan Greenspan all the way up to today under Fed Chairman Jerome Powell.
The Fed has been especially active during recessions such as the Dot Com Bust, 2008 Mortgage Crisis and the pandemic and Howard Marks thinks that all of their actions were necessary to help the economy but he would like to see the economy stimulated less often instead of continuing to provide stimulus through periods even when the economy is growing like from 2010-2020.
Howard would also like to see more of a free market in interest rates where the rates are being influenced naturally from market forces as opposed to by influence from the Federal Reserve. He believes this would lead to a healthier allocation of capital.
Howard says that no one can predict whether we are heading for a continuing period of higher inflation or if the inflation we are experiencing will only be transitory so all we can do is prepare.
The old Howard Marks would have warned of a stock market bubble today, but after the conversations that he had with his son, Andrew, in 2020 that he discussed in his last memo "Something Of Value", he is now looking through a new perspective and thinks that it makes little sense to significantly reduce market exposure based on inflation expectations that can’t be known for sure, other's positive counterarguments and because investing isn’t a short term endeavor, it's a long term one.
Howard Marks believes that asset prices today are fairly priced based on where interest rates are. Interest rates could increase from here due to inflation or the Fed responding to an overstimulating economy but investors shouldn’t make significant asset allocation decisions based on macro expectations that aren’t knowable.
P/E ratio of S&P 500 is low 20s
Earnings yield is 4-5%
10-year treasury is 1.25%