Howard Marks Discusses the Interest-Rates Machine

be an absolutely fascinating conversation. Rather than have me go on at length, instead, I'm just going to step away and say, with no further ado, my conversation with Howard Marks, I have an extra special guest. His name is Howard Marks, and he is co chairman and co founder of oak Tree Capital, which manages over a hundred and twenty two billion dollars. Howard comes to us by way of the Wharton School at Pennsylvania, where he did his undergraduate got

his MBA at the University of Chicago Boost School. He formed oak Tree and after spending about a decade at Trust Company of the West. According to the most recent Bloomberg data, I looked at oak Trees seventeen distressed debt funds have averaged annual gains of nine after fees since inception, about seven hundred basis points better than its peers, according

to Boston based consulting firm Cambridge Associates. His first book was called The Most Important Thing, and he has authored a new book called Mastering the Cycle, Getting the Odds on Your Side, returning for his third Masters in Business, Howard Marks, Welcome to Bloomberg. Thank you, Mary. It's great to be here. So I was excited to see your new book because I figured it would be an excuse to get you back in here. Let's talk a little bit about what motivated you to write another book. Um,

who's the intended audience? What? What was the thinking behind this? When I wrote the first book, I thought it would sell about three thousand, and I thought it would be die hard professional investors. It has sold about three quarters of a million so far, and uh, and I believe it's uh professionals, uh do it yourself investors, and uh, maybe even some people who just want to hear about a new topic. So the first book came about because some guy named Warren Buffett said, Hey, Howard, why don't

you write a book. Why don't you take all these chairman memos and turn them into a book. If you write it, I'll give you a blurb for the front cover. That's pretty good. Motivation was the motivation in this book. Well, as you know, the first book was called The Most Important Thing, and it talked about twenty different things, each

of which was labeled the most Important Thing. Because in investing there really are many, many things that are essential, and all of which have to be dealt with simultaneously. But I do believe Barry that UH, recognizing on dealing with risk and understanding where we stand in the cycle are really the two keys to success. UH. And if you're going to be an active investor and active manager, I think those are the two areas in which, UH you can best make a contribution. So let's talk a

little bit about cycles. There's a quote of yours that I really like. Rule number one is most things will prove to be cyclical. And rule number two some of the greatest opportunities for gains and losses come when other people forget rule number one. Tell us about that. Well, you know, back in in the early seventies, somebody gave me a great gift they shared with me the three

stages of a bull market. The first stage, when only a few incredibly insightful people believe there could be improvement, the second stage, when most people accept that improvement is taking place, and the third stage, when everybody thinks things will get better forever. And you know, it's obvious that if you buy in the first stage, because so few

people are optimistic, you can get a real bargain. And if you buy in the last stage, when everybody and his brother is on board, uh, you know you're likely to overpay. It's it's almost as simple as that. So you know, what I try to do in the book is go through understanding where we are in the cycle, why, and what we should do about it. So let's talk

a little bit about this cycle. Clearly, oh nine, very few people thought, all right, this is an opportunity where we're at the bottom of this cycle, and those folks have been pretty well rewarded. If we look at I don't know is that a fair assessment for phase two where people felt, hey, things are getting better. Are we

at that final stage yet? Have we gotten there? Because so many people have been so negative this whole run up, it makes it a little tricky to figure out where that last stage where everybody thinks, hey, this can't ever stop, it's going to keep going. Sure, Well, you know that's the key question, that's the hard question. Um My approach on these kinds of things is, uh, we never know where we're going. We're sure as hell out or no where we are. What do we know? Barry about this market?

As you say, we're not in O eight oh nine when everybody thought we were heading for a meltdown. We're not in twelve or thirteen when things were beginning to lift off. Uh. By some measures, this is the longest bullmarket in history. The S and P has quadrupled from the lows. And uh So I think the first thing I would say is the easy money has been made. We're not in that first stage anymore, where where most people are nonbelievers. That's that's the easy thing to say.

Um I think that, And and and lately you get more and more people, you know, the higher things go, the more people say, well I guess it could it could keep on. Uh. It's usually prefaced by those four dangerous world words. It's different this time. You know, the historic rules do not apply. The pe ratio, history doesn't matter,

um and and so forth. Uh. But you know, Uh, when you're in the tenth year of her economic recovery, and there's never been one of more than ten years, the only thing you know is that the odds are not really on your side anymore. Nobody can say it's gonna end tomorrow, It's going to end a year from now. In investing, we sometimes know what's going to happen, but

we never know when. But you know, Uh, if you, if you, if you accept that the easy money has been made, and that the pe ratios, for example, are higher than the post war norm, and that interest rates are rising, etcetera, then I think you have to conclude that the odds are not strongly in your favor. You have to take some risk off. Makes sense. Back you said you were thinking we were falling into an everything bond bubble? Um, What are your thoughts about that today?

Is our bonds still in a bubble? Uh? And how does this resolve itself? You know, at that time, Barry, I think interest rates were the lowest that they've ever been period. And you know, it seemed that with the strength in economy and with the Fed no longer wanting to be so stimulative that interest rates would be rising. Rising interest rates folding bond prices. That's the math. So you know, we've seen eight interest rate increases from the

Fed already. Most forecasters think we'll see half a dozen more over the next couple of years. Uh. Clearly, interest rates are no longer the lowest in history. Although still low, they'll probably continue to rise, you know. So you know, a straight high grade bond is nothing but an interest rate machine. And as interest rates go higher, the prices of existing bonds with old fashioned low interest rates go down.

I don't think you want to own straight long term bonds in a period of rising interest rates, and the consensus is that rates will rise. So if you don't want to own straight up bonds and we're in a rising rate environment and a lot of people have um fairly substantial exposure to equities, how do you offset that risk? If you want some form of a balanced portfolio, where where is the value on the fixed income side, if anywhere? Well, you know, I think that across the board, what I

say about rates has really affected all bonds. Uh. You know, the the impact of of rates on bonds is universal, and uh, you know, at the present time, there are no exceptions. The one thing you want to think about is this, Barry. One of the main reasons that we will probably have rising interest rates is that we will probably have continued prosperity and maybe even a pick up

in inflation. Those two things, prosperity and inflation add to the profitability of corporations, and so UH, strengthening corporate profits will translate into a positive influence for corporate bonds. So you'll have the negative influence of rising rates, but the positive influence of improving profitability. And that suggests that corporate bonds are somewhat sheltered UH from the deleterious effects of

rates alone. But you know, I believe that most asset classes are fully two U fully value too at the beginning of rich. And this is a time for caution, you know. The book is about trying to figure out what time it is for what and which form of behavior is appropriate. If we're low in the cycle, we should be aggressive. If we're high in the cycle, we should be defensive. I think, on balance, through most asset classes, we are high in the cycle, and I think that

calls for defense. So if we were putting this in terms of a baseball game, What what inning are we in in? In that longer cycle? I get that question a lot. They started asking it back in oh eight when they said when will the what inning are we in? In the crisis? Meaning when will the financial crisis enid? Sure, I remember eighth inning fisher of the Fed governor from Texas who basically said, we were in the eighth inning.

Turn out we were in the second inning. But still exactly and today when they say what inning are we in, they really mean when will the bull market end? How far are we in the cycle? Exactly? Now? I think we're in the eighth inning, But about a year ago I figured out there's a problem with saying that, which is this is in baseball, right, and we know in baseball that a game is nine innings except except ties, But in investing, we have no idea how many innings

there will be in the game. So I think we're in the eighth inning, but this game could go nine or eleven or thirteen. And I think that the outlook is not so poor and the prices are not so high, that this is the time for defense. Our own motto at oak Tree has been moved forward, but with caution and Uh, we're essentially fully invested. That's what moved forward means. But I also think it's time for caution because I do think we are elevated in the cycle. So so

how does an investor manage that risk? Is it just staying away from the most expensive, most speculative paper being fixed income or stocks On the equity side, how do you stay fully invested but cautious. Well, I think that's the right idea. Everything you want to do in the investment business, you can do it aggressively or you can do it defensively. As you say, you can be in quality stocks as a post to speculative stocks. You can be in large companies rather than small. You can be

in the lower price, not the higher price. Now, usually the higher price has the prettier story. That's why it's higher price. But but but you pay smartly for that. The fangs, the texts, these are the ones that have been selling very high, high in price, great story. But if you want to be defensive, you drop down to a little less glamorous story at a lower price. In bonds, you can go for quality. You can certainly go for UH shorter duration short shorter maturities UM and uh. I

would not advocate getting out of the market. It's not so egregious that cash is preferable. I do think that the things you want to do in your portfolio are better done in a cautious way than in an aggressive way. So you talked about corporates, you talked about high grade low grade. Before we came into the studio, we were discussing tips. If we see even modest inflation, is that a bad place to hide or is that a half decent place to think about. There are two risks in bonds.

One is the risk of a negative price fluctuation, interest rates up, prices down. The other is the risk of not getting paid. What is a bond. It's a promise of a string of payments, interest, and then principle at the end. So you know, most people should not buy bonds where the risk of being unpaid is substantial. So let's assume that we are our managers can exclude the ones that default. Now we're down to the the ones

that pay but could experience a negative fluctuation. We don't know rates, what rates are gonna do, We don't know what how they'll fluctuate. But if you buy bonds that are gonna pay. You buy a bond today. Let's say it's a high yield bond and you can buy it at a six percent yield. If rates go up, there could be a negative price fluctuation, but if the company is credit worthy, it will still pay at the end

and you'll get your six percent. And I think that, you know, if somebody, if somebody can live with a fluctuation, and if six percent is good for them, I think they should be buying six percent bonds. The biggest mistake you can make, in my opinion, is to buy six percent bonds in the hope of getting nine because that's probably not in the cards, to say the least. So let's talk a little bit about mastering the market cycle. What is it that most people seem to get wrong

with longer term cycles? What is it that makes the market go up and down? When you see a market that's rising, it's usually the news is good. The economy is doing well, the corporations are reporting good or ings, the the investors are happy, the media are putting out

positive stories, and prices are rising. Everybody feels good. But if you take those things together, very what they mean is that prices are probably high the enthusiasm to buy thus is the highest when the prices are the highest, which is not when we should be buying the most. So and the reverse is true in the opposite direction, you know, in the in the in the very bad times, people get depressed. The news is for everybody wants to

get out, regardless of how the low the prices. So you know, when I was a kid, my mother said, Howie, buy low, sell high. Most people's emotions lead them to buy high, sell low. We want to counter that. So the element that causes the problems in investing is psychology. If we knew that positive news would result in good price performance, life would be very easy. But it would be only true if if we could buy in at

a fair price or an attractive price. If the news will be good, but we overpay for the security to get in, then we may be looking at losses despite the good news. So it's all a matter of emotion. And uh, you know, the reason I wrote this book is so that people could understand what it is that contributes to market cycles. Could understand perhaps the mistakes others may perhaps the mistakes they've been making. His darkly and stop it. Get the you know, the subtitle is the

key getting the odds on your side. So let's talk a little bit about that in terms of one of your favorite subjects, which is value. And one of the quotes that I really like of yours is the essential character of value is not what you buy, but what you pay. That clearly has a cyclical element to it. If we're talking about the overall market. What what motivated you to phrase that quite in that that way? Very easy?

I started in business fifty years ago. Uh and uh, you know, I started a city bank, and all the New York banks adhered to what was called the nifty fifty investing. They brought the stocks of the fifty best and fastest growing companies in America to which nothing bad could ever happen. And in most cases they were right. There were great companies. They went on to great success, but they were valued so high in nineteen eight that if you if you bought them and held them for

five years, you lost almost all your money. Because there is no asset which is so good that it can't be overpriced and us dangerous and and uh and the inverse. You know, there are very few assets which are so bad that you can't make money at them if you I am right. So in night ten years, when I had ten years under my belt, I was asked a city bank to start up the fund for high yield bonds. So in the first few years we bought the best

companies in America and lost a lot of money. Starting in seventy eight, I bought the debt of some of the worst companies in America and made a lot of money steadily and safely. And that's when I concluded, it's not what you buy, it's what you pay. I've I've always hated the phrase that came out of the financial crisis toxic assets, because it wasn't the assets that were toxic, it was the prices you could buy the worst bond

portfolio if you paid a low enough price. Hey, a lot of people bought bout blocks of paper and double and triple their investment because the price they had paid was so low. Exactly, you know, Barry, at the beginning of the hour, uh, you quoted returns for our distressed dead funds. Well, in our distressed debt funds, we're buying securities of companies that are bankrupt or that everybody thinks will become bankrupt. But you've had very consistent returns over time.

We've had very good returns buying stuff that was very dubious in its financial merits, but so cheap that the odds were on our side. And and that's all about price, not quality assets exactly. Let's talk a little about one of your more recent chairman's memos and we'll we'll get into the chairman memos in a In a bit, you said something that kind of caught my eye and was

was sort of fascinating. You asked about computers. We were discussing computers, and you asked the following questions, Can they sit down with the CEO and figure out whether he's the next Steve Jobs or not? Can they listen to a bunch of venture capital pitches and know what's the next Amazon? So I thought that was really an intriguing question, but it made me stop and ask myself, well, people do that either? Also, I don't know how good humans

are at that process. Well, that's exactly the right question, Barry. Certainly not everybody can. Sure certainly the average person can't. There's a few percent at the top, the people with the most foresight who can figure those things out. They can be great investors. They should be paid a lot for their services. But the average person can't do those things. And the computer may be able to do a better job than the average person because it can digest a

lot of data. It doesn't make mistakes, you know. One of the themes of the book is that emotions are the investors enemy. Computers are not very emotional. So in many regards, I believe computers can probably do a better job than some very large percentage of investors, but just not as good as the best. And those folks who are the people who can peer into the future and spot the next Steve Jobs on the next Amazon, there

really outliers. We're talking about a teeny tiny percentage of investors, exactly. It's not it's not even the best of the average investors. You're talking about, you know, two and three standard deviations away from that normal Bell Bell curve. I don't want people listening to think, well, I could be one of the better. The average person is never going to be a starting player on an NBA team, and most people are not going to be those outlier who can spot

the future ten years before it happens. So if you think about it, what your listeners should spend their time doing is, in my opinion, is figure out how they should position themselves in the market. And and that really comes back to the cycle. You know, in this business, there are only really two things we do. We want to select the better securities and avoid the worst ones.

And we want to have more risk exposure when the time is appropriate and less when it's not that ladder thing that cycle positioning, and uh, you know that's the reason for the book. That's my main job at oak Tree is to figure out how we should be positioned in those regards. Uh. Most people can't figure out the next Amazon. You're right, they should they should uh bypassive products or hand off their capital to a professional manager

who can add value. But I do think that that you, the listener, should be figuring out where are we in the cycle, what does that imply for my behavior, and how do I want to be positioned visa v risk at this time. So let's talk a little bit about the institutional investor versus the individual. We know most mom and pop investors at home can't do the things that these outliers are capable of doing. Your office works with

a lot of institutions. What sort of challenges do institutional investors face that perhaps mom and pop don't or are they just human and suffer the same emotional consequences as anybody. Institutions don't make investments. People make investments for institutions, And you're right, those people have emotions too. Those people are bombarded with the same news that the mom and pop investor is. News is good, news is bad, Taxes up,

taxes down, this company beat, this company fell short. Uh, end of the world, you know, trees growing to the sky, whatever it is. Everybody gets those same inputs. Everybody has emotions. So it's not true. Now the the institutional investor may be better educated in finance, may have more experience, etcetera. But uh, it's just not that easy. In general, the professional has the advantage of doing these things full time. But guess what, the mom and pop investor has the

advantage that they can't get fired. The the institutional investor has to worry about getting fired. And that makes it hard to do the right thing at the extremes. You know, let's go back, Barry to the fourth quarter of oh eight. Lehman Brothers has gone bankrupt. That stock market is get skating down bond prices are collapsing, and you had to buy.

But maybe you say, you know what if I buy today and uh and the market goes down further, maybe I'll lose my job, so I can't do it, and and uh, personal concerns make it very hard even for the profession. You know, career risk is certainly presents all the time, exactly. So around that time, UM, I'm doing this off the top of my head. Somewhere in October, we saw the markets that fall about before they recovered in oh eight, you had already raised money from clients

for new distress bond funds. Tell us what you were doing during the fourth quarter of oh eight when really I was about as early in the cycle as as anyone could have um thrown a dart and got lucky with. Well, it really goes back to what I've been saying, which is to do the right thing visa VI the cycle, you have to kind of understand what's going on around you. You know, five oh six, we vastly reduce our risk because we felt that that implausible, undisciplined deals we're getting done,

and that shows that the market is undisciplined. So we cut our risk first day of eight of oh seven. Excuse me, we thought there was something coming. We went to our investors. We said we'd like to raise a fund for distress debt. We went out for the biggest amount of money we'd ever raised. We got much more than that because I guess we told the story well, our clients, you were looking for three billion dollars, raised something like seven or eight billions. He ended up at fourteen.

So we took We took the first three and a half. We put that in a fund. We said, okay, that's her active management today, we're gonna start investing that. But we took the other eleven and we said we're gonna put that on the shelf in a standby fund. We think there'll be a big opportunity. That's when we will

invest that money. So the first close was MARCHO seven. UH. We didn't start investing it and then only slowly until June eight, and we had a lot of cash, well money we could call uh when Lehman went under, and then we we concluded that that was the time to spend it. And from September fifteen O eight, which was the Leman bankruptcy, until the end of the year over those fifteen weeks, we invested over half a billion a week. That's amazing that, that's quite quite amazing. So during that period,

are you getting any sort of pushback from clients? Howard? What are you doing? It's crazy out there. Can't you just sit on your hands for a few months? And how do you deal with that sort of stuff? Well, I'm proud of my clients because I did not get the pushback. I think they credit us with with doing the right thing, and I think they were perhaps glad

to have us behaving in a countercyclical way. You know, so many people were afraid in that fourth quarter that may remember, and these were people who had brought into our story that there was an opportunity coming, had given us money for that occasion. They realized there would be a mistake to try to talk us out of spending. So so the point is, um, you know, the negative civity around us was so great that again it's all about recognizing what's going on in the environment where we

are in the cycle. Prices were down so much and there was no limit to people's negativism, no limit. I've never heard anybody quite phrase it that way. Well, I tell a story in the book about a pension fund. I went to see and I talked to the CEO, and every time I made a conservative assumption about what would happen to my bond portflio, the CEO said, well, but but what if it's worse than that? I said, Okay, well what if this happened? No, what if it's worse

than that? Okay that this could happen. No, what if it's worse than that? And there was no assumption I could make that would satisfy the c e O s fear, and I ran back to my office literally ran probably and I wrote a memo called the Limits to Negativism. I recall that very specifically, and what I said was a good investor, be it the mom and pop you talk about, be institutional investors. A good investor has to

be skeptical. You know, everybody sees the same story. The great investor has to be able to figure out the truth as opposed to the story. Skepticism is an important element in that we all know that that in times of high optimism, the key is to say no, that's too good to be true. People had said that they wouldn't have invested with made off for example, too good

to be true. But what I realized when I wrote that memo in at the low point for the credit markets of mid October oh eight was that if we're professionals and if we want to be great investors, we have to be skeptical. And in times of excessive pessimism, it's our job to say, no, that's too bad to be true. And that's the kind of thinking, uh cyclical inference that permitted us to invest aggressively when people were talking about the end of the world. We have been

speaking with Howard Marks of oak Tree Capital. If you enjoy this conversation, be sure and come back for the podcast extras. Will we continue discussing all things cyclical as well as distressed debt and other such things. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. You can check out my daily column on Bloomberg dot com. Follow me on Twitter at rit Halts. I'm Barry rid Halts. You're listening

to Masters in Business on Bloomberg Radio. Welcome to the podcast, Howard. Thank you so much for doing this. Um. I'm not sure if this is our second or third time around, but every time I sit and have a conversation with you, my email lights up, and people are always so intrigued and fascinated, um by your philosophy. I wanted to spend a little time talking about the arc of your career and some of the really interesting things that you've seen and done and written and all that has to start

with memos to clients. But I've been calling them chairman's memos for a long time. And the last time you hear you told me something that I found absolutely fascinating. When you began doing these, you were literally this wasn't just an email or web thing. You were literally printing them out and mailing them to various people. When did the chairman's mamos two clients begin? They started a n okay so kind of pre email, pre website. We carved

him in and stop and stones in the cave. But you know, I I observed a couple of facts, the juxtaposition of which I thought really told a great story. I talked about the importance of consistency and investing in

risk control. And uh so I wrote it out and I folded it up, and I put it in envelopes and put stamps on and we sent it out to our our clients, and I did one in nineteen nine, and I did one in And you know, I don't remember, ever, uh, making a conscious decision to to make this a regular thing. I never remember saying that I thought it would result in a advantage business wise. I just thought there were interesting observations that I wanted to share with my clients.

And they, you know, they went out a few hundred of them at a time. And what was the feedback when you sent the first one out? For ten years, Barry, I never had a response, crickets, just nothing. Not only did nobody say they thought it was good, nobody said I got it. That's amazing. And and and so the interesting question is what kept me going? And I have no idea. And the answer I think is that I was writing for myself. You know. Number one, it's creative.

I enjoyed the writing process. Number Two, I thought that two topics are interesting and that I wanted to put them on paper. Number Three, writing makes you tighten up your thinking. That's Daniel Boston's famous quote. I right to figure out what I what I think. And besides, at that hour, the bars are all closed, is what the librarian of Congress once said, but I'm you know, we

live in an era where it's immediate feedback. You post a tweet or something to Instagram, immediate likes, immediate up votes. It's just you know that that feedback loop is designed to give you that dopamine hit. It's amazing that you spent a full decade sending these out and not a peep from anybody. So what was the one that that changed it? But you look like you're about to say so. On the first day of two thousand, I put out a memo that I've been working on called bubble dot Com.

I recall that also that was a huge balance story. That's right and it not. It had two advantages. Number one, it was right, and number two, it was right fast, because in our business, being too far ahead of your time is indistinguishable from being wrong. Here, you know, I I raised some questions about the text docs, and within two months, a few months, it was January two thousand. By the first or second week in March, it was all over. But the crime they kind of turned over

and collapsed. And the way I put it is, after ten years I became an overnight success. And and you know, and and there was a lot of response to that memo. Of course, by that time we did have email and internet, things did go viral. You know. Then I had the opposite experience of the first decade. Then I had the experience of, you know, I'd put out a memo on a Tuesday morning and Tuesday afternoon, Uh, one of my friends would call. Obviously some guy in Russia just sent

me this. It's terrific, you know, so so Uh, you know it's been it's been really great. Uh, they're they're well over a hundred memos now, all available by the way at www dot oak Tree Capitol dot com under the heading Insights and uh the price is right there free and uh and uh, you know I take I take great pride and have great fun with it. Well, I know, in my office, whenever a new memo comes out,

everybody starts talking about it. It becomes um, lunchtime conversation, or or people will print it out reading on the way home or what have you. Um. I hope you continue to do these for the uh long term, because I've personally found them to be very educational and very thought provoking. Let's talk a little bit about one other thing before I get to the other questions that I missed. You describe the importance of cycles in the new book. Uh. Knowing where you are in the cycle is so crucial

for your investment posture. How do you figure out where you are in that cycle? I describe a process that I call taking the temperature of the market. And there's the quantitative, which is looking at you know, for for every investment, there is a valuation parameter. For stocks, it's pe ratio. For bonds, it's the yield and the yield spread over other bonds. For real estate, it's what we call the capitalization rate the income uh. For for companies,

it's the profitability. There are all these indices, and so we can figure out quantitatively what's going on or ares things expensive or cheap relative to the past. But the other thing is qualitative, And and what I look at is how are people behaviorally? Are they excited or depressed? Are they greedy or fearful? Are they optimistic or pessimistic?

Um are they risk uh tolerant or risk averse? And you know, UH, if I if I looked at a stock or an investment, and if I could only ask one question, Barry, it would be how much optimism is in the price. We want to buy things where the price falls short of the real value, that's called the bargain. And we get that when people are not optimistic about that stock or company. If the if, if everybody thinks it's terrific, could never stumble like the nifty fifty or

fifty years ago. Uh, then the optimism is high. The chances are that the price is high relative to the value. So we want to take the temperature to understand where we are in the cycle. And I always say that if I go to a cocktail party and people gather around, I know the markets too high. Some someone else described that as conversational alpha. When people start start chit channing at barbecues and cocktail parties. Hey, that's a that's a

sign that we're getting close to the top. Um, how do you identify that when you're talking about individual stocks? Are you thinking about this in terms of the whole market, because there's always stocks that seem to become unhinged and take off. Look at what happened with bitcoin from practically nothing to nineteen thousand. What does that tell us about? Uh, the sentiment that's out there. Well, you know, most of my references are to the market. That's why the book

title references the market cycle. Uh. I imagine similar thinking can be applied to individual investments, individual stocks, and as you say, even individual currencies. Uh. But you know the same thing is true when you consider making an investment, whether you're operating at the market level or the individual

security level. Hard to figure out. Has this stock or bond been the beneficiary of a buying frenzy, in which case you probably want to avoid, or it has been disrespected and downtrodden, in which case it may be worth a good look. And one of the things they didn't get to before was your time at Trust Company of the West. You worked with a gentleman named Jeff Gunlock, who very famously left and launched Double Line with UH yours and oak Tree's help. I believe at one point

in time Outrey was a owner. Is that still the case? We are still owner? And and that was one of the fastest growing funds from zero to a hundred billion, like almost like that. Yes, I think it probably took it felt like a snap of the fingers. It might have taken five years. But as you say, probably for an investment management firm. The fastest zero to a hundred in history. And you know Jeff as a contrarian. Jeff, Jeff marches to his own drummer, does a very good

job of managing money. And it's been a great investment for us. And that's owned by oak Tree. So you biotry, you get um, you get Howard Marks, and you get a little bit of a hedge with Jeff Gunlock as UH slug exactly. Huh quite quite interesting. What what was it like when you were working with Jeff at Trust Company and of the West And how did you know he was gonna end up being as successful as he

turned out to be? Or the my last year at TCW, UH around February, interest rates rose the fastest they had ever risen in history. And Uh, Jeff was probably seven years of experience at that point in time. His portfolios ran into some problems. UH, and Jeff and I began to work together at that point. Formally, UH I was asked to UH to let him report to me together. We we we verified the values in the portfolios and importantly we were able to convince the clients to stay

with it. You know, the cardinal sinuh in investing is not buying something closed down. The cardinal sin is selling out at the bottom and not participating in the recovery. And we were able to enable Jeff's clients to participate in a great recovery. Uh. It was obvious that he was super smart. And uh so when when Jeff left t C W in uh you oh nine, Uh you know, we were very glad to to join forces. So what else are you looking at these days that has you worried?

I know you said evaluate that valuations are pretty stocks and bonds are both pretty fully valued on the verge of richness. What else is the potential move forward with caution type of a factor? Well, is unloved today? That's a question. Hardly anything except maybe emerging markets for sure. Okay, maybe China, Uh you know now, Turkey, Argentina, these are pretty terrifying. Uh, but Russia for that matter. But they are unloved, which means you maybe you should start looking there.

I'm not saying bye, but but investigate. Uh. But you know the truth of the matter is that, as you say, there's very little today on the bargain counter. And if you're criterion for investing is that you want bargains for the most part, they're not there. You're a decade too late.

Exactly now now, Warren Buffett talks about one of the great things about investing is that you know, you can stand at the plate with the bat on your shoulder, and in investing you can't get called out on strikes, so you can you can wait until you get a fat pitch. And today it's very challenging because there are a few fat pitches. At the same time, those of us with money, be at my institutional clients, be at the individual investor with money, the money has to go someplace.

You want to get a a credible return, You want to control your risk. And you know, in theory, one could figure out when the markets at are real high and sell. You could figure out when the market's terribly depressed and buy. And these things are exciting and they're extremely rewarding. But much of the time the market is somewhere in between. And what do you do in those times not so obvious, but you know, uh, figuring it out is key. Standing with the bat on your shoulders

maybe key. Reducing your risk in the ways we discussed before. These are the keys, but again they all start with figuring out where we stand. That's behind the concept move forward but with caution. That's been our mantra for for a couple of years now. And uh, you know, when you when you apply caution, you don't get the full return of the market when it soars, but you also stay in the game. It makes sense. Let's talk about another chairman's memo. I really liked the title what does

the Market Know? Tell us a little bit about the thinking behind that in the market got off to its worst start in history, and I wrote a memo called on the Couch, and I talked about the fact that sometimes the market is nutty and needs a trip to the shrink. And you know, because sometimes the market obsesses about the positives and ignores the negatives and that's dangerous. And sometimes it ignores the positive and obsesses about the

negatives and that's the time to move. And that market was collapsing and I didn't see any reason for it. So I talked about the the the non fit between reality and market behavior. I came into Bloomberg TV, as I often do when I write the memos to talk about it, and the anchors were saying to me, well, uh, doesn't the fact that the market is going down is not a cell signal. Again, I ran back to the office to write a memo called what does the market? No,

there is no market. There's only a bunch of people, and their decisions are not better than they're The collective decision of the people in the market are not better than the decisions of the individuals, and they are riven with psychology and they are everything in our bodies is directed at making us do the wrong thing. And one of the one of my major themes is how to figure that out and resist it. But you know, you don't want to buy at the top when things are great.

You don't want to sell at the bottom when things are terrible. And uh so, uh if the market is down, you can't take that as a cell single. All it tells you is that people have lost faith. But if they've lost faith, maybe that's a buy opportunity. So you you must not let the market give you your signals. Your your investing has to come from place of of an analysis and not emotion. So in other words, the market just doesn't go straight up or straight down if

you have a bad January. So what it's one month? Is that the thinking, Well, that's that's for sure. I mean the thinking, Barry, is that the fact that things have gone down is not a cell single. I mean, look at the stores. When they put stuff on sale, people buy more. In the investment business, when they put stuff on sale, people sell when they should be buying. And uh, you know, in order to be an effective investor, one of the themes in the book says you have

to develop kind of a contrarian way of thinking. If I said to you, you know, Barry, uh, you should buy this because nobody else is willing to. Well, nine people out of ten probably would say, well, if everybody else is selling, then it's probably not a good thing to buy something. But that one person out of tend says, well, if nine people out attend a selling, uh, it must be cheap. I'm going to be a buyer. That's a contrarian. And uh, you know that's the opposite of letting the

market tell you what to do. And believe me, in the long run, it pays off better, even though it's more difficult and more emotionally uncomfortable and more challenging and filling the blank all of that. And you know, uh, I never in my books or any place else, I never want to give people the impression that this is easy. If it was easy, everyone would be wealthy. But uh, but it can be done. That's the point. If you can, if if you can learn the lessons, you can learn

to do this thinking. You can learn to assess what's going on in the market, where is in a cycle? What should I do? And uh, you know that was my purpose in writing. That's what I hoped to do with the book. So let me get to my last couple of questions before I jump to my list of favorites. We haven't discussed very much about the FED or the possibility of an inverted yield curve. We watched that spread

narrow and tighten, but hasn't quite inverted yet. Let's talk about the cycle with the Federal Reserve, which you reference also in Mastering the market cycle. Where is the FED relative to what's going on? Are they behind the curve or they just are they ahead of the curve? What? What do you think about the U s Central Bank and what they've been doing. We've gone through a unique period, the significance of which is hard to discern. In O eight oh nine, we had the worst crisis since the

Great Crash of twenty nine and the following depression. As a result, the FED engaged in the greatest program of stimulus that it ever has. It took interest rates to the lowest level they've ever been. By the way, you mentioned that earlier, and I wanted to tell you. I had Richard sillah In who runs the Museum of Financial History. He said, literally, this is the lowest interest rates since the Babylonians, since the Romans, since the Macedonians, the lowest

in human history. I wonder if the Macedonian bank state and business. But so anyway, the point is, we had a terrible financial crisis, we had an ultra strong period of program of stimulus and quantitative easy we had and usually low interest rates, and now we've had a long economic recovery, a long bowl market. Now the Fed, as we said before, is raising rates. It's done at eight times already, they're up to two plus and they're probably gonna go on another half a dozen times and get

them into the into the threes. I don't know if they'll get the FED funds rate up to four. But the point is that, uh, this has never been done before on this scale and this duration, and we cannot say for sure what the outcome will be. You know, if you if something is going on that has never been seen before, you certainly can't say that you know how the movie's gonna end. And so uh you know, Uh, can they overshoot? Can they raise rates so high that

that the that it results in a recession? Uh? What is the result of the withdrawal so much liquidity from our economy? Uh? Nobody can say they know for sure. And I think that uncertainty over what the FED will do and more importantly, what the consequences will be is one of the great unknowns out there today, one of the great unknowns. So so let's talk a little bit

about um for a while. We went about the yield curve for while people were really obsessing about what the tightening spread ment is the yield curve and always accurate forecaster of recession or given that this time is a case of first impression, I'm not saying this time is different. But since we've never experienced this before, Uh, what are we to make about the fears of the inverted yield curve? I'm not sure that's my profound answer. That is a

profound answer. Look, because I can't tell you how many people would give me a long winded answer full of confidence in bravado and basically I like your answer better. You know, Mark Twain said, is not what you don't know that gets you into trouble. It's what you know for certain that just ain't true. The best thing you can do in investing and in many walks of life is when you don't know, admitted you know. How many people are there out there whoever say you know what?

I don't know? So everybody says that the that the yield spread between long and short interest rates has a significance. It has been observed that that that when the short rate is higher than the long rate, UM, it has always been followed by a recession, sometimes a few months later, sometimes a year or two later, but eventually. So the real question is is it coincidental or is it causal? And if it's causal, what is the linkage? And it does it work every time? UM? I don't know. I

don't manage. I don't care that much about rates. I don't I'm not a so called fed watcher. I don't you know. One of the uh one of the six tenets of oak Tree's investment philosophy is that our investment decisions are not governed by this kind of macro UH forecasting. We don't believe in forecasting, Barry. You know, I'm always want to say, we may not know where we're going, but we sure as hell or don't know where we are. And UH, that's that's what I know. So that that's

a pretty savvy observation. I wish more investors would would recognize that the making forecasts and then sticking to them despite the evidence that they're not coming to pass is a problem that investors have. UM. I actually love to tell television anchors they ask, where's it down gonna be next year? Say I don't know, and just watch the

try and process it. Their their heads explode. So so, given that we were not paying close attention to the FED, we don't really care a whole lot um or try and predict if and when a yield curve is going to invert on the inflation side and on the yield side. What's the most important factors to look at for that longer term cycle? What do we know rates are lower than usual? Current level of rates is not consistent with economic prosperity. UH. Usually in prosperity, we have higher rates.

The current level of inflation is unusually low. Usually when we have such a low unemployment rate and such economic growth, we start to get higher inflation. We're not getting it. So, uh, we don't know for sure. You know. One of the things people have to understand is that umnomics is not a science. There is no schematic diagram which says how things work. There are no rules that work all the time. You know, if you if you have an apple in your hand, as Newton said, and you drop it, it's

gonna fall down. It never falls up. In the sciences, things work the same every time. But and if you come in this room and you turn on the lights, which the lights go on every time. But in investing that's not true. Sometimes it happens, and B happens. Sometimes it happens and B doesn't happen. Sometimes it happens, and see happens. Uh, you know. Uh. Richard Feyneman, the great physicist, said that physics would be much harder if electrons had feelings.

The point is that investing and the markets are dominated by humans. Humans have feelings, so they don't always do what they're supposed to do. That's really the purpose of the book. That's one of the main themes. And uh, you know nobody can tell you answers on these questions which are dependable enough to be investable. That that seems pretty reasonable. I know, I only have you for a finite amount of time. Let's get to some of my

favorite questions. Tell us one thing that people who know you don't know about, Howard marks well, I think most people would say that I'm quantitative and financial and analytical, but I really think I have a creative side, and I think that the memos are an expression of the creative side. And in the memos in the book, in in in my work with clients, I do a lot of graphical presentations which I draw by hand, and uh,

I think that's an expression of my creative side. Interesting, So what investors influenced your approach to thinking about value and distressed assets and everything else that Oatry does well. A great example is John Kenneth Calbraith. He wrote a book called Short History of Financial Euphoria, which really was probably my first introduction to discussion of cycles and also

to an understanding of the need for contrarianism. So that was terrific Charlie Ellis, who's real great investment thinker board as well told the story about the an amateur tennis player if if the game is not within your control, then the win. Then you win a tennis not by hitting winners, but by avoiding losers. And I think I've spent a lot of my career trying to avoid losers. Um and uh, Peter Bernstein was a great stage and uh, you know, he's written a great deal about risk, which

which I tried to incorporate into my own thinking. So these are some examples. Bernstein's book, The Story of Risk is really every page is so rich, it's it's astonishing. Speaking of books, tell us about some of your favorite books. What what are you reading? What do you like? What are you fiction? Nonfiction? Finance? What have you I read more on finance, and I tried to read a lot on the behavioral side. So a terrific book which I got a lot out of, which has very important ideas,

is fooled by randomness to love exactly. And you know, people see the past and they think that the past expresses a fundamental truth, but in actuality there were many different histories which could have come to pass and only one did. That's a great way to think about the world, because that's really the right way to think about investment risk.

So you want to avoid hindsight bias, and you want to avoid thinking that each outcome is the only outcome of Elroy Dimpson, who retired from the London Business School, said that UH risk means more things can happen than will happen. Right, So you know, I think I think we we do better thinking about the future if we realized that a lot of different possibilities are out there. And one of the ways to come to that conclusion is by realizing that in the past there were a

lot of possibilities, only one of which transpired. And one has to be careful not to draw a conclusion based on what may have turned out to be a random outcome and to to something for I always talked about the difference between Alexander the Great and George the Unlucky, Right, it was that it was the name at birth. Is that what what doomed Georgia Unlucky could have been? Um?

So you mentioned Peter Bernstein and any other books that you want to uh make refere So pretty much everything he's ever written is well he wrote a book called Against the Gods, which talked about the beginnings of UH the science of probability, and if you think about it, it's only by appreciating probabilities that we can deal rigorous rely with risk. UH. The whole creation of the insurance industry, for example, is based on UH an understanding of the

science of probability. I love that book. I thought that was just absolutely fascinating. UM. So you mentioned Charlie Ellis and tennis. I know you're a bit of a tennis fan. What do you What do you do when you're not in the office. What do you do for fun? Well, I spend a lot of time with my kids now

my grandkids. UM. And you know, my wife and I moved from California to New York at the beginning of because our kids came here after college and put down roots and we can who they're not going back to California. So we've been here. We love it here, but it's it's all it's all family centric, great friends, you know, UH, California and London, and then again since we moved here, we've made fabulous friends here in New York. It's it's such an interesting city. UH. And then you know, to

pass the time. I love to play games. I love to play gin. I love to play backgammon. Backgammon, by the way, is a great exercise for anybody who wants to be an investor, because it's all about probabilities and getting the odds on your side. You you know, no matter what the layout of the board is, there's a move which will optimize your chance of having success. It may be improbable. You may be able to pick something else which has a higher probability, but it will not

be so optimal. That's life and that's investing. Quite quite interesting. Tell us about a time you failed and what you learned from the experience. Well, good one, Barry. Um. I don't think it's necessarily failure. But one of the most important things is that we each should understand ourselves and assess ourselves. And I am a conservative person. Uh slow plotting, UH mistake, cautious mistake averse. So for example, uh you know, uh, I was the last of my group of my peers

to leave City Bank. They all left. I said, well, what's wrong with me? Why am I hanging around? But I think I I ended up with a very very sound foundation for my investing, and when I left it was it was for a good opportunity at t c W. It worked out well, so, uh, you know, it follows through into other areas of my life. I'm a cautious investor. If if, if if in nineteen seventy eight, City Bank would have said to me, we want you to start a venture capital fund, I think that would have been

a disaster. I'm not a seer. I'm not a dreamer or a futurist. But instead they said we want you to start a heel bond fund. All I had to do was figure out which ones wouldn't be able to pay and exclude them from my portfolio, and that I could do my my my conservatism of caution paid off. So I have to push back on your claim that you are an inherently cautious person, because as I've prepped for this and gone over your whole career, I see measured risk, but I see a lot of embracing of

risk taking. A lot of people would have been presented with, hey, there are these new fangled distress bonds. See what we can do set up a distress bond funds. When when Gunlock left Trust Company of the West, Hey, this guy seems to be a budding superstar. There's a lot of risk in in launching a new fund, but we want to get behind that. And obviously the oh seven oh eight, Hey, let's embrace distressed assets because the market is in free fall. I see you not as someone who's risk averse, but

rather as someone who makes intelligent risk based decisions. So I want to push back a little. Okay, I think I think you got me on that. Uh, you know, I think I think that that the key is intelligent bearing of risk, not because it's fun, not because you're not not out of the spirit that a lot of people say. Well, you know in Vegas they say the more you bet, the more you win when you win. That's not a good spirit for risking. But intelligent risk bearing makes a lot of sense. And by the way,

risk control, not risk avoidance. So in the early eighties, one of the first cable uh TV networks interviewed me about my work with the hi Eel bonds and they said, how can you invest in hiel bonds when you know some them are going to go bankrupt? And I said, well, how can life insurance companies ensure people when they know they're all going to die and and and the answer is it's intelligent risk bearing. So so a cop to that.

But I do think that it that it is my caution that makes me insist on intelligence in risk bearing. And let's talk a little about the state of the industry today. What do you think is um in the midst of changing what what? What do you think is worth thinking about? As being a person who's been within the finance industry for fifty years, rewind this podcast thirty or forty five minutes, and we were talking about the fact that it's really only the exceptional few who can

add value by making active decisions. And for many years that realization did not dawn. So all money was run what we now call actively. There were no index funds, there were no passive products. They all had high fees and not all of them earned those days right. And it was really that combination, I think you'll agree, that led to the dawning of the age of passive products. And now anybody who wants to invest has the option of doing it passively or in an index vehicle at

a very low fee. And I know you're a believer in that. I certainly think a chunk of people's portfolio, not necessarily all of it, but some exactly. And so now we're in a new era where you're more likely to get what you pay for. So you know, uh, exceptional people can still make an exceptional contribution and be very well paid. But you know, this isn't like Woe Begone where everybody's above average, and and nowadays not everybody gets paid as if they are above average. So I

think that's been a big change. Uh. Now they say that something like three eighths of all mutual and equity capital is now run passively, that's what they said, and certainly not and uh, what that means is that there are fewer people looking for bargains every day, because by definition, a passive vehicle doesn't look for bargains. They just emulate.

And if if it goes, if that trend goes far enough, maybe some inefficiencies what we call them, some bargains will come back into the marketplace, maybe active management will begin to pay off better. Are you suggesting it's cyclical between passive and active? Well said, And um, let's talk about about millennials in recent college grads. If someone came to you and said they were debating, uh, thinking about having a career in finance, What sort of advice would you

give them? I think the most important thing is to figure out what what you're good at and what's good for you. My favorite quote is from Christopher Morley, the English writer, who said there's only one success, and that's to be able to live your life your own way. Figure out your way, pursue it, take it on, stick to it, keep your head down, work hard, even if it's the right thing for you. Don't assume that every

day is going to be fun. You know, the millennials are used to constant stimulus and frequent rewards, and if they don't get them, they move on. But I think that that being steadfast at something, sticking with it, getting good at it, and uh rising to the top is a good idea. Do what you love, uh, don't expect to love it every day. UM. And you know, my

ultimate advice is we only get one life. Optimize that life, and we probably, other than sleeping, we spent well, maybe including sleeping, we spend more time on work than anything else. If you look at it that way, isn't it a mistake to just do what pays the most? If you have the luxury of being able to choose between careers and still support yourself and your family. Don't just take what pays the most. Take the thing that is good

for you that you'll enjoy. Maybe that's good for society, that will give you a quality of life, but you know, not dominate your life. I think, uh, you know, investment has done it for me, but it it's certainly isn't the right thing for everybody. And our final question, tell us something you know today that you wish you knew fifty years ago. When you began fifty years ago, forty years ago, the world felt like a steady, steady place where the environment was stable and events played out in

front of that backdrop. And now the world changes every day, and now we can't imagine how fast it changes. If I had known fifty years ago what the world would be doing today, maybe I would have gravitated towards technology investing instead. Or maybe not because it didn't fit with my personality. But clearly, uh you know, the people who are who have optimized their benefits from this change in the environment, Uh, you know, have have been extremely well situated.

Um you know, could it have been me? I don't know, but clearly that's the most profound change in my lifetime. And uh, you know, the world changes so fast, by the way, you know, Barry, I was thinking about this the other day. Go back long enough, and the number one company was probably twice as big as the number two company and made three times as much money. And now the number one company maybe a hundred times as big as the number two company and made two hundred

times and much money because of these technological advantages. The payoffs are enormous. And uh that that's a big change in my lifetime, quite quite fascinating. We have been speaking with Howard Marks, co chairman and co founder of oak

Tree Capital Management. If you enjoyed this conversation, we'll be sure and looked up an Inch or down an inch on Apple iTunes, Bloomberg dot com, Stitcher, or overcast wherever final podcasts are sold, and you can see any of the other two hundred plus conversations we've recorded over the past four plus years. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg

dot net. I would be remiss if I did not thank our crack staff who helps put these podcasts together. Each week. Medina Parwana is my producer, Taylor Riggs is our booker. Attica val Bron is our project manager and coordinator. Michael Batnick is my head of research. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio