Oaktree Capital Management co-founder Howard Marks joins The Final Round to discuss the impact of the coronavirus outbreak on financial markets.
JEN ROGERS: And joining us on the phone, billionaire investor, Howard Marks. He's the co-founder and co-chairman of Oaktree Capital Management. So, Howard, I want to start big picture here with where you think we are right now. Where we find ourselves in America in terms of the economy and the labor market and the stock market. Do you have a sense that there is opportunity right now here?
HOWARD MARKS: Well, where we are in terms of the things you mentioned, obviously-- first of all, I don't make forecasts. I only regurgitate other people's forecasts. Jobless claims were 211,000 two weeks ago. 281,000 last week for a major increase. At least one brokerage firm is saying 2 and 1/2 million for next week. So, obviously, we're heading into an enormous unemployment challenge.
The economy, likewise, most forecasters are saying that GDP will decline by 15%, 20%, 25% in the second quarter, which I imagine would be the worst quarter in history. So, these things are not going well at the present time. Obviously, there's a lot of optimism around the Fed's actions. And certainly the Fed and the government are throwing everything at this financially that they can. And I don't believe that anything is off the table.
Where we would go, how fast will it trickle down, how fast will it work. These are the questions. Millions of small businesses have had to close, now, for a couple of weeks. They'll probably be closed for another couple of weeks. People will lose their jobs in the millions. And how fast will the economy come back? These are all economic questions.
On top of that, we have the challenge of the coronavirus disease itself, and we shouldn't lose track of the fact that that's the problem. And, you know, I don't think you can buy the virus off. So, the point is, the economy will stay closed for some period of time. Exactly how long? We don't know. But if it's brought-- if we attempt to bring it back too fast, I believe we'll have an echo. A rebound in cases.
The US has not taken the draconian actions that Singapore, Korea, China, and maybe Italy have taken. You know, people are still socializing. I still shudder at those pictures of college kids on the beach. What happens when they go home from the beach to their home communities, where, until now, there haven't been outbreaks?
So, you know, I think the outlook for the economy is weak. The outlook for the disease is bad. On the other hand, there's good value in the markets. I liked them before they went up 9% today more than I do now. But there is good value. And, you know, I put out a memo Thursday saying, that there's no argument for spending all your money now. But, in my opinion, there's also no argument for not spending any.
MYLES UDLAND: You know, Howard, you've written a lot about cycles and the shape that they take over time, and, you know, you mentioned that you don't make forecasts. You just regurgitate what others make. But you rattled off some of those GDP numbers, and those were revised 3, 4, 5 times by some strategists just in the span of a week. When you see people on the street, people in this business scrambling to throw bigger and broader numbers out there to get a sense of what might happen, does that say anything to you about what part, psychologically, of this cycle Wall Street might be in?
HOWARD MARKS: Well, look, first of all, as you probably know I put out a memo a couple of weeks ago, and the title was "Nobody Knows." So, nobody knows what's going to happen with the disease or, I don't think, what's going to happen with the economy. And if anybody has a strong position, they should get in touch with me because I'll bet them they're wrong. Whatever it is.
There's just no justification for having a confident view at the present time, in my opinion. Wall Street takes it as its job to fill the void with forecasts or information. I was talking to one of the major investment houses last week, and, at that time, they had cut their earnings estimate for the S&P 500 for the year from 173 to 158, which was a decline of about 15%. And, when I next caught up with them, their estimate was 115%. So, the question in my mind is, do these estimates do any good?
On the one hand, people like to have information. But what good is it to have information if it's probability of being correct is low, as, in my opinion, it usually is. The point is, nobody knows. You can decide to be optimistic today. You can decide to be pessimistic. I don't think you should rely on so-called data, because there is no data with regards to the future.
In the face of uncertainty, my approach is to hedge my bets. Not to go all in or stay all out. Even now.
- Can we talk about that a little bit more, I guess? I mean, you are known as managing risk. And that's what everyone's trying to figure out right now is to-- how to manage risk, given all the unknowns that are out there that you're talking about right now. Does that mean just keeping your powder dry? Does it mean trying to find some of the values that exist today? How do you manage risk in this environment?
HOWARD MARKS: I think that your question is indicative of the challenge. When most people say manage risk, what they mean is, avoid the potential for loss. But there's another risk, which is the risk of missing out on gains. Let's say that you and I are talking, and we say, well, there's a 60% probability that the market will be down three weeks from now. Let's say you and I agree. So the question number one is, what do we do in our portfolios about the 60% probability of a decline?
But we mustn't lose track of the fact that we also should deal explicitly with the 40% probability that it's up. And what do you do about that? So, you know, if you say to somebody, there's a 60% probability of a decline, it's easy to say, well, then you should get out of the market. But what do you do about the 40% probability that it goes up? And, if you're out of the market and that's what happens, then you really will have missed out on something and will regret it.
So, you know, I prefer to think of risk as the probability of having undesirable outcomes. Not just losses, but also gains that you miss out on. And you have to balance the two.
I think that the fundamental outlook, as I said, for the disease and for the economy is poor, but, on the other hand, stocks are on sale relative to where they were a month ago. I think that those sale prices cover a lot of the carnage. So, as I said before, I don't think there's a good case for investing all your cash today, but I also don't think there's a good case for not investing any.
MYLES UDLAND: Howard, I want to ask you about what you called some illogicalities in your letter a couple of weeks back. One of them was the-- not specifically-- I mean, you made the mention that some people compared this to 9/11, and you mentioned that that's a one day event--
HOWARD MARKS: Can you hold on one second please?
JEN ROGERS: Hey, Myles. I'm still here.
MYLES UDLAND: Hello. Yeah, I mean, I think challenging time and, you know, interesting comments so far from Howard. We'll see if we get him back here.
JEN ROGERS: Yeah, I mean the idea of keeping some powder dry I think resonates a lot of peopl--
HOWARD MARKS: I'm sorry to have jumped away.
MYLES UDLAND: Oh, no worries, Howard. I just wanted to ask you about the comparisons from this moment to any prior points in your career. I think a lot of people in the investing world right now are really struggling to find any decent analogs to the past. One that you mentioned in your letter that didn't make much sense to you was 9/11. That hasn't really been mentioned quite as often, but it certainly was, in the beginning of this phase, something people compared it to. Are any pockets of this market that you're looking at reminding you of anything from the past? Or are we just across the board in uncharted waters here?
HOWARD MARKS: Well, I do think that it has a lot of similarities to the global financial crisis. Because that was a sweeping crisis. It began in the financial markets, and the biggest culprit was leverage. There was chaos. There were major markdowns across most asset classes. Of course, it started with subprime mortgages and their defaults, but it spread rapidly.
And when assets are marked down rapidly in price, anybody who owns them, either on margin, that is, using leverage, or more than they should be holding, let's say, intestinally-- more than they have the intestinal fortitude to hold in tough times-- anybody Who's holding assets in either of those circumstances may be forced to sell. And then declines produce sales. Sales produce further declines. So you have a downward spiral.
And we had a bunch of that in the global financial crisis. It turned out to be a crisis of leverage and liquidity. This one is as well, although not to the same extent. The good news. You know, but there are also differences. That was a financial crisis. This starts off as a health crisis. At that time, our lives were not in danger, as they are now. That's one.
Number two. That time, the banks were levered 33 times their equity, 32 times their equity. And so, you know, there were rumors of bank meltdowns. And, of course, even some real cases. This time they're levered one third of that. So nobody's talking about problems at the banks themselves.
So, differences, but similarities. I think it's a relevant comparison. But let's remember what Mark Twain said, "History doesn't repeat. Although, it rhymes."
JEN ROGERS: So, we've got a little bit of rhyming going on, and, of course, there are the liquidity issues that you mentioned. What about the solvency concerns? As somebody who has a lot of experience in distressed assets, what do you think we're going to be seeing here in the next few months?
HOWARD MARKS: Well, part of it depends on how fast they bring the economy back. And part of it depends on how broadly they distribute these, let's say, bailout programs. But if they can't bring the economy back, let's say, you know, I've seen a lot of forecasts that had the economy up in the third quarter. I think that's very optimistic. And if the economy goes six months from now in negative territory and starts off down, let's say, 15% to 20% in the second quarter, then I think you're going to have a lot of defaults.
Now, on the one hand, most debts today don't have covenants. Which means you can't be forced into default because you have too little net worth or too little cash or what have you. The only way in this climate-- the main way in this climate to have a default on outstanding debt is to not be able to pay interest or principal. So that's good news. That means fewer defaults.
On the other hand, in the last five years, lending standards have been low. And companies that shouldn't have gotten loans have gotten loans. And when your business goes to zero, a bunch of those will default on their interest payments. So I think we'll have substantial defaults in the next year.
JEN ROGERS: Howard Marks, so great to talk with you. Oaktree Capital. I wish it were under different circumstances, but getting your thoughts on a day like this, we really appreciate it.
HOWARD MARKS: I'll come back to discuss the good news in the future.
JEN ROGERS: Fantastic.
HOWARD MARKS: Thank you.
JEN ROGERS: I'll hold you to it. Hopefully, it'll be sooner rather than later.
HOWARD MARKS: Good. OK, bye bye.
JEN ROGERS: Again, Howard Marks with Oaktree Capital.
