Investing in Today’s Uncertainty

In Recovery: Long Way to Go the possibility of a longer than expected economic recovery is discussed. How should that possibility be considered and how does it impact the tenets of value investing?

Exploring the approaches used by the best in the business is a good place to start. Hedge funds often consider their investments confidential and their methods and evaluations trade secrets. Value investors have a huge advantage because some of the most successful value investors in the world graciously share how they do it.

One of the masters willing to share his wisdom is Howard Marks, chairman of Oaktree Capital Management LP. Oaktree is the biggest distressed debt investor in the world overseeing more than $80 billion for pensions and the world’s largest sovereign wealth funds. Bloomberg reports Oaktree’s seventeen distressed debt funds have averaged annual gains of 19 percent for the past 22 years; about 7 percentage points better than its peers.

He is widely known for the Oaktree memos that detail investment strategies, insights, markets and economics. These insights have earned Oaktree a strong following of value investors. Howard Marks published an excellent book “The Most Important Thing: Uncommon Sense for the Thoughtful Investor” In 2011. Warren Buffett, called the book a “…rarity in its usefulness. When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.”

In a recent memo to Oaktree clients entitled, “On Uncertain Ground” he shared his views on this investing climate. You are encouraged to read the memo in its entirety as the summary below cannot do his well written thoughts appropriate justice.

He opens with: The world seems more uncertain today than at any other time in my life. That’s a simple sentence but one with significant implications. And it’s not just me.

On the macroeconomic picture: It’s my belief that we’re going to see relatively sluggish economic growth in the U.S. for a prolonged period of time. My expectations for other developed nations, given their specific issues, are even less positive.

Explaining the excessive use of debt: Over years consumers grew spending faster than incomes due to availability of credit. Capital markets facilitated deficit spending on the part of governments. The world spent money they didn’t have to buy things they couldn’t afford. Few recognized the negative implications:

  1. increased leverage,
  2. increased dependency on the capital markets
  3. increased precariousness  

In other words, unwise behavior in the short run led directly to problems in the long run. This is a normal aspect of the economic process.

The other specific element that gives me pause relates to confidence. Psychology plays a huge role – perhaps a dominant and self-fulfilling one – in influencing economic growth. In short, if people think things will be good in the future, they’ll spend and invest, and things will be good. But if they turn pessimistic regarding the future and go into their shells, refusing to spend and invest, growth will slow down. Consumers were traumatized…it could require significant healing before these influences abate.

It’s easy to view problems like these as insoluble and part of a self-feeding vicious circle. When people who are overly indebted reduce their spending, their collective action weakens the economy. The weak economy discourages businesses from hiring and expanding, and thus it stays weak. It’s essential, however, to remember that it can be just as wrong to see things as hopeless as it is to consider an environment risk-free. One mustn’t overreact in either direction.

Potential economic pluses do exist, and they tend to be overlooked in downcast periods like today. These include the incipient housing recovery; the possibility of energy self-sufficiency; the fact that U.S. manufacturing has slimmed down and our Chinese competitors have seen costs rise; and the fact that the U.S. still leads in higher education, creativity and entrepreneurship.

Summarizing where things are: For me, the bottom line of all this is that we aren’t looking at a period of prosperity. A recovery is underway and is likely to continue, but it is more likely to be lackluster than vigorous. Most Americans’ financial memory consists of V-shaped recoveries and periods of good feeling like the 1990s, when they couldn’t think of reasons not to borrow and spend. Five years from now, I think people will still be asking, “When will the economy get going? When will we get back to good times?”

Then asking rhetorically is there no good news? The first is the possibility that things won’t turn out to be as bad as I describe. Because of the impact of psychology on people’s thought processes, it often turns out that things aren’t as bad (or as good) as they seemed at the extremes…

Macroeconomic issues now dominate the conversation and it is easy to get caught up in it all. Here’s Howard Marks perspective:

Since macro events determine most of the results, it’s on the macro that investors believe they should spend their time.

I couldn’t agree less. Playing the market in the short term based on macro forecasts is one of the many things in investing that could add greatly to results if it could be done right . . . but it can’t, certainly not consistently.

Our investment destination is best reached by accurately valuing assets, assessing the relationship between price and that value, and acting resolutely and unemotionally when mispricings are detected. That’s still the best – I think the only – reliable path to investment success. Nothing about the current environment alters that one bit.

Concluding: Unless you consider loss avoidance overwhelmingly important and can truly forgo making money, the approach for today has to balance risk aversion and the pursuit of return.

Have moderate investment expectations and faced with today’s conditions:

  1. Invest in well priced corporate securities and income-producing assets.
  2. Corporations have the best chance of adjusting to inflation, dislocation and competition.
  3. Take control and strive for reasonable returns with the risks handled responsibly.
  4. You can’t just do nothing; even doing nothing is doing something. It’s choosing to stay with what you have rather than switch to what you could have.

The outlook certainly isn’t calling for investing aggressively. But…..isn’t a time for hiding under the bed. “Move forward, but with caution” — that’s my mantra today. The environment is uncertain, but we shouldn’t find that paralyzing.


The information contained herein is provided for informational purposes only, is not comprehensive, does not contain important disclosures and risk factors associated with investments, and is subject to change without notice. The author is not responsible for the accuracy, completeness or lack thereof of information, nor has the author verified information from third parties which may be relied upon. The information does not take into account the particular investment objectives or financial circumstances of any specific person or organization which may view it. Nothing contained within may be considered an offer or a solicitation to purchase or sell any particular financial instrument. Any investment can be very risky and is not suitable for everyone. You should never enter into an investment unless you can afford to lose your entire investment. Always complete your own due diligence. Before making any investment, investors are advised to review such investment thoroughly and carefully with their financial, legal and tax advisors to determine whether it is suitable for them.

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    • Rueben,

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