Good morning. The US stock market traded sideways yesterday as Treasury bond yields climbed. It still feels like we are still in between the actions in the market drama. But there is still a lot to say.Email me [email protected]

Howard Marks on economic growth in the “low return world”

Howard Marks is the co-chairman and co-founder of Oaktree Capital Management, which is the co-chairman and co-founder of Oaktree Capital Management. management $150 billion in alternative assets.He is also a famous writer, famous for his books and investors letter, This is a must-read on Wall Street. We talked on the phone during the weekend.

The first topic is inflation. As a person with a career in risk management, his views are carefully balanced, and he does not like to make predictions. He said that we have no idea whether inflation will be temporary. Max believes that the probability that inflation will be higher than 3% (above the Fed’s long-term comfort zone) within three years is roughly flat.

In other words, the Federal Reserve and political institutions have recently tended to be dovish. “even [Fed chair Jay] Powell must be re-elected. I think it is a year from now, so he may not do anything tough next year. “Therefore, Marks estimates that the probability that inflation will truly become a financial market problem is about 30%.

In addition, it seems that there may be strong economic growth in the future, at least this year, and possibly even more. This should allow the market to remain stable for the time being:

“As long as we publish good economic data, it is difficult for me to see this market turn around… If there are four years of growth in the next four years, will the stock market really die?”

Therefore, investors should be in their “normal risk position”: neither particularly bullish nor particularly bearish, perhaps a defensive shadow.

Given economic growth, why not be more bullish? Because high liquid asset prices limit long-term returns:

“We are in an asset bubble. This is everything. It doesn’t specifically target high-yield bonds, bonds, or stocks. It’s real estate, it’s private equity, it’s all-encompassing. The way I describe it is that we are in a low return The world… How do you get a decent return in a low-return world? The answer is: it’s hard.”

Max offers five options for investors, but none of them are very attractive. You can accept lower returns. You can put yourself in a defensive position, “in this case, the return may be lower.” You can go for cash and receive zero return. Or you can increase the risk, “But is this really when you want to increase the risk?” Finally:

“You can say that I want to find a special niche, a special person, so that I can get high returns in a low return world. But you have: a) lack of liquidity, because most special things are illiquid; b) Manager risk, because if you try to find a genius who can give you high returns in a world of low returns, but you make a mistake, you will get a dummy.”

In short, it is “illogical” to think that you can “safely and reliably” get high returns in today’s low-return world. Max described a conversation with the chief investment officer of a national pension fund, who sought his advice because the fund’s target rate of return is 7%. Max suggested that the CIO find a new goal.

At the same time, Max said, you have to be in the market. Successfully avoiding bubbles requires two decisions: exit and re-entry, and most people choose one of them.

Sometimes, Max said, when the market offers such extreme prices, the logic of market timing is convincing and the probability of success is high. But this is not one of those times. “Between those once-in-a-year opportunities, there is nothing to say.”

Is duration selling or speculation?

There is now a single narrative dominating the hustle and bustle of the market.it is Inflation story, The corresponding strategy is deflationary trading. That is: buying “value” stocks in industries where economic growth and inflation are booming, from materials to banking, and selling “growth” stocks in most technology sectors. This is a chart that tells the story. It shows the relative performance of the Russell 2000 Growth and Value Index:

In the second week of February, economic growth rebounded and values ??soared. Half the value of this transaction makes perfect sense to me. Cyclical stocks, from industrial stocks to bank stocks, perform better in a hot economy with lower inflation. But why should we fight growth?

The popular stories are as follows. Much of the company’s growth value comes from profits in the next few years. In the proverb, they are “long duration”. For value stocks, more value is recent. The interest rate is the interest rate at which those distant profits are discounted. Therefore, as we are doing now, rising interest rates have hit growth stocks particularly hard. This is a kind of “duration selling.”

There is some truth to this story, but I am a little skeptical because it underestimates the role of speculation and excitement (and its dissipation) in the growth selloff. My guess is that we are seeing more than just an upward adjustment in investor discount rates. We have also seen a decline in investors’ speculative appetite. The two are different.

The change in the discount rate is an adjustment to the way the future cash flow is determined. The change in speculative appetite is a change in the degree to which investors care about cash flow—the degree to which they believe that there will always be another person (the “bigger fool”) who pays more for assets than they do.

one example. Since the sudden change in the situation in February, the fast-growing Nasdaq 100 technology index has fallen by 5%. But some index members are doing well. Here are the five best performers in the index:

Of these four, only applications may be called value stocks. Yes, all of these are very sensitive to the economy. Facebook and Google are in the advertising business, and the other three make semiconductor manufacturing equipment (so the current chip shortage puts them on the back wind). But they are not only growing well now. They also have high long-term average revenue growth rates (even Applied Materials; compound sales of 6% are far beyond your standard value stock hopes). In other words, all of these have a lot of value in the cash flows that will occur in the next few years, but somehow, duration transactions leave them unscathed.

These are solid businesses sold at appropriate valuations (note that the P/E ratio/growth ratio is below 1.5). Their stocks performed well, but they did not go completely crazy during the speculative growth spree that preceded the February reversal.These are solid Grow investment.

In contrast, the five worst performers in the Nasdaq 100 index since the February reversal are DocuSign, Zoom, Okta, Splunk and Baidu. Splunk is an outlier, but the other four have risen by 200%, 388%, 108%, and 131% in the previous year, making them four of the five best performing indexes in the same period. Except for Baidu, their P/E ratios are all over 50.

We do not sell duration. We are selling lunatics.

A good book

One of the biggest market problems is when will the inevitable collapse of commercial real estate, because flexible work will stifle demand.The Economist did a great job Explanation Why can the dam last so long.