Howard Marks: More reasons for offensive rather than defensive investing right now

The head of Oaktree Capital uses an automotive analogy to answer a question that’s on the minds of many investors today: How should you think about risk?

Marks says every investor should think of their portfolio positioning in terms of a car’s speedometer.

“It goes from zero to 100 – maybe zero is all defence with no offence and 100 is all offence, with no defence," he says during a recent interview with Oaktree financial writer Szymanski.

As a starting point, you need to establish what your appropriate, normal risk posture looks like – perhaps think of this as your cruising speed.

“Clearly it varies from investor to investor based on their resources relative to their needs, where they stand in the lifecycle of producing inflows relative to outflows, what are the aspirations, and importantly, their ability to withstand volatility,” Marks says.

After establishing that baseline, you must then decide whether to maintain that risk posture indefinitely, or whether you’ll vary it based on what’s happening in the market. There’s no right answer to this question – as with so many things in the world of finance, it depends on individual circumstances.

“But if the answer is ‘no, I’d like to try to vary my risk posture,’ the next question is ‘how, today?’” says Marks.

Key macro trends in the current environment

The roll-off of the US Federal Reserve’s massive stimulus program is the big story for global markets currently. As Marks describes it, “this environment created a tsunami of liquidity.” Having now been reversed into a “de-stimulative” direction, with every indication suggesting tightening will continue over the next couple of years, he notes this is less salutary for markets.

“Fifty years ago, we used to talk about the fact that bonds and stocks diversify. But they’re both impacted by changes in rates and recently we’ve seen higher rates and lower prices for both,” Marks says.

“But higher rates tend to reduce economic activity, which means company earnings are lower, and of course, we have a very high degree of geopolitical uncertainty and turmoil these days.”

All these factors suggest that more defence rather than less offence is the new “normal” posture.

Reasons to stay on the offensive

There are some powerful counterpoints to the factors Marks discusses above. For example, most people believe the Fed’s actions to control inflation will cause a recession in the next couple of years.

“But when the Fed is finished raising rates, they’ll still be among the lowest in history,” he says.

Marks emphatically believes low interest rates will remain the norm, alluding to a receipt that hangs on his office wall showing a mortgage rate of 20-odd per cent.

“I think the Fed will remain biased towards easy money conditions – governments like it too much and everyone likes growth,” he says.
“It is the norm and to go back to historic interest rates would be quite a negative shock.”

“A chain that is very hard to break”

On the topic of inflation, Marks harbours hopes it – or at least some elements of it – may yet prove to be transitory. He alludes here to the simple supply-demand imbalance that created the inflationary environment in which world economies find themselves mired. The faltering supply chain, which saw more money chasing goods that were less available satisfied the basic requirements for inflation to take off.

It also comes back to inflationary expectations: “Once they become embedded, they’re hard to dispel and become self-fulfilling. It’s a chain that is very hard to break,” Marks says.

“We hope that, as the supply mechanism gets back into a groove, demand for goods and supply of goods will come into a better balance.”

Which is worse: Buying high, or selling low?

The difficulty of timing market exits and re-entries is another strong argument against becoming more defensive in your portfolio allocations.

“If you turn more defensive, at some point in time you’ll have to turn aggressive again to participate in the normal progression of markets. It’s much more important to be in than out,” Marks says.

“I really believe that getting out at the bottom – and failing to get in – is the cardinal sin in investing.”

As he describes it, there is an almost indisputable trend that means developed economies and markets always rise over time.

“But if you sell at the bottom and fail to get back in, you’ll miss the recovery and the long-term trend. We really have to take advantage of the long-term trend, that’s the main job of an investor.

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