In 2007 Howard Marks released a memo titled The Race to the Bottom, the note shared his view that investment markets are like an auction house, the item that’s up for sale goes to the person willing to pay the most. When buyers are scarce the items for sale go for low prices, conversely when there are many buyers and money plentiful, the prices paid will be high.  

The catalyst for this note was Marks’ observation that investors were becoming more eager to invest in riskier assets in the hope of higher returns.  

“Almost every day we saw deals being done that we felt wouldn’t be doable in a market marked by appropriate levels of caution, discipline, skepticism and risk aversion.”  

In his latest memo, Marks argues that once again there’s a prevalence of ‘imprudent deals’ being done, as too much money chases too few deals. The full memo is 6,200 words long, so we’ve pulled out a few highlights for those short on time, and included a link to the full memo below. 

On the current environment 

Marks makes special note of the number ‘ten’. Highlighting the ten years of artificially low interest rates, the U.S. economic recovery in its tenth year, the recent ten year anniversary of the collapse of Lehman Brothers and that the current market upswing is also in its tenth year.    

"Enough time has passed for the trauma of the crisis to have worn off; memories of those terrible times have grown dim; and the reasons for stringent credit standards have receded into the past." 

5 attributes driving markets right now 

Marks calls out specific elements of the investment environment that have been focal points of his presentations over the past months. These include the lofty expectations being ascribed to FAANG stocks, exuberance in corporate credit markets, the fact that private equity has been able to raise more money than any time in history and the 1400% rise in crypto currencies - led by Bitcoin. 

He says these examples lead him to conclude that the market is being run on the following five attributes: 

1. Optimism, 
2. trust in the future, 
3. faith in investments and investment managers, 
4. a low level of skeptiscism, and 
5. risk tolerance not aversion 

"Assuming you have the requisite capital and nerve, the big and easy money in investing is made when prices are low, pessimism is widespread, and investors are fleeing from risk. The above factors tell me this is not such a time" 

A Case In Point: Direct Lending 

In the immediate aftermath of the GFC, the banks were reluctant to do much lending. This led to the rise of 'a few bright investors' setting up direct lending or credit funds to fill the gap. With limited competition the lenders could be selective in who they made loans to and demanding in their terms. Over time the market has become congested with the pricing of deals becoming more competitive and the terms becoming looser.  

"At the present time, the managers raising and investing large funds are showing the most growth. But in the eventual economic correction, they may be shown to have pursued asset growth and management fees over the ability to be selective regarding the credits they backed.

Lending standards and credit skills are seldom tested in positive times like we’ve been enjoying." 

From the general to the specific 

Marks backs up his views in compelling fashion, dishing out a three-page hit list highlighting the current size and quality of corporate debt including a snapshot of the most imprudent deals the Oaktree investment team has observed. 

• The debt of U.S. non-financial corporations as a percent of GDP has returned to its Crisis level and is near a post-World War II high.
• Total leveraged debt outstanding (high-yield bonds and leveraged loans) is now $2.5 trillion, exactly double the amount in 2007. 

You can access the full note here: (VIEW LINK)

Have a great weekend!