Howard Marks: Get Equity-Like Returns with Less Risk: The “Zone of Reasonableness”

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During his latest Insight Conversation, Howard Marks says the current market and economic climate call for a cautious and strategic approach to investment, prioritizing stability and potentially shifting from equities to credit-based options.

In terms of the market and economy he says:

  • The market is not excessively high or low, making it a “zone of reasonableness” where no urgent action is needed
  • Predicting the short-term trajectory of the economy is difficult and uncertain. Neither a boom nor a crash is guaranteed
  • The Federal Reserve’s future rate decisions are unpredictable, making long-term planning challenging

In terms of the best investment strategies to implement:

  • Given the stabilized interest rates, investing in credit (debt) presents an opportunity for equity-like returns with potentially lower risk, especially in high-quality, less leveraged companies
  • These credit-based returns, ranging from 10% for liquid options to above 10% for private credit, can be competitive with equities and offer greater safety

Here’s an excerpt from the Insight Conversation:

Marks: Well, following on from my last answer, I don’t think today’s a fat pitch. The market is not crazy high and it’s not crazy low. It seems a little high, not enough to make you take action. It’s really important to notice that if I were to tell you, “Okay, Anna, stock market is 10% overvalued.” And you were to agree. That’s not synonymous with going down tomorrow.

And it doesn’t mean you should sell because from 10% overvalued is pretty close to fair value. And from 10% overvalued, stocks can go up, go sideways, go down. Anything can happen. Now, the fact that it’s 10% overvalued means that there’s a slightly greater tendency than usual for it to go down rather than up. But the point is not enough to take action on. I feel the same way about the economy.

First of all, anybody who thinks they know what the arc of the economy in the near-term future is going to be is nutty because we’re all confused. And anybody who’s not confused, doesn’t understand what’s going on. I didn’t make that up.

Somebody once said that. But it’s not clear that the economy is going to boom. It’s not clear that it’s going to crater.

So I don’t think there’s anything we have to do about the macro.

Now, special mention to the Fed. Will the Fed have another rate increase? Will it pause? Will it start cutting rates in ‘24? When? How often? These things are really hard to say. The answer is different from three months ago, when people thought they had the right answer three months ago, it turned out it wasn’t the right answer. What makes them think today’s answer is the right answer.

So what the point is, we’re in that middle zone, what I call the zone of reasonableness. The market is not too high or too low.

The outlook for the economy is not convincingly positive or negative. Nothing smart to do today in those regards, except that given the change in interest rates and where they are, and what the outlook is, and I think that when we do this two years from now, victory against inflation will have been declared and the fed funds rate will probably be about three and a half, maybe three.

But that I believe is going to be the norm for the coming years. And so you’ll have some stability. But you won’t have continuous declines. And that’s important. That shapes the question of what strategies will do best. The other thing to note is still you can potentially get equity type returns from credit with less risk in better companies than used to be the borrowers with less leveraged companies than used to be the borrowers.

And these returns, whether they’re approaching 10 for liquid credit or above 10 for private credit, these are fully competitive with equities more than most people need, and they can be earned with greater safety than with equities.

So I continue to think that the opportunity is compelling.

You can listen to the entire Insight Conversation here:

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