During his recent interview with Bloomberg, Howard Marks offers a clear perspective, noting that “stocks are expensive relative to what I call fundamentals or you might call reality.” The primary reason for this, he suggests, is a prolonged period without a major downturn.

“There hasn’t been a serious market correction in 16 years. So people get out of the habit of thinking about market corrections.” This extended run of success breeds a dangerous complacency, leading to what Marks identifies as the biggest single mistake an investor can make.

“They conclude that the way things are today is the way it’ll always be and the things that have been happening will always continue to happen.” This mindset ignores the powerful force of reversion to the mean, which is a much more likely outcome over time.

The current environment is not yet at a critical breaking point. “We’re not at a nutty valuation. I’m certainly not ringing the alarm bells,” Marks clarifies. However, he draws a parallel to a previous period of enthusiasm, specifically “around 97 when the market was kind of falling in love with tech stocks.”

He cautions that while markets can remain elevated for years, the fundamental truth remains. “The point is that things are expensive. They may go on to become more expensive, but the fact that they’re expensive should not be lost.”

While many focus on the so-called magnificent seven tech stocks, Marks finds broader concern elsewhere. “It is the fact that high valuations are being applied to more average companies that I think’s more alarming than the fact that exceptional valuations are being applied to exceptional companies.”

In such a climate, the focus shifts toward defense. Marks argues that “this is a time to put a little more defense into your portfolio.” His preferred method is a shift in asset class, moving from equities to credit.

“Debt is inherently more defensive than equities. And you have a promise of payment.” While credit spreads are also tight, the nature of the investment is different. “A contractual guarantee approaching something in the sixes over the next 10 years is I think more defensive than being in the stock market at these elevated valuations.”

The core of his argument rests on probability; credit offers a high probability of doing fine, while expensive equities carry a reasonable probability of doing less than fine. This is not a call for alarm, but a prudent recommendation for caution.

You can watch the entire interview here: