In a recent interview on the WONK Podcast, investing legend Howard Marks provided a clear-eyed assessment of the current market landscape, marked by a peculiar and persistent disconnect.

“The S&P 500, which is our main gauge of the stock market, was considered expensive given its valuation level at the end of 2024 and it has gone up in the face of increasing uncertainty this year. So, it’s more expensive now,” Marks observed. This divergence between a stalling economy and record-high equities presents a complex puzzle for investors.

Marks attributes part of this phenomenon to inherent investor psychology. “I think that optimism dies hard. I think that optimism introduces cognitive dissonance. That is to say, investors are good at ignoring negatives for a long time and if there are ambiguous events, interpreting them positively.”

This tendency to explain away bad news is compounded by tangible positives, like the potential of AI and the strength of the so-called Magnificent Seven companies. However, Marks cautions that when the market incorporates such unusual optimism, it introduces “room for disappointment and if the reasons for the optimism tend not to be realized then you can have some real damage done.”

Faced with this expensive market and heightened uncertainty, Marks offers a nuanced strategy rather than a simple buy-or-sell directive. He proposes investors consciously manage the balance between offense and defense in their portfolios.

“I said in the memo that I recommend possibly going to Defcon 2… which is to say just to start biasing your portfolio more towards defense and less towards offense. I’m not saying get out of the markets.” This shift involves moving toward safer assets, notably in the fixed income space where yields are now significantly more attractive than in recent years.

Ultimately, Marks emphasizes that successful investing requires confronting complexity and making a personal choice about one’s priorities. “You can’t maximize the probability of increasing your wealth and maximize the probability of holding on to what you have at the same time. Everybody has to make a choice.”

His counsel is not to panic but to proceed with caution, acknowledging that while this is not a time for a carefree attitude, emotional reactions are often the investor’s worst enemy.

You can watch the entire interview here:

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