Tennis with Howard Marks

Dare I volley back at Howard Marks, one of my investment industry idols and favorite writers?

I liked his new memo, but not as much as I’ve loved pretty much all of his other previous memos. I don’t think he’s wrong in what he’s saying, but I think he leaves some crucial things out.

The Cliffs Notes version of what he said yesterday is that now is a time to be cautious, based on how people in various asset classes are behaving. It took him an astonishing 10,849 words to say this. But he has tremendous words, the best words. Many people are saying this…

Anyway, through a battery of anecdotes about everything from FAANG stocks to Bitcoin, Marks tells a story of an environment in which everyone accepts that returns will be prospectively low, risks have almost never been higher, but people trudge on with their investing regardless. He earns 500 Pundit Points for admitting that he already turned cautious back in 2011, and so if you are always cautious over six years and markets do what they will do anyway, it’s not necessarily a useful opinion. I like that.

So what does Marks miss? I’ll return his serve…

re: Bitcoin and digital currencies being “not real” and based on nothing, he’s right. But so what? Nothing is real, in truth. Did you read Yuval Noah Harari’s book Sapiens yet? Why does the automaker Peugot exist? It’s not real! Just a thing we all agree upon. It’s based on nothing, we just accept that it’s a thing and treat it accordingly.

Harari:

In what sense can we say that Peugot SA (the company’s official name) exists? There are many Peugot vehicles, but these are obviously not the company. Even if every Peugot in the world were simultaneously junked and sold for scrap metal, Peugot SA would not disappear. It would continue to manufacture new cars and issue its annual report. The company owns factories, machinery and showrooms, and employs mechanics, accountants, and secretaries, but all these together do not comprise Peugot. A disaster might kill every single one of Peugot’s employees, and go on to destroy all of its assembly lines and executive offices. Even then, the company could borrow money, hire new employees, build new factories and buy new machinery. Peugot has managers and shareholders, but neither do they constitute the company. All the managers could be dismissed and all its shares sold, but the company itself would remain intact…

In short, Peugot SA seems to have no essential connection to the physical world. Does it really exist?

Peugot is a figment of our collective imagination. Lawyers call this a ‘legal fiction’. It can’t be pointed at; it is not a physical object. But it exists as a legal entity. Just like you or me, it is bound by the laws of the countries in which it operates. It can open a bank account and own property. It pays taxes, and it can be sued and even prosecuted separately from any of the people who own or work for it.

Saying something “isn’t real” is a slippery slope. Nothing that doesn’t appear in nature is real, including countries and religions and, yes, currencies. Things become real enoughwhen people begin to believe and agree that they are. The Declaration of Independence didn’t make America real, it made people believe that it could be real and then will it into existence with their cooperation and their actions.

Okay, that was a little meta…let me get to one other thing I think Marks could have included here. He runs down a laundry list thousands of words long about all of the various and sundry ways in which people are taking risks, and even excessive risks, in the markets.

I would say two things to that…

One – there is a more interesting list to be made of the ways in which people are not taking risks.

Consider that we’ve got an entirely Lost Generation of investors, the millennials, who prefer to hold cash and even bonds (!) rather than own stocks. They view putting money into their friends’ startups as less risky than the public markets. They invest purely through 401(k) accounts. The joys of speculating in brokerage accounts has entirely eluded this generation – practically all 73 million of them.

They are not reading Barron’s or day-trading or anything of the sort. It will never occur to them to look at the investment markets as a recreational activity. Even when something like the Snap IPO comes along – the app allegedly serving as the Rosetta Stone to understand this generation – they can’t even maintain an erection lasting 48 hours for the secondary market in its shares. How do you have a bubble when the up and coming highest earners and savers refuse to play along other than peremptorily through corporate retirement plans at work?

And how about a mention of the fact that this is the first boom in stock market history during which Wall Street was laying people off!?! Unheard of in the annals of the game, go back ten decades and you can’t find anything like it. Investment banking and trading headcounts are down as the S&P 500 triples in price.

I explain this in further detail here: I’d like to solve the puzzle, Pat

There has never been an asset bubble in which the industry that catered to that asset didn’t participate. Wall Street has never had an extended bull market during which everyone spent the entire time worrying.

Can you imagine a real estate boom where the brokers and mortgage people stood on the sidelines, forlorn and only taking part out of obligation? How about a gold boom where the miners told polls every week how bearish they were?

Unheard of.

Until now. Job insecurity will do that to people.

The stock market is now 35% passive and 65% terrified. The bond market is not far behind.

So, to recap – the millennial cohort is joylessly investing in the missionary position while professionals are being downsized and dismissed. And this we’re calling this 1929? Or 2000? Or 2007? Valuations may tell a similar story to those eras, but the behavior of the crowd tells an opposite story.

Two – and the last thing I will add here – the plural of anecdote isn’t data. Marks does a good job of piling up the Softbank Vision Fund, the tightness of credit spreads, the lack of risk premium in emerging markets bonds etc. But what he’s really doing is grabbing a bunch of stories from the headlines to build the case that people are, in general, acting speculatively.

My answer to this: You can always always always find examples of people acting speculatively.

If I were trying to demonstrate speculative fervor in 2012, I could have used the monstrously large IPO that Facebook came to market with that spring, dwarfing all but one or two prior offerings in terms of dollars raised or initial valuation. I could have done the same thing a couple of years later with Alibaba selling the NYSE’s largest ever new issue. I could have pointed to the all-time record S&P 500 highs in 2013 (as many did) and made the same case. Pick a year, I’ll show you a dozen examples that could be spun as speculative excess.

Now you’re probably saying “Oh yeah, do it for 2008-2011!”

No problem. Gold, silver and platinum. If you weren’t there, you have no idea.

Not just the massive price increases and the boom in assets going toward mining stocks and commodity ETFs – but the activity! A veritable beehive. I attended a large convention for publicly traded miners in Vancouver in 2012 and dared to say – on stage – that gold had broken its uptrend and was technically at risk. I had to be smuggled out of the building in a f***ing laundry cart. Peter Schiff refused to shake my hand in the green room. Ask Tommy Humphries if I’m lying. I called it Gold-by-Goldwest, probably why I was never invited back.

Price predictions for the precious metals were out in the stratosphere. CNBC had a gold ticker on-screen all day. Gold-buying entrepreneurs were going house to house all across the country for melt parties. It was a speculative mania in the context of a Great Recession. There is always a casino somewhere. Right at the top, there was a moment when GLD had more assets under management than SPY! That’s not a canary in the coalmine, that’s a bald eagle slamming into your windshield at 70 miles per hour, smashing your car through the guardrails and over the cliff.

So I appreciate Howard Marks’s message but I think now is no more a time to be cautious than at any other time. We should always invest as though the best is yet to come but the worst could be right around the corner. This means durable portfolios, a willingness to miss out on 100% of a given asset’s upside, hedges, cash reserves, tactical asset allocation, diversification, realistic goals and objectives, etc. There is no better or worse time for any of these things that we can foresee in advance.

Caution should never go out of style. And by the way, I learned that from Howard Marks.