And we have Howard Marks in the waiting room from Oaktree Capital. Let's bring him into the TV pin ultra. How are you doing?
Thank you so much for joining. I would love to kick it off with the high level on your theory of the market cycle, and then maybe we can walk into how you're thinking about markets today and over the last few years. But the high level thesis on the market cycle, how do you explain your overall thesis?
Sure. Well, thanks for having me on today. You know, I've watched what you do and it's terrific and I'm glad to be part of it.
You know, basically a company or a market or an economy makes progress along what we call a trend line. And so the value that it creates should progress along that trend line.
But the point is that while the progress there is pretty steady and gradual, sometimes people get too excited and they overvalue that progress and the market goes to an unsustainable high. And then something comes along that makes that correct back toward the trend line. But given the way human nature works, it goes through to an unsustainable low. And then eventually that's corrected back toward the trend line to a high. So the point is that whereas the underlying thing progresses gradually, the price fluctuates wildly around that trend line and the main reason is the fluctuation of psychology.
Yeah. How far back do you go when you think about market cycles? Does the same theory apply pre-industrial revolution?
Well, I'm old, but I'm not that old. And I didn't mean it like that. You know, I wasn't there, but yes, I think one of the most valuable operative quotations is from Mark Twain, who supposedly said that history does not repeat, but it does rhyme.
So the things that rhyme are the elements of human nature that cause these excessive fluctuations around what I'll call intrinsic value or reality. So you know, the desire to get rich quick, envy of seeing others get rich quick, the belief that it's possible to get rich quick, the fear of missing out, the fact that people get more excited the higher the price goes which should be worrisome. So these things I think have always been in place and you read about bubbles that took place, let's see, the tulip bubble I think was 1620, the South Sea bubble was 1720. And so these excesses, these human failings have always been part of what goes on.
But this time is different, kidding. How do you think a lot of the guests on the show have maybe been through the COVID kind of brief correction and chaos of ZERP, but don't have much else to go off of. That can kind of be an advantage because you can just be so optimistic that even if something bad, you know, you do get a big correction, maybe you get a fast rebound. Has being through a number of these cycles ever hurt your performance because you just weren't optimistic enough or this idea that optimists make money and pessimists sound smart?
Well, you know, my firm Oaktree Capital Management first of all doesn't invest for the most part in the stock market. We're mostly investors in what's called credit or debt. But I think that we are what's called contrarians. I think my partner Bruce Karsh and I are essentially innately contrarian, which is to say that we're most comfortable doing the opposite of what the herd is doing at the extreme because we see its error. And so I think we've always done that naturally. And so we are, I think we're conservative by nature. And I always say, by the way, in 1978, Citibank asked me to go to the bond department and start a high yield bond fund and the convertible bond fund. And it worked great because being a lender requires conservatism. If they would have said, I want you to start a venture capital fund and predict when Amazon is going to be created, I would have been a disaster. I'm not a futurist. I'm not an optimist, etc. But when I have seen excessive pessimism and excessive gloom causing crashes, and I've seen a few, it has come kind of naturally to go against that excess. And so I think one of the things we've done best for conservative people is seize the opportunity at the lows again by being contrarian. And you know, I wrote a memo in October of '08 after the bankruptcy of Lehman with the title 'The Limits to Negativism' and there is such a thing as being too negative.
Mhm. Do you think contrarianism like you just described is purely innate or can it be learned? Is it a muscle that you can build over a career? Is it something that folks in everyday life who maybe aren't professional investors but might benefit from not getting overheated and falling in with the herd can learn? And if so, how?
I think you can learn these things. You know, I wrote a book called Mastering the Market Cycle. I'm not really trying to plug the book, but it wouldn't hurt. But it all talks about how to deal with the cycle. And what I think is I get all these questions. Can you learn this? Can you learn that? Can you learn to be unemotional? Can you learn to be what I call a second level thinker? Can you learn to be a contrarian? The answer is I can tell you why it's important. I can explain to you why it's essential. Is it something you can ingest? I don't know. You know, I for some reason or another come by it naturally. It's easy for me relatively. By the way, I don't want to give the impression that when I make these calls at the highs or the lows that I do it without some trepidation. I'm never sure. Anybody who's sure is an idiot. You know, they say there are two kinds of people who lose a lot of money. The people who know nothing and the people who know everything. So I'm not trying to imply that it's easy. But it does come fairly naturally to me through the combination of my emotional makeup and the application of logic. If somebody else doesn't have my emotional makeup, they could learn the logic. Maybe they could learn to do it. It might not come so easy. That's all I can say.
How do you think about the concept of black swan events or the integration of black swan events into a market cycle? Because going into COVID, I was looking at the fundamental health of the American consumer, the fundamental health of the economy, everything looked very strong and I think that's why the economy rebounded as quickly as it did and then sort of overheated. But how do you need to put black swans out of your mind? Are black swans even a real thing? Like, how do you think about that concept?
They're a real thing. I don't think you can do anything about them. My term, the term I've always used for what Taleb calls a black swan is an improbable disaster. And by the way, they're not all disasters. They're improbable bonanzas, too. But if you just think about the improbable disaster, it is something where if it happened it would be disastrous but it's very improbable. What do you do about it? And in my opinion you can't do anything about it. If you say, well, I'm concerned that there could be an eight magnitude earthquake, I'm concerned that there could be four hurricanes in a row, I'm concerned that there could be nuclear war and I'm concerned that there could be inflation at 20%. Well, you can protect yourself against that. You can call that guy who lives in Omaha. He'll write you an insurance policy to protect you against all of those things. You just won't like the premium. And if you take out that insurance policy and you pay that high premium and you're protected, in the vast majority of years, it's not going to happen. And after a little while, you'll get tired of paying those premiums and you'll stop probably in time for it to happen. So you really can't. And the things that are in the way, way distant tails of the probability distribution are just things you have to live with. That's real life.
How do you think about the education that goes into becoming an investor and how that's changing? It feels like it's easier to learn without mentors because everything's been compacted into AI and open sourced on the internet and you can watch great lectures and podcast interviews. What's changed and what's the same?
Well, my perception is that AI, number one, AI has a mentor. It reads everything that ever happened. And ingests it and remembers it and can find it. And then AI becomes a mentor. And it tells you how to think. It gives you examples of thought processes. So I think it just makes it so much easier to learn. And I wrote a memo in December. I write memos to my clients. October was the 35th anniversary. And I talked about AI in a memo December 9th. And then I have a son named Andrew. He's in the tech world. He's a terrific venture capitalist. He's co-founder of a group called TQ Ventures. And given the recent events, he pushed me to revisit that memo and update it. And he had this great idea. He said, 'Why don't you ask Claude to tell you about what's been happening.' And so he and I developed a request which we inputted to Claude. His help was invaluable, but of course he does this all day with all of his brilliant founders. And so Claude wrote me a tutorial which enabled me to update the memo. And I learned an incredible amount in a field that is not native to me through doing that. And so it was a mentor to me and it can be a mentor to others, but as we know, you have to ask it the right questions. And Andrew and his buddies helped me do that.
Yeah. How has technology changed the credit markets or just investing in credit over your career? I can imagine computerization, the internet. There's sort of a continuum of advances that just help information flow more freely. AI feels like just an extension of that. But how has the actual work changed over your career?
Right now, AI is helping us marshal data with a thoroughness and a speed and an error-free that we never had before. I don't think it has changed the process because what you see, it all comes down in the end to looking at a company and assessing the probability that it'll pay its debts. And I don't think we're still better at doing that than AI is. Oh, by the way, I should tell you that an hour or two ago, I put out a new memo updating the December memo. You probably haven't seen it. I may make reference to it.
Please. But we do have it pulled up, but for the audience.
Okay, great. So it says in there, and I asked Claude and Claude said, look, the truth of the matter is that the thing that AI is the weakest at is doing analyses on brand new things where there aren't established patterns. And I think that's a lot of what we do. So at the present time, I think AI can marshal the data, organize the logic, frame the question. I don't think it's at the top of the heap in answering the question yet, of course I can always be wrong. And I say in the memo that I think that what AI does is predicts based on past patterns, it predicts what kind of companies will pay their debts and whether a given company will pay its debts and it puts forth a hypothesis with regard to an individual situation and it tells you you should or shouldn't invest. I think as I understand the status of things today, you need people to check the hypothesis. You know, I don't think I would make an investment commitment based on the hypothesis alone. I would want to check it, but I think it gives you a great starting point. And by the way, so I wrote the memo. I said to Andrew, 'Do you want to look at it?' He says, 'Why send it to me? Why don't you send it to Claude?' Ask Claude to take a look at the memo. So I did. And I was absolutely, and if you read the memo, I was absolutely dumbstruck by what I got back because it responded to me, it felt like a note from a colleague or friend. It was personal. It was warm. It drew analogies to my 35 years of memos. It talked about some of the people I respect. It injected humor. It was complimentary. It talked about a section it thought was really good. So I wrote to Andrew. I said, 'Is AI, is Claude an assisser?' because I thought it was maybe unduly complimentary. He said, 'Well, Dad, ask it to be hypercritical.' So I wrote back, I made a few corrections. I said, 'Now, would you please be hypercritical?' So it writes me back and it says, 'Do you want me to be hypercritical or hypocritical?' It's making a joke. And so I think that it's going to change our world.
I think that we have an activity in our investment world called indexation where rather than pick stocks, a lot of people who invest in the stock market now instead just invest in a vehicle that emulates the S&P 500 or some other index. And indexation has put a lot of people out of business because a lot of people used to do an inferior job, underperform the S&P and then charge highly for their services. There's something wrong with that. And a lot of those people are out of the business now and the majority of equity mutual fund money is managed through indexation or passive. I think AI will advance that. What it does is it just raises the bar and weeds out the people who don't add value. I don't think it'll replace the best. But it'll replace a lot.
