#431: Howard Marks on the US Dollar, Three Ways to Add Defense, and Good Questions

Howard Marks on the US Dollar, Three Ways to Add Defense, and Good Questions | Brought to you by LinkedIn Jobs http://linkedin.com/tim and "5-Bullet Friday https://go.tim.blog/5-bullet-friday-1/?utm_source=podcast&utm_medium=podcast&utm_campaign=podcast-sponsorship." More on both below. "Move forward but with caution." — Howard Marks Howard Marks (@HowardMarksBook https://twitter.com/howardmarksbook) is co-chairman and co-founder of Oaktree Capital Management https://www.oaktreecapital.com/, a leading investment firm with more than $125 billion in assets under management. He is the author of the books Mastering the Market Cycle: Getting the Odds on Your Side http://www.amazon.com/exec/obidos/ASIN/1328479250/offsitoftimfe-20 and The Most Important Thing: Uncommon Sense for the Thoughtful Investor http://www.amazon.com/exec/obidos/ASIN/B004U5Q1O0/offsitoftimfe-20, both critically acclaimed bestsellers. Warren Buffett has written of Howard Marks: "When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something." Marks holds a BSEc degree from the Wharton School of the University of Pennsylvania with a major in finance and an MBA in accounting and marketing from the University of Chicago. Please enjoy! This episode is brought to you by LinkedIn Jobs https://linkedin.com/Tim. Whether you are looking to hire now for a critical role or thinking about needs that you may have in the future, LinkedIn Jobs https://linkedin.com/Tim can help. LinkedIn is an active community with more than 675 million members worldwide. LinkedIn screens candidates for the hard and soft skills you’re looking for and puts your job in front of candidates looking for job opportunities that match what you have to offer. With LinkedIn https://linkedin.com/Tim, you can hire the right person quickly when you need them. And if you need to hire for healthcare or essential services, you can post your jobs for free. When it’s time to find and hire that right person, LinkedIn is here to help. Just visit LinkedIn.com/Tim https://linkedin.com/Tim to get started! Terms and conditions apply. This episode is also brought to you by "5-Bullet Friday https://go.tim.blog/5-bullet-friday-1/?utm_source=podcast&utm_medium=podcast&utm_campaign=podcast-sponsorship," my very own email newsletter, which every Friday features five bullet points of cool things I've found that week, including apps, books, documentaries, gadgets, albums, articles, TV shows, new hacks or tricks, and -- of course -- all sorts of weird stuff I've dug up from around the world. 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• 0:24Tim Ferriss?

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• 4:14Tim Ferriss?

  Hello, boys and girls, ladies and germs. This is Tim Ferriss and welcome to another episode of The Tim Ferriss Show where it is my job to interview people who are world-class performers in their respective fields. And today, my guest is Howard Marks, @howardmarksbook on Twitter. Howard is co-chairman and co-founder of Oak Tree Capital Management, a leading investment firm with more than $125 billion in assets under management. He is the author of the books Mastering the Market Cycle, subtitle Getting the Odds on Your Side, and The Most Important Thing, subtitle Uncommon Sense for the Thoughtful Investor, both critically acclaimed bestsellers. Warren Buffett has written of Howard Marks, quote, "When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something."

• 4:59Tim Ferriss?

  So, he has some very bright minds who pay attention to his writing. And Howard has been on the podcast before. This is round two, and we dig into all sorts of subjects, including the US dollar as reserve currency, investing, how to add defense to investment strategy, three different ways to do that, and much, much more. So, without further ado, please enjoy a wide-ranging conversation with Howard Marks. Howard, welcome back to the show.

• 5:28Speaker 00

  Thank you very much, Tim. It's a pleasure to be here.

• 5:30Tim Ferriss?

  It's nice to hear your voice again. And of all the people I could speak to on the show during these most exciting times and difficult times for many people, you are very much at the top of the list. And there are a lot of different topics and a lot of different questions that I'd like to cover, but I thought we could start. I have a number of your memos in front of me, and there's one called "You Bet." This is from January 13, 2020. And I thought we could start with the story of arriving at First National Citibank in

• 6:11Tim Ferriss?

  May of 68 and how that contrasted with what you then did in 1978. Would you mind telling that story for people listening?

• 6:21Speaker 00

  No, if you have some time.

• 6:22Tim Ferriss?

  I do, I have all the time in the world.

• 6:24Speaker 00

  It'll take a while. Um, well, as you say, uh, I arrived at Citibank for a summer job in the investment research department in May of nineteen sixty-eight, between years of graduate school at the University of Chicago. And I was assigned to the investment research department.

• 6:44Speaker 00

  Um, the

• 6:47Speaker 00

  bank and most of the money center banks at the time in their money management departments were adherents of what was called misty fifty investing. And they invested in what they considered to be the fifty best and fastest growing companies in America. Extremely high quality companies.

• 7:13Speaker 00

  Where nothing could go wrong. And, uh, you know, the, the, the, the idea of growth stock investing, investing in companies because their earnings grew rapidly had been born in the early nineteen sixties. And, uh, these, uh, companies epitomized that activity. Um, IBM, Xerox, Kodak, Polaroid, Merck, Lilly, Hewlett Packard, PerkinElmer, Texas Instruments, uh, Avon, Coca-Cola, uh, AIG, et cetera. And, um,

• 7:53Speaker 00

  you know, the, the basic idea was you hitch yourself to a company with a bright future and rapidly growing earnings. And, uh, if you, if you did so, the day I got there in nineteen sixty-eight, and if you held those stocks firmly for the next five years, you lost almost all your money. In the best comp- in the best companies in America. Because one thing had been overlooked in the process.

• 8:25Speaker 00

  Which was price. And nobody talked about the fairness or attractiveness of the price. The belief was that these are companies which were so good that it didn't matter what you paid. And if you paid a price that was a bit high, the earnings would grow so fast that kind of the stock would grow into the price. And so, of course, this was a painful education. The stocks, generally speaking, fell from price/earnings ratios of perhaps eighty, which

• 9:04Speaker 00

  even today would be practically unheard of, to eight when the wheels came off the market in the early nineteen seventies. Now, some of it, some of it was the collapse of the market, some of it was the collapse of these, this particular field of investing, and some was the function of the flowering of rapid inflation, which was perplexing the country at that time. But, but for whatever reason, here you are, you're, you're investing in the best companies in America, and you lose eighty or ninety percent of your money. Now, fast forward, as you suggest, Tim, to nineteen seventy-eight.

• 9:44Speaker 00

  In part because my meanderings with equities had worked out so badly as part of the machinery that, that ran this nifty-fifty effort, I left the investment research department. I always say I'm lucky I didn't get fired. And my boss asked me to join the bond department, which was at that time a backwater of investing, and start a fund that would invest in convertible bonds, which was something that very few people had ever heard of. And I started to do that, and I loved it. So I went from being head of the department of

• 10:28Speaker 00

  Seventy-five people with a five-million-dollar budget and membership on all the bank's senior investment committees to working alone with no colleagues, no budget, no committees, and I was ecstatic. Because rather than know two sentences on four hundred companies, I could know everything about a few. So I, I loved money management, and I loved the fact that I was operating in, in an uncrowded area. And then in August of nineteen seventy-eight, I got the call to change my life. The head of the bond department called up and he said, you know, there's a guy named Milken or something out in California, and he deals with something called high-yield bonds. Do you think you could figure out what that is?

• 11:10Speaker 00

  Because a client had asked for a high-yield bond portfolio. So I, I researched high-yield bonds. I met with Mike Milken. Um, I started Citibank's High-Yield Bond Fund late in nineteen seventy-eight. Uh, I believe that was the first high-yield bond fund from a mainstream financial institution. And that was the very beginning of the high-yield bond world. And one of the great lessons, of course, as Malcolm Gladwell makes clear in his book, uh, Outliers, is that it's great to be first in line. And the timing accident of my being assigned to the bond department in nineteen seventy-eight put me at the beginning of the line in high-yield bonds.

• 11:55Speaker 00

  And high-yield bonds are the bonds of companies which are not rated investment-grade. They're considered speculative grade by the rating agencies. At the time, they were verboten by the vast majority of investors. And so I went from investing in what everybody loved to what everybody hated. From the best companies in America to the worst public companies in America. And now I'm making money safely and steadily in the worst companies in America. Because they were so cheap.

• 12:32Speaker 00

  Because the interest rates they had to pay in order to secure financing as, as a, a disrespected group was excessive under the circumstances. So this was quite an epiphany. Um, and it has, uh, really directed my whole career.

• 12:57Tim Ferriss?

  And you've written in this particular memo, "Success in gambling doesn't go to those who pick winners, but to those with the ability to identify superior propositions. The goal is to find situations where the odds are generous to one side or the other, whether favorite or underdog. In other words, a mispricing." And you explore this in the context of different types of games, some games of chance, some games that have different profiles, and you can categorize them. You have, let's just say, no hidden information, no luck and skill chess, no hidden information, luck and skill backgammon, no hidden information, luck, no skill roulette, hidden information, luck, skill, blackjack and poker.

• 13:42Tim Ferriss?

  And you have quite a history with many different types of games, and you, I think, are very good at thinking about the future probabilistically, framing good questions. If you were to look at our current circumstances as a game and perhaps compare it to 2008, what are the games that we're looking at?

• 14:06Speaker 00

  Well, it's a very interesting set of circumstances we find ourselves in because nobody knows anything about the future. There's, you know, in the fields that I'm involved in, economics and investing primarily, there is no such thing as knowledge of the future because the future does not operate according to a fixed schedule or the laws of nature like physics and so forth. All we have is extrapolation from past patterns which help us in terms of our expectations for the future. The problem we have now is that there is no history

• 14:51Speaker 00

  for what we're engaged in. First of all, we have, I would say, the worst public health crisis to come to America in over 100 years, or certainly one of the worst. The worst economy since the Great Depression, more than 80 years old.

• 15:15Speaker 00

  The worst collapse of oil in history.

• 15:20Speaker 00

  And the greatest rescue and stimulus program from the Fed and the Treasury in history. So we have four things going on which are unprecedented. And as a result, we really can't say what lies ahead in any of them.

• 15:41Speaker 00

  And it is further complicated by the fact that they all interact. And we can't know how they will interact and what that will produce. So I would say that we are unusually ignorant with regard to the future today. And you know, one of the things I said to one of my colleagues, Tim, is that we all have the same information about the present and we all have the same ignorance about the future. And today, I think that ignorance is greater than at other times.

• 16:17Speaker 00

  So we have to, um, to use the outline you were posing, there's a lot of hidden information. We don't even know how many people really have it. We don't know how many people have died from it because there are unreported cases of infection and there are deaths that took place that were not known to be the result of infection. So we have, we have hidden information and we have so much about the future that we don't know. You know, will the disease turn down? Will the effect of warm weather be a positive?

• 16:59Speaker 00

  When will an immunological test be developed and a vaccine? If we reopen business, will the cases strike up again? And so forth and to what extent? So we are really dealing with a lot of ignorance and a lot of uncertainty. And yet we have to take action in positioning our capital for the future.

• 17:33Speaker 00

  When the future is unusually unpredictable.

• 17:36Tim Ferriss?

  And how do you, how are you currently thinking in bets, to use the title of the Annie Duke book that I know you are a fan of, or perhaps it's not the, the best way to address the, the question really, but given the uncertainties, given the situation, how are you trying to navigate that, or what questions you finding most helpful?

• 18:04Speaker 00

  Sure. Well, I think a lot of it goes back, Tim, to what you said about the memo you bet, is that it has to do with the quality of the proposition. I wrote a book, we talked about it a year and a half ago, called Mastering the Market Cycle. And I thought that the subtitle of that book was unusually helpful. The subtitle is getting the odds on your side. When you're dealing with the future, given the ignorance, you can never have certainty. There's nothing that's sure to work or sure to fail. You only have probabilities. But

• 18:46Speaker 00

  sometimes the probabilities are very favorable to the investor, and sometimes they are very unfavorable to the investor. And the whole thing about studying cycles is trying to figure out which is which. So let's, let's talk about propositions. And let's talk about picking winners. So you go to a horse race, and there's one horse that stands out among all the others. It's great lineage, looks terrific, great recent record, and this horse is by far the favorite.

• 19:27Speaker 00

  And everybody concludes that this horse will win the race. Does that mean that you should bet on this horse? That's really the key question in investing. And the answer is, it depends on the odds. Because when one horse is an overwhelming favorite,

• 19:50Speaker 00

  you may have to bet five dollars to win a dollar. He's so sure to win, but nobody wants to bet against him. And if you want to join the hordes who want to bet on that horse, as I say, you may have to put up five bucks to get back six. There may be a long shot in that race that somebody can figure out, well, maybe that horse is going to have his day. And that horse may be a ten to one shot. Or a fifty to one shot. Because we're so sure the favorite will win, that this long shot is absolutely unpredictable to win. Nobody wants to bet on this horse. So if you will bet on this horse, and you put up a dollar, you can get fifty, if you're right.

• 20:34Speaker 00

  So even though the horse is unlikely to win, it may be the better bet. Even though the favorite is overwhelmingly likely to win, it may be a bad bet. So it's not only what you think will happen, but it's also the payoffs. So let's take that through what we were just discussing. 1968, the Nifty Fifty companies were believed to be great companies with a bright future. And let's assume that their future success was assured. You still have to look at the proposition. And the answer is that it costs so much to bet on those companies that betting on what were believed to be good companies turned out to be bad bets.

• 21:20Speaker 00

  1978, high-yield bonds. Now we're betting on what are believed to be bad companies, but because they're believed to be bad companies, the payoff is extremely generous.

• 21:31Speaker 00

  Not expected to be favorites, but highly remunerative if they pay off. So high-yield bond investing was very successful. Um, now you come into the, into the present and, and life gets tough. But, you know, we have to make some judgments about the future. And the judgment, you have to, you have to say, how bad will it get now? How quickly will we go back to work? What will be the experience when we go back to work? Will there be a rebound in cases? How quickly will the economy come back to life?

• 22:14Speaker 00

  What will G N T do in the second quarter of this year? Which is roundly believed to be the worst recession quarter in history. Uh, and how fast will we get back to the 2019 levels of economic activity and surpass them? When will we have a vaccine? All the, you know, there, there are dozens of questions, um, and no answers. Um, I've been quoting, uh, Mark Lipsitch, who's a epidemiologist at Harvard, who says that when, in studying the virus, there are, there are facts.

• 22:53Speaker 00

  There are inferences based on analogies to other viruses and there are opinions. And when we started off in this round, there were no facts. The highly skilled epidemiologists could make inferences and the rest of us were left to just guess. But, you know, there's, there's some, um, consensus developing, which is that, you know, the, the country will go back to work in the next few months.

• 23:28Speaker 00

  Clearly, no agreement on the pace that there will be, there are likely to be a rebound in new cases, but not as bad as the first. And that gradually, the economy will recover and it'll show a much better 2021 than 2020. 2021 may or may not be back to the 2019 levels, but by 2022, we'll be back to or surpass the 2019 levels and with vaccines and treatments, the coronavirus will be demoted to just another

• 24:13Speaker 00

  seasonal disease. That's the consensus. And of course, the consensus opinion is reflected in the bidding for stocks and in the prices of stocks and other securities. And that's where we are now. And, you know, so that's, I would say, I would describe that as a fairly positive, forward-looking case. And it's incorporated in the prices of stocks. And the prices of stocks are surprisingly high, some of them, or if you look at the averages, which are dominated by, you know, the great companies like Amazon or Microsoft.

• 24:53Speaker 00

  Those averages, like the S and P 500, are surprisingly high relative to where they were on February 19th, which was the all-time high. And we're probably down, you know, low double digits of percent, 12, 13, 14 percent, depending on the date you air this. And so, you know, the way I've described it, I would say, not a bad outcome, not a bad future. And so, stocks have recovered very substantially from their lows.

• 25:30Speaker 00

  They're up 27 percent, I think, from their lows, because the consensus has settled on this good news. Now, the, now, let's talk for a minute, if I can go on, about proposition. The challenge today is that if the favorable unfolds and 2021 or 22 are

• 25:58Speaker 00

  healthy economically versus 19, nobody thinks the stock market has that far to go on the upside. And if the negative case unfolds and everything I've said so promisingly fails to materialize or materializes less and later than hoped, there are pessimists who think that the market has far to fall. And it's hard to choose between the optimistic and the pessimistic case. So the odds for buying here, the S and P 500, for example, do not seem to me to be tilted heavily in the investors' favor.

• 26:44Tim Ferriss?

  Now, you have been thinking about uncertainty for a very, very long time. You, for instance, first read a book in 1963 titled Decisions Under Uncertainty, subtitled Drilling Decisions by Oil and Gas Operators by C. Jackson Grayson Jr. And you've proven an ability to act on a sort of spectrum of uncertainty over the subsequent decades. And I think the way that you phrase questions is part of that. Questions to yourself, questions among your

• 27:24Tim Ferriss?

  team. And I just wanted to give an example of that from your most recent memo. This is Knowledge of the Future, and it's a paragraph that's discussing the word limitless, which was used, I think, in quoting Fed Chairman or someone of that type. And here's the wording. Is the program really limitless? And is that okay? The stimulus loans, bailouts, benefits and bond buying that have been announced thus far add up to several trillion dollars. What are the implications of the result in additions to the federal deficit and the Fed's balance sheet? Here's the part that I want to highlight just because I think it's a useful, I think it's a useful framework for looking at a lot of these, a lot of these elements.

• 28:09Tim Ferriss?

  Okay, so here we go. "To be facetious, the government could send every American a check for 1 million at a cost of 330 trillion. Would there be any negative consequences from doing this, such as burgeoning inflation, a downgrade of US creditworthiness, or the dollar losing its status as the world's reserve currency? If the answer is yes, is there a point below 330 trillion at which those ramifications might kick in? And if so, where? Could we be there already?" I'd be very curious to hear how you've attempted to answer or think about any of those things that were mentioned in that paragraph. We could pick one certainly if it's helpful, such as the US dollar, the status of the

• 28:49Tim Ferriss?

  dollar as a reserve currency in these wildly unusual times. But how have you continued to think about those questions or attempt to tackle some of those unknowns?

• 29:02Speaker 00

  Well, this is the $64 question these days, Tim. I want to make it clear before I try to do so that I'm not saying the Fed is wrong to do what it's doing. The Fed is throwing everything in the kitchen sink at the problem, and the problem has to be, has to be solved. You know, back, if I go back to March, let's say, 18 or 19, I think it was, you know, I was actively considering the possibility with my partner Bruce Karsh of a global depression comparable to the 1930s.

• 29:42Speaker 00

  And you recall that we had, we had a decade with unemployment in excess of 14% in the US and a total absence of growth and widespread suffering.

• 29:55Speaker 00

  And, you know, we were talking about the possibility of that as this economy contracted, imploded. So, the Fed and the Treasury came along. They threw everything at it. They used all the lessons learned in the global financial crisis of oh eight, oh nine. Things that were developed over the course of months at that time were implemented in weeks this time. And certainly, you know, I think it was the New York Times describing Jay Powell's statement as saying that the resources thrown at the problem would be limitless. And I think that's the right thing.

• 30:39Speaker 00

  Because the alternative, you know, back in the 30s, they were judicious in trying to fight the Depression, almost austere. And, as a result, a decade of suffering, a generation truly scarred. And, you know, arguably, we only got out of the Depression because of the arrival of World War II. We don't want to wait for that as a curative. So, I say strongly that the Fed and Treasury were right in doing what they did. But, the fact that there may be negative unintended consequences doesn't mean that they weren't right.

• 31:23Speaker 00

  But, you know, again, we are battling problems we've never seen before with weapons we've never seen before. And we certainly can't say that they don't have negative potential unintended consequences. We just, we don't know what they are. We would probably bear them nevertheless. But, for example...

• 31:53Speaker 00

  If the government floods, prints money, the normal reflex reaction is to say that if they print a lot of money, that causes the currency to be devalued. And that is a lockstep relationship that has always been considered. Now, in the last, you know, we've been running big deficits for a long time, and extremely big deficits in recent years. And yet, we don't have serious inflation, which is the normal sign of a currency being debased.

• 32:35Speaker 00

  If a currency is being debased and people think less of it, then if you want to buy a goat, you have to pay more dollars to get the goat, or a car, or a barrel of gold, or whatever, or, you know, a bunch of bananas. And in recent years, we haven't had inflation, even though we've been running huge deficits, vastly increasing the national debt and so forth. So, you know, economics is not a mechanical process, which works according to a schematic in a dependable fashion. And all the printing of money that has taken place in recent years has not brought on

• 33:19Speaker 00

  inflation. Inflation is supposed to work in response to the unemployment rate. The less unemployment there is in the country, the higher the inflation is supposed to be because there's less slack in the economy and the workers, for example, can demand higher wages. Hasn't happened. That was, this is something called the Phillips curve, and it's been having for sixty years, and just doesn't work. So, we don't know. But, you know, that's why I use that extreme and I said in the memo, facetious example. If the government sent everybody a check for a million dollars, and it cost three hundred

• 33:58Speaker 00

  and thirty trillion, would there be an effect on the value of the dollar, on inflation, et cetera? And you have to believe there would, or I have to believe there would, but... Where does the negative effect cut in, short of that? Since we're not going to do that. But, you know, the government is probably spending on buying securities and pumping into the economy, you know, close to 10 trillion this year. Is that enough to cause an impact? And the answer is, we don't know. But I would just say, you know, it's clear that we all have our biases and we deal with

• 34:40Speaker 00

  our uncertainty with regard to the future, implementing our biases. It's very hard to get away from that. And I worry. I'm not a dreamer, I'm not a Pollyanna, I'm not the person who says, "Oh, they'll find a solution." I worry. And so, you know, I worry that there will be some negative effects that I can't predict or describe or quantify. And so that would, among other things, tend to cause me to implement some caution.

• 35:13Tim Ferriss?

  And you're right, the Fed Chairman Jay Powell, his quote was, "When it comes to lending, we are not going to run out of ammunition," which was in the Wall Street Journal, that's on March 30th. What form might that caution take? Or perhaps more specifically, if we look at the Fed buying all sorts of things that historically would not necessarily be associated with purchasing junk bonds, distressed debt, et cetera. How does that affect your playbook and how you think about crowded versus uncrowded opportunities?

• 35:54Speaker 00

  Sure. So many things in that question require an answer. First, let me say that I think every investor has to make a choice. They have to balance offense and defense, just like a soccer team that a coach fields to play against another team. You know, you have to have the players on the field who, in totality, can both defend their goal and attack the other side's goal. So your portfolio, for the investor, has to strike a balance between trying to make

• 36:37Speaker 00

  money and trying to avoid losing money at the same time. And the way I dope it out, Tim, is to say that every investor faces two risks every day. The risk of losing money, which is obvious, and the risk of missing opportunity, which is a little more subtle. Now, you can eliminate either risk if you are willing to totally surrender to the other risk. So, I can, if you wanna, if you wanna eliminate the risk of losing money, you can put all your money into T-bills, and then you will miss all the opportunities. Or if you wanna make sure you don't miss any opportunities, you can make sure that

• 37:22Speaker 00

  all your investments are aggressive and yet there are no T-bills or cash, in which case you're exposed heavily to the possibility of losing money. So, most people compromise. Most people say, "Well, I don't wanna lose a lot of money, but on the other hand, I don't wanna miss all the opportunities, so I'm gonna strike a balance between offense and defense." That's what we all have to do, if we're not crazy. And so, the question is, how do you strike that balance today? And Oaktree, my firm, in recent years, has been concerned about the market and about

• 38:04Speaker 00

  the fact that we thought that it was exposed to significant uncertainties and risks, although we didn't enumerate pandemic, that asset prices were high, that prospective returns were low because interest rates in the environment have been so low for so long, and because a lot of investors were engaging in risky behavior in order to make a good return in a low-return world. So, you put all that together, and we thought that made the world a risky, low-return place in which one should emphasize defense over offense. And, and we did. We, we adopted a mantra, "Move forward but with caution," and that has guided us.

• 38:49Speaker 00

  Now, we are cautious investors, so when I say "with caution," I mean more than usual. And that's what we've done.

• 38:57Speaker 00

  Next question. How do you implement defense? And there are basically three ways that an investor can add to defense in his portfolio or her portfolio. The first, the obvious one, is you sell some assets and you go to cash in part or in whole. Now, this is very hard to do because this is black or white, wrong or right, and rarely is it right to be overwhelmingly in cash. And on the rare occasions when it's right, most people can't find those occasions. So going to cash is problematic.

• 39:40Speaker 00

  And by the way, if you go to cash and you're wrong and you miss good performance in the market for a couple of years, you know, the individual investor will rue the day and the professional investor might be out of work. So cash is tough. The next thing you can do is you can go into more defensive asset classes. We know what they are. More bonds rather than stocks, larger companies rather than small, value rather than growth, stable rather than cyclical, US rather than foreign, developed world rather than emerging. And, you know, there are many, many ways to increase the defensiveness of your asset

• 40:25Speaker 00

  allocation. And then the third form of going defensive doesn't even require you to disturb your asset allocation. It's just that everything you want to do in investing can be done in a more aggressive or more defensive way. So you might say, well, I have 40% of my portfolio in stocks and I want to keep it that way. But you can buy more defensive stocks.

• 40:50Speaker 00

  Or you can put your money with a more defensive manager. Or you can put your money in a mutual fund which has a record of not making so much money in the up years, but protecting money in the down years. So there are three ways to be defensive. Go to cash, take a more defensive asset allocation, or use more defensive tactics. And we've been doing the latter. Our asset allocation is assigned, our clients give us money and they say, here, put this in this, or put this in that. For the most part, we don't choose our asset allocation. But what we've been doing is, in recent years, we have been fully invested.

• 41:31Speaker 00

  And so we participated as the market rose, but with a portfolio that we think was more defensive than most. And so we came into this virus episode with a higher quality, more defensive portfolio. And that stood us quite well in the first quarter. But frankly, with the risks on the table, and a lot of securities now cheaper than they used to be, and a lot of risky behavior now discouraged, I don't think one has to be as defensive as we were.

• 42:11Speaker 00

  So we have shifted the balance in our portfolios, moved more on to offense to take advantage.

• 42:19Tim Ferriss?

  And if you're looking towards offense, capitalizing on some of your historic strengths, what does the, how does the Fed purchasing all sorts of asset classes that it might not normally purchase affect how you look at those opportunities?

• 42:39Speaker 00

  Sure. That was part of your original question, which I forgot. But, well, you know, as should be clear, you know, we're specialists in non-guilt edge debt. Gilt edge is an old fashioned term, non-investment grade debt, speculative grade debt. And, um, you know, that means high yield bonds, uh, leveraged loans, convertible bonds, which I mentioned before, um, you know, emerging market debt, lots of, lots of, um, let's say, less than stellar quality debt. And usually, in a crisis like this, that stuff would be hurt more than most, which meant

• 43:23Speaker 00

  that we could pick it up cheaper than most. Perhaps our, one of our flagship strategies is investing in distressed debt. The debt of companies that are either bankrupt, in default, or highly likely to be, in the opinion of the market. And we've been investing in distressed debt, uh, since nineteen eighty-eight. Uh, my partner, Bruce Karsh, joined me in eighty-seven. He's been running these portfolios since then. And, uh, in the thirty-two years, there were five periods, uh, when there were very high defaults among high yield bonds, a lot of distress, and when we got to, uh, take advantage of very good opportunities.

• 44:05Speaker 00

  And those were nineteen ninety, ninety-one, two thousand and one, oh-two, and oh-eight. Those were crisis years. And in the crises, the low-quality, risky debt tended to melt down, and we tended to get great buying opportunities. So your question is, well, what does it mean that the Fed is involving itself in these areas? And the answer is, it's, we, we wish they'd go away. Uh, you know, because, because it, you know, historically, in, in negative times, uh, and this is something we haven't discussed much, but maybe we should, uh, most people get discouraged. Most people, uh, shrink to the sidelines. And, uh, you know, when, when, when these things would cascade down in price, we would

• 44:50Speaker 00

  be able to buy them very cheaply. If the Fed comes in and buys in those markets, then it makes our lives more difficult, because things don't fall the way they otherwise would have. We don't get the bargains we otherwise would have.

• 45:05Tim Ferriss?

  When you look, uh, well, I mean, I, I want to ask if you think the Fed is truly with infinite ammo. I mean, I don't know if they have the, the sort of bandwidth to participate super widely indefinitely in high volume, but possibly they do. This is way outside of my area of expertise. So it's a bit above my pay grade, but where would you, thinking probabilistically, where would you, how do you look at the possible outcomes and probabilities that this type of spending continues for a long period of time?

• 45:43Speaker 00

  I think that they, the, the Fed and the Treasury want to soften the impact on America and its economy. And I think they're going to continue to spend, um, until the economy is, can take over for itself. I think one way to think of this, Tim, is that, you know, many times if a patient has a serious disease, they'll put the patient into a coma so that they can treat the disease. And while the patient's in the coma, they keep them on life support. And then when the patient is, the disease has been healed, the patient

• 46:23Speaker 00

  can be brought back and the life support can be removed. So the disease is the virus. In order to fight the virus, we had to close businesses, freeze economic activity and help people stay home. So stores, movies, and hotels, and airlines, and concerts, and sports all stopped cold. And that's putting the economy into a coma. And we have 26 million people who have filed for unemployment insurance in the last five weeks. And we are expecting

• 47:05Speaker 00

  a decline of GDP, uh, in the second quarter here of, uh, well, most people say 20 to 30%, which would make it the worst quarter in history by a order of magnitude. So they have to. Keep it on life support until they can bring the economy back. And the life support is all this injection from the Fed and the Treasury. And they're going to continue it until they're highly confident that they're out of the woods. They're not going to take a chance and say, well, if we let's let's suspend it now and see if the economy can pick up. They're going to wait until the economy is operating with some strength and growing

• 47:50Speaker 00

  from this depressed base before they withdraw it. I'm confident of that.

• 47:55Tim Ferriss?

  What are the, as someone who's, I I've never taken an economics class, which is not something I brag about, it's quite something, a source of embarrassment for me, but what are the markers or metrics that they would look to to assess whether the patient can be taken off of life support?

• 48:14Speaker 00

  Well, unemployment is is usually the best short term indicator. You know, remember that unemployment reached 10% in the global financial crisis. And it was down to 5%. Five, five to five and a half is is has generally been considered something like a structural level of unemployment. In other words, there are people, there are some people who can't get a job because they're unqualified. There are people who can't get a job because they can't pass a drug test. There are people who just quit a job. There are people in the process of looking for a job. So transactional frictionally, most people assume that five, five-ish percent is is is structural.

• 48:57Speaker 00

  And the Obama administration, over eight years, did get the unemployment rate, I believe, down to 5% by 2016. And then the Trump administration came in and continued very aggressive stimulus, pro-business environment, reduction of regulation, and the unemployment got down to three and a half. So it's a barometer of how the economy is doing. And I would think that the they'll want, well, it's, you see, it's not going to be all or nothing. It's not, they're not going to spend, spend, spend, and then stop. They'll slack off.

• 49:37Speaker 00

  The term we use in the in the discipline you never studied, economics, is taper. And they'll taper. But, you know, I think that they'll support the economy certainly.

• 49:51Speaker 00

  Aggressively until the unemployment rate gets into single digits and perhaps until it gets into mid-single digits. And then, of course, they'll look at GDP. They'll, you know, uh, GDP's been growing at around 2% and Donald Trump has been trying to say he'll get it to 3 or 4. Um, but GDP will be deceptive because, you know, it's gonna be so horrible in the second quarter of 20 that it's gonna be easy to show growth in the second quarter of 21. But we, we have to take that growth with a grain of salt. And I think what they'll look for is for the GDP to be getting close back to the track

• 50:32Speaker 00

  that it was on if this virus hadn't, uh, developed.

• 50:37Tim Ferriss?

  You're, uh, you, you've listed some questions that, uh, debt traders on the Oak Tree team, Justin Quaglia, if I'm saying that correctly, Sam Rotondo.

• 50:47Speaker 00

  Right, yep.

• 50:48Tim Ferriss?

  That are related to behavioral change, uh, more than anything else. So assuming that quarantine is lifted, when will you take your first flight? How will you react when the person next to you starts coughing? What has to happen to make you feel it's safe to send your child back to school? Uh, one of my favorites is the, when you go to a dinner with your wife, husband, friend, family, do you want to be served by a waiter or waitress wearing mask and gloves? Uh, so, so these are behavioral questions and, uh, you seem to be a connoisseur of questions. And I, I wanna bring up a quote that also was, uh, featured in the "You Can't Predict, You Can Prepare" memo, which was, "What the wise man does in the beginning, the fool does in the end."

• 51:31Tim Ferriss?

  And these, these might not be totally, uh, apples to apples, but what types of questions are the wise asking these days? Are, are any particular types of thinking or questions, uh, present in those people you had, you admire as good thinkers right now?

• 51:55Speaker 00

  You know, the future, the outlook for the economy has been mostly described as a V. Sharp down in the first and second quarter of 2020, maybe some lingering effects in the third, and then sharp up. And, you know, there's a lot of debate about how sharp the recovery will be. You know, I think, I personally think we're going to come back gradually. I think that people who have a choice are not going to rush back to work. One of the questions that you didn't ask from that memo, Tim, was mine for a New Yorker. When are you going to get back on the subway?

• 52:36Tim Ferriss?

  Right, that's a great question.

• 52:38Speaker 00

  And be in close contact with all those other people. And, you know, taking an airplane flight is a big deal because, you know, they want you to be six feet away from the next person. And I, the way I calculated it, at best, you could have one person for every nine seats. And they're not going to do that. Of course, they'll fill the seats, and they'll have people wearing masks. But, you know, I think that people who have a choice are going to wait a while before they get on a full airplane. And another question, of course, is assuming that there is a reopening and assuming that

• 53:18Speaker 00

  the virus hasn't been killed off, and we don't have yet a vaccine, will people engage in their previous activities? I think that people who have a choice will not rush back. And then, I read about one state that passed a rule that restaurants can reopen, but only one out of every four tables can be occupied. But also, an article yesterday, which said that a business which is operating at a low level of its capacity is probably not more profitable than it was when it was closed.

• 53:56Tim Ferriss?

  Yeah, that's definitely true. That's definitely true here in Austin. A lot of restaurants are opting not to open with 25% capacity.

• 54:05Speaker 00

  Right, right. So, you know, the...

• 54:10Speaker 00

  The expectation that we're gonna come back is probably right, but nobody knows the pace. Uh, and these are important questions to ask. Um, but, you know, one of these days, I assume, I assume we'll have a vaccine. It's not easy to produce three hundred and thirty million doses and get them in- into distribution. Or if we need to, like you do for shingles, for example, there's six hundred and sixty million doses. And, um, you know, these are massive issues and they don't happen overnight. Um, and then, of course, um, you know, we have, uh, large numbers of people who don't,

• 54:53Speaker 00

  you know, only, only half of Americans, I think, get flu shots. Uh, where, where flu shots are, where flu kills a lot, you know, kills a lot of Americans. I think flu probably averages forty to fifty thousand deaths a year, and yet only half the people get the shots. Um, will people get the shots? Uh, and, um, you know, there's a, there's an anti-vaccine, uh, cohort in America, and, and will they get them and so forth? And if they don't, what does it imply for everybody else? So, I just think that it's, you know, when, uh, what I say about these unprecedented events, Tim, is that if you haven't seen something happen in the past, you can't say you know how it's gonna turn out.

• 55:37Speaker 00

  And we have to, we have to allow windage. Now, a warrior like me allows for the possibility of bad outcomes. An optimist wants to make sure he contemplates the possibility of good outcomes, surprisingly good outcomes. And so, uh, that's why we have differences of opinion, that's, uh, uh, that's why, uh, you know, that we have markets in which people can, can meet and express their opinions through price.

• 56:10Tim Ferriss?

  Just a few more questions, Howard. I appreciate all the time today. The question of informational filtering is one I'd like to chat about for a second. What I mean by that is how do you choose amongst a deluge of possible books, articles, sources of information, what you read these days, for instance? Or a better question is probably, what are some of the higher signal sources of information? Books, people, anything that you're paying attention to these days?

• 56:41Speaker 00

  Well, you know, there are no, I don't think there are useful topical books on the subject of this episode yet. It's too new. We have to, you know, always review our thinking, how we think about propositions and odds and bets and probabilities and how we think about making decisions under uncertainty and these kinds of things. And you've talked about some of those. You know, I think that we all have to take in a lot of input, primarily through the newspapers. And of course, we have to be aware of the biases of the newspapers.

• 57:24Speaker 00

  When I was a boy, I used to believe that if it was in the newspaper, it was true. But, you know, newspapers have slants too. And then importantly, we have to be very aware of our own slants. And, you know, we tend to, we have what's called confirmation bias. And we all tend to read the things we agree with, more than the things we disagree with, and believe the things that support our biased position, more than the things that throw it into question. And this is a, this is a great challenge. So we should try to read broadly.

• 58:06Speaker 00

  We should try to read from the newspaper whose editorial slant we agree with and the one we disagree with. And we should try to appreciate all the input. But I think it's, this is a great challenge. And...

• 58:25Speaker 00

  You know, if you, if you, if you read broadly and everybody on the, on the internet, every, every brokerage and securities house is putting out its own COVID report nowadays. And you see such disparate information. By the way, there are probably, I don't know, we've been, you've been talking to me about questions today, Tim. There are probably a hundred or two hundred, three hundred questions that bear on the future and nobody can take them all into account. So which ones do you think about? Well, number one, your selection of the questions to ponder will be shaped by your bias, uh, because you can't do them

• 59:09Speaker 00

  all. So, you know, it's, it's, it's a terribly challenging thing. Uh, and, um, I think a lot about bias. Um, and, uh, let's go back to what I said earlier, uh, quoting Professor Lipsitch of Harvard. Facts, analogies, guesses. Um, you know, when I read layman, investment people, talking about the likely medical course of developments, you know, I, I say,

• 59:50Speaker 00

  well, where's their expertise? But, you know, everybody has an opinion and you can't argue you're right, but on the other hand, you can't say, well, I, I'm not an expert, so I'm not going to have an opinion. And, uh, you know, it's very, very difficult to decide these things in a uniquely uncertain environment like today's.

• 1:00:15Tim Ferriss?

  Well, Howard, I, I, I really appreciate you carving out time for the conversation. Uh, I, I think that we could cover a thousand additional topics, but I'll just ask one more or maybe two more, and that is, what would you hope people would think more about? Uh, or what aren't people paying enough attention to in your mind? Is, does anything, does anything occur to you?

• 1:00:41Speaker 00

  Well, just in, in the narrow field of investing, um, you know, most people want to hear somebody like me say buy or sell. Uh, but it's, it's a much more nuanced question than that. Uh, you know, uh, you, uh, the, the, the person who wants advice has to think for themselves. Do I want to put a lot of emphasis on making sure I don't lose money? Or do I want to make a lot of, put a lot of emphasis on making sure that I take advantage of the opportunities? And those two things work in opposite directions, as I explained before. So, the, the, the person has to decide for themselves, uh, how they feel about these things.

• 1:01:26Speaker 00

  Now, they can, uh, they can ask for advice, but, uh, they, everybody has to, uh, uh, decide this on a personal basis. And, uh, the other thing is whether you should buy or sell has a lot to do with, uh, nu- number one, your current position. So, I, I mentioned that, that Oaktree became more aggressive because we had been very defensive. If you have been aggressive until now, that doesn't mean you should necessarily become even more aggressive. So, you know, what's, what's, uh, becoming, increasing aggressiveness for us may not be right for everybody.

• 1:02:08Speaker 00

  And then the other thing is, is, uh, the investor has to ask themselves and be tough on themselves to spec out what their timeframe is. Because, you know, if you say to me, how, how are we going to look in five years? I think in five years, we're going to be okay. And so, you know, if you, if you said to me, I'm going to put on a position today and I'm not going to look at it for five years, I'd say, okay, well, then you, you should have a pretty normal, non-defensive investment posture. If you're going to look every day.

• 1:02:43Speaker 00

  And if you're going to get upset if the market goes down, then you might want to have a little more defensiveness than normal. So, again, the same answer is not right for everybody because it depends on their ability to take a long-term view rather than short and their ability to live with the agita of short-term ups and downs.

• 1:03:06Tim Ferriss?

  Well, thank you very much, Howard. People can find you on Twitter at Howard Marks Book. Certainly, I'll link to your writing, to your book and everything else in the show notes, including any of the memos and references that we made in this conversation. Is there anything else you would like to add or anything else you would like to suggest that people take a look at?

• 1:03:32Speaker 00

  No. You know, Tim's good to link to all the memos. There's 30 years' worth in the archive at oaktreecapital.com. It's free, so you can... The price is right and you can look at what I was thinking at various points in time in the last 30 years. I want to thank you, Tim, for inquiring about these things and asking such good questions. These are difficult topics. They're even difficult to frame the questions. And I want to apologize for the length of my answers, but there are never easy answers and that's especially true today. So, thank you for having me with you.

• 1:04:12Tim Ferriss?

  Oh, my pleasure, Howard. And to everybody listening, as always, everything will be in the show notes, tim.blog/podcast. And until next time, thanks for tuning in. Hey, guys, this is Tim again. Just a few more things before you take off. Number one, this is Five Bullet Friday. Do you want to get a short email from me? Would you enjoy getting a short email from me every Friday that provides a little morsel of fun before the weekend? And Five Bullet Friday is a very short email where I share the coolest things I've found or that I've been pondering over the week. That could include favorite new albums that I've discovered. It could include gizmos and gadgets and all sorts of weird...

• 1:04:53Tim Ferriss?

  Shit that I've somehow dug up in the world of the esoteric as I do. It could include favorite articles that I've read and that I've shared with my close friends, for instance, and it's very short. It's just a little tiny bite of goodness before you head off for the weekend. So if you want to receive that, check it out, just go to fourhourworkweek.com. That's fourhourworkweek.com all spelled out and just drop in your email and you will get the very next one. And if you sign up, I hope you enjoy it. This episode is brought to you by LinkedIn Jobs. Now more than ever, businesses are grappling with incredibly challenging times. A lot of things in life and business are changing and we're all adapting to new priorities.

• 1:05:36Tim Ferriss?

  While it does take time to adjust, LinkedIn believes that it's also possible to find and create opportunities in times of turbulence and times of change. Whether you're looking to hire now for a critical role or thinking about needs that you might have in the future, LinkedIn Jobs can help. LinkedIn is an active community with more than 675 million members worldwide. LinkedIn screens candidates for the hard and soft skills you're looking for while putting your job in front of candidates looking for job opportunities that match exactly what you have to offer. With LinkedIn, you can hire the right person quickly when you need them. And if you need to hire for healthcare or essential services, you can post your jobs for free right now. When it's time to find and hire that right person, LinkedIn is here to help.

• 1:06:20Tim Ferriss?

  Just visit LinkedIn.com/Tim. Again, that's LinkedIn.com/Tim to post a job now. Terms and conditions apply.