Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: Hello and welcome to another episode of the All Thoughts podcast.
Speaker 2: I'm Tracy Allaway and.
Speaker 3: I'm Joe Wisenthal.
Speaker 2: So, Joe, we recently recorded an episode with Kevin Muhror
Speaker 2: where we were talking about concentration risk in stock indices,
Speaker 2: and I guess historical analogies with the dot com bubble
Speaker 2: of the two thousands, and I know that this is
Speaker 2: one of your favorite subjects. I think I said it
Speaker 2: was like your own personal catnip. That's right, And so
Speaker 2: I thought, you know what, I did not get Joe
Speaker 2: a Christmas present this year. In fact, I don't think
Speaker 2: I've ever gotten you a Christmas present, But wouldn't it
Speaker 2: be nice if I got him a whole episode where
Speaker 2: we're talking to one of the world's most famous investors
Speaker 2: who correctly call the Internet bubble.
Speaker 3: Let's do it. Let's jump right into it. No more intro.
Speaker 3: I'm so thrilled about this conversation. Let's just get it started,
Speaker 3: all right.
Speaker 2: I will also admit this is a belated Christmas present
Speaker 2: to myself as well. So we are going to be
Speaker 2: speaking with Howard Marx. He is, of course the co
Speaker 2: founder and co chair of oak Tree Capital Management. He's
Speaker 2: famously a credit investor, but he did call, as I said,
Speaker 2: the dot com bubble correctly. So Howard, thank you so
Speaker 2: much for coming on the show.
Speaker 4: It's a pleasure to be with you. Tracy, and also Joe.
Speaker 2: Maybe just to begin with give us some context around
Speaker 2: what the early two thousand's late nineteen nineties were like
Speaker 2: for you. What were you doing and what were you
Speaker 2: observing at that time?
Speaker 4: Well, the nineteen nineties were a slow time for credit investors.
Speaker 4: We're kind of opportunistic and bargain hunters, and bargains come
Speaker 4: from dislocation and you know, people feeling urgency to get
Speaker 4: out of positions. And the nineties were generally a placid period,
Speaker 4: except for the around ninety eight we had the evaluation of
Speaker 4: the Russian ruble and a Southeast Asian crisis, and we
Speaker 4: had the meltdown of a highly levered hedge fund called
Speaker 4: Long Term Capital Management. But those were all kind of
Speaker 4: vidiosyncratic events, not macro and not broad based. Other than that,
Speaker 4: the investment environment was placid. Importantly, it was the best
Speaker 4: decade in history I think for stocks and the S
Speaker 4: and P five hundred rows an average of twenty percent
Speaker 4: a year for ten years, which is an astronomical an
Speaker 4: astronomical accomplishment. If you rise twenty percent a year for
Speaker 4: ten years, I would guess that something goes up roughly
Speaker 4: eight times in ten years, which is incredible. And of
Speaker 4: course this was all powered by the what we call
Speaker 4: the TMT bubble, tech media and telecom bubble, some people
Speaker 4: call it the Internet bubble, which prevailed in ninety eight,
Speaker 4: ninety nine and into two thousand. So it was hot times,
Speaker 4: not for credit investors, hot times for equity investors.
Speaker 3: You know, you recently wrote a memo that called back
Speaker 3: to a memo that you had written basically exactly twenty
Speaker 3: five years ago. So right at the start of two thousand,
Speaker 3: of course, the dot com bubble or the TMT bubble peaked,
Speaker 3: I think it was in March of that year. You
Speaker 3: got the timing right. And that's sort of extraordinary because
Speaker 3: there were a lot of people probably starting in nineteen
Speaker 3: ninety eight, the nineteen ninety nine, maybe even earlier, like
Speaker 3: this is ridiculous. There's all these companies they literally don't
Speaker 3: have a penny in earnings, or perhaps don't even have
Speaker 3: a penny in revenue, they just have the name dot
Speaker 3: com in their name. They ipo at crazy prices. What
Speaker 3: is the experience like? I mean, that was very fortunate
Speaker 3: timing on your part, But there were a lot of
Speaker 3: people who you know, were famously correct in early and
Speaker 3: they had clients abandoned them and so forth, and they
Speaker 3: thought it was like, oh, you don't understand the new paradigm,
Speaker 3: et cetera. What's that like in the years before that,
Speaker 3: as it feels like the market is becoming increasingly untethered
Speaker 3: from any sort of reality and yet there's no payoff
Speaker 3: in being correct, right.
Speaker 4: Well, there's so much to say in response to your question.
Speaker 4: You know, I use a lot of quotes and adages
Speaker 4: and when I write, because you know, other people have
Speaker 4: said things so much better than we can. And one
Speaker 4: of the first adages I learned in the early seventies
Speaker 4: was that being too far ahead of your time is
Speaker 4: indistinguishable from being wrong. So yeah, it's painful to say
Speaker 4: something and predict something and then have to wait years
Speaker 4: and years for it to come true. Alan Greenspand famously
Speaker 4: said I think it was in ninety six that we're
Speaker 4: beginning to see signs of irrational exuberance in this, and
Speaker 4: of course the market went straight up for the next
Speaker 4: four years. And you know, there are people who pronounced
Speaker 4: that we were in a stock market bubble. I think
Speaker 4: I can think of one in June of twenty twenty,
Speaker 4: and here we are almost five years later. And of
Speaker 4: course we did stall out in twenty two. But if
Speaker 4: you went out in twenty and weren't smart enough to
Speaker 4: come back in in twenty two, you've missed a big ride.
Speaker 4: So I think, well, you know, one thing I argue
Speaker 4: strenuously Joe, is that in the investment business there's no
Speaker 4: place for certainty. And Mark Twain said, it ain't what
Speaker 4: you don't know that gets you into trouble. It's what
Speaker 4: you know for certain that just ain't true. And so
Speaker 4: you can have opinions, but you should never be certain
Speaker 4: that you're right, and you should never arrange your financial
Speaker 4: affairs on the assumption that your forecast is right, because
Speaker 4: it can be right intellectually or factually irrationally, but just
Speaker 4: take a long time to materialize. And if you can't
Speaker 4: survive between when you take your position and when it
Speaker 4: when your expectation comes true, then obviously it's not something
Speaker 4: you should do. And one of my colleagues once wrote
Speaker 4: a note to his clients. He says, if you name
Speaker 4: a price, don't name a date. And if you name
Speaker 4: a date, don't name a price.
Speaker 2: That's anybody advice or journalist too.
Speaker 4: But anybody who names a price and a date is
Speaker 4: probably going to get carried out of there sooner or later.
Speaker 2: So what was it like then when you hit the
Speaker 2: published button on the note? I think it was called
Speaker 2: bubble dot com and you published it. I think it
Speaker 2: was right at the start of January first. Still, what
Speaker 2: was it, Yeah.
Speaker 4: January, It was January second, two thousand. It was the
Speaker 4: first business day of two thousand.
Speaker 2: And then start later that month.
Speaker 4: Right, yeah, No, I think a little later that year.
Speaker 4: Joe said it was in March. I don't remember exactly.
Speaker 4: I thought it was a little later than that. But
Speaker 4: you know, i'd started writing these memos in nineteen ninety
Speaker 4: I've been writing for ten years. Of course, in those
Speaker 4: days they went out in the mail and to a
Speaker 4: limited audience, just my clients, and you know, for ten
Speaker 4: years I never had a response. And then I spent
Speaker 4: the fall of ninety nine working on this memo bubble
Speaker 4: dot com and was ready to push the button. I
Speaker 4: guess I polished it over Christmas probably and sent it
Speaker 4: out the first day. And you know, let me just
Speaker 4: clarify one thing for the record and for the benefit
Speaker 4: of the listeners. If you read that memo, it does
Speaker 4: not predict the bubble, and it does not say you know,
Speaker 4: the market's going to collapse. All it did is describe
Speaker 4: the current conditions. And that's two different things. Now. I
Speaker 4: don't make predictions. I only describe current conditions. And my
Speaker 4: motto is we never know where we're going, but we're
Speaker 4: sure as help or to know where we are. And
Speaker 4: I believe, you know, this is a little bit of
Speaker 4: a matter of semantics. I believe that where we are,
Speaker 4: if we properly assess it, informs where we're going. But
Speaker 4: I think people who waste their time figuring out making predictions,
Speaker 4: which I'm strongly against, are wasting their time. I think
Speaker 4: that describing current conditions can be done accurately and obviously
Speaker 4: has an impact on what the future holds. So as
Speaker 4: I say, read the memo, I think it reads well
Speaker 4: in retrospect, but don't expect to find a place where
Speaker 4: I say, get out of the market or the market's
Speaker 4: going to collapse or there or in a bubble that's
Speaker 4: going to pop. What I say there is I just
Speaker 4: want to call your attention to all these forms of
Speaker 4: excessive or overheated behavior and let you know what I
Speaker 4: think is going on. That's all it says.
Speaker 3: So in the art of just identifying where we are,
Speaker 3: and when we're talking about financial markets, obviously we can
Speaker 3: use all kinds of ratios, etc. You know, price to earnings,
Speaker 3: price to forward earnings valuations, a million different ratios that
Speaker 3: you can come up with. And then you know there
Speaker 3: are sort of cultural markers. And I remember in summer
Speaker 3: ninety nine, I would get lunch every day at the
Speaker 3: same pizza shop with the pizza shop owner head CNBC
Speaker 3: on and he was trading tech stocs at the time,
Speaker 3: and these other sort of indicators that people are just
Speaker 3: excited about the prospect of making money and making money fast.
Speaker 3: And when you do an assessment and you say, okay,
Speaker 3: here's where we are, how much do you sort of
Speaker 3: hew strictly to the math, so to speak, and how
Speaker 3: do you systematically incorporate other indicators of exuberant which perhaps
Speaker 3: can't always be captured on a Bloomberg terminal for example.
Speaker 4: No, look, I think you're absolutely on the right track, Joe.
Speaker 4: You read the memo. My observations are, I would say
Speaker 4: ninety nine percent what you call cultural markers, which I
Speaker 4: think is great, or behavioral indicators, and one percent math.
Speaker 4: And to me, it's the behavior that is so indicative.
Speaker 4: And in my first book, which is called The Most
Speaker 4: Important Thing, I have something in there called the poor
Speaker 4: Man's Guide to Market Assessment, and it really takes culture,
Speaker 4: mostly cultural markers, and puts them on in two columns
Speaker 4: left and right, and whichever column is prevailing, it tells
Speaker 4: you something. And for example, I say in there that
Speaker 4: if people like me are being invited to cocktail parties
Speaker 4: and are the center of attention and so forth, then
Speaker 4: it probably means that investing is has been doing well
Speaker 4: and everybody's optimistic about it. And it indicates that maybe
Speaker 4: things are too hot, and if people like me are shut,
Speaker 4: not invited, or shunt it off to the corner, maybe
Speaker 4: the markets are too cold, too cheap, and it's time
Speaker 4: to strike. So I think that these behavioral indicators are
Speaker 4: extremely important. And I wrote a memo in I think
Speaker 4: it was the summer of twenty three called taking the Temperature,
Speaker 4: and I describe what I do in this regard as
Speaker 4: taking the temperature of the market to figure out if
Speaker 4: it's hot or cold. And when I was working on
Speaker 4: my second book, which is called Mastering the Market Cycle,
Speaker 4: and I was speaking with my son Andrew, who is
Speaker 4: a venture capitalist, I said to him, you know, I
Speaker 4: think my forecasts over the course of my career have
Speaker 4: been about right. And he says to me, yeah, that's
Speaker 4: because you did it five times in fifty years. Five
Speaker 4: times in fifty years, I found the market either so
Speaker 4: crazy high or crazy low that you could make a
Speaker 4: logical case that was either overextended or too cheap, and
Speaker 4: you could do so with a high degree of confidence.
Speaker 4: And I recount the five times I did it and why.
Speaker 4: But you know, if I had tried to do it
Speaker 4: five hundred times or five thousand times in my career,
Speaker 4: I mean I've probably been in an investment business for
Speaker 4: about almost twenty thousand days. If I tried to do
Speaker 4: it five thousand times every fourth day, you know, I'd
Speaker 4: probably be fifty to fifty at best. So to me,
Speaker 4: it's noting extremes of behavior. And that's what I was
Speaker 4: doing with bubble dot com. And that's what I did
Speaker 4: in the five other observations.
Speaker 2: So you've emphasized that you're describing current conditions, not necessarily
Speaker 2: making predictions. I'm curious how you translate those, you know,
Speaker 2: let's say, accurate assessments of the current environment into actionable
Speaker 2: investments or I guess another way of asking this is,
Speaker 2: you know, if you're looking at stocks and thinking they're
Speaker 2: overvalued or there might be signs of overvaluation, how does
Speaker 2: that translate into the credit space?
Speaker 4: Good question, Tracy. To me, the main access along which
Speaker 4: one establishes one's behavior as an investor is the access
Speaker 4: that runs from aggressive to defensive. Each of us should
Speaker 4: figure out based on our personal conditions, our wealth, our income,
Speaker 4: our needs are dependents, our age plans, et cetera, and
Speaker 4: also ability to withstand fluctuations. Each of us should figure
Speaker 4: out what our normal risk posture should be. Normally, should
Speaker 4: I be a low risk person normal or a high
Speaker 4: risk person? And then you should build the portfolio that
Speaker 4: responds to that decision. But then you might try to
Speaker 4: vary your position from time to time as conditions in
Speaker 4: the markets change. And I believe that as I said
Speaker 4: that the main access along which one should should think
Speaker 4: about varying one's position is between offense and defense. So
Speaker 4: you know, you establish a position which is your normal position,
Speaker 4: which has a certain amount of aggressiveness, is a certain
Speaker 4: amount of defensiveness. But then are there times when you
Speaker 4: should become more aggressive and are times when you should
Speaker 4: become more defensive. And that's what I did on those
Speaker 4: five occasions. And I'll give you an example. And by
Speaker 4: the way, these are all described in Taking the Temperature.
Speaker 4: And I've mentioned or you've mentioned the memos from time
Speaker 4: to time, and I just want to note for the
Speaker 4: listeners that they're all available at Oaktreecapital dot com under
Speaker 4: the heading of Insights. There's thirty five years at worth
Speaker 4: of memos. There about two hundred and there's no price
Speaker 4: of admission. They're all free and anybody wants to sign
Speaker 4: up for a subscription can do so. But you know,
Speaker 4: in Taking the Temperature, I described the way in nine
Speaker 4: in five oh six, I was getting really leary of
Speaker 4: the markets. What was my indicator, my indicator, or as
Speaker 4: Joe would say, my cultural marker. My indicator was that
Speaker 4: I'm reading in the in the paper about new deals
Speaker 4: that are getting done, and the deals were crazy deals,
Speaker 4: deals that in my opinion, should not get done. They
Speaker 4: were too good for the issuer and in my opinion,
Speaker 4: too bad for the investor. And the deals were getting
Speaker 4: done anyway. And you know, one of the investor's main
Speaker 4: jobs is to decline to engage in stupid deals. And
Speaker 4: you know, if somebody comes and says, you know, I'm
Speaker 4: going to sell you a gold mine and if you
Speaker 4: can put up a million dollars, you're going to make
Speaker 4: one hundred thousand dollars a month for the rest of
Speaker 4: your life. Your job is to say no, that's too
Speaker 4: good to be true. Or you know, if I say,
Speaker 4: I think there's a gold mine in Australia and if
Speaker 4: you put up a million dollars, it'll probably give you
Speaker 4: tay you a million dollars a year the rest of
Speaker 4: your life. If we find gold, you should say no,
Speaker 4: that sounds too risky. You know, I just think that
Speaker 4: we're unlikely to find gold. But if you see those
Speaker 4: deals getting done, it tells you that investors are not
Speaker 4: applying vigilance. They're not doing their job of resisting deals
Speaker 4: that are too risky or structured not in their favor,
Speaker 4: and in five oh six, I was seeing these deals
Speaker 4: done that made absolutely no sense. And I describe myself
Speaker 4: as wearing out the carpet between my office and my partner,
Speaker 4: Bruce carsh And you know, every day I would go
Speaker 4: and say, look at this piece of crap that you
Speaker 4: got issued yesterday. A deal like this shouldn't get done,
Speaker 4: and if a deal like this can get done, there's
Speaker 4: something wrong. Ninety nine percent of my observation at that
Speaker 4: time that investors were not being suitably skeptical, cautious, demanding,
Speaker 4: and risk averse. And you know, Buffett has a great
Speaker 4: saying which feeds right into this. He says, the less
Speaker 4: prudence with which others conduct their affairs, the greater the
Speaker 4: prudence with which we must conduct our own affairs. And
Speaker 4: when others are wacky, we should head to the sidelines.
Speaker 4: That was the foundation of that conclusion. Now what happened
Speaker 4: was it turned out we were in a housing bubble,
Speaker 4: and the housing bubble gave rise to a mortgage bubble,
Speaker 4: and the mortgages, the subprime mortgages issued to people who
Speaker 4: could not or would not document their income of their
Speaker 4: assets were packaged into mortgage backed securities, and the people
Speaker 4: who bought the riskier tranches of those securities, lost all
Speaker 4: their money, which the rating agencies rated very highly, because
Speaker 4: they didn't understand it. And this was going on en mass,
Speaker 4: and it was the collapse of the mortgage backed securities,
Speaker 4: of which the banks had in many cases retained the
Speaker 4: risky portions when they structured them. It was the collapse
Speaker 4: that took you know, bear Stearns and Merrill Lynch and
Speaker 4: Lehman Brothers and other AIG, etc. Out of business as
Speaker 4: independent endings. I hastened to point out I didn't know
Speaker 4: anything about mortgage backed securities. I didn't understand subprime. I
Speaker 4: didn't know what was going on. It was going on
Speaker 4: in a distant corner of the investment world which I
Speaker 4: was not in on. I just knew that the climate
Speaker 4: was too permissive and the mortgage backed developments were a
Speaker 4: manifestation of that. But your question, I always try to
Speaker 4: come back to the question. Your question was what do
Speaker 4: you do about? So what did we do? We sold
Speaker 4: most of our real estate holdings, We reduced holdings in
Speaker 4: many areas. We liquidated holdings in large funds, our opportunistic
Speaker 4: debt funds that we had formed in two four ET cetera.
Speaker 4: We sold those holdings. We raised either small funds or
Speaker 4: no funds, and we waited for this behavior to produce opportunities.
Speaker 4: After it passed. On the first day of seven, Bruce
Speaker 4: and I sent the memo to our clients saying we'd
Speaker 4: like to have three and a half billion dollars for
Speaker 4: distress debt fund. The largest distress fund in history had
Speaker 4: been two billion. It was our one fund. We wanted
Speaker 4: three and a half because we thought there was something
Speaker 4: big coming, and within a month we had eight billion.
Speaker 4: We went to our investors, we said we can't use
Speaker 4: eight billion, we'll take three and a half. We closed
Speaker 4: that fund in March of seven, but we said we'd
Speaker 4: like to have the rest of your appetite for a
Speaker 4: stand by fund, and we continued for a year to
Speaker 4: raise a stand by fund again in an area where
Speaker 4: the biggest fund in history was two billion. We raised
Speaker 4: eleven billion and that was our fund seven B and
Speaker 4: we put it on the shelf and we said this
Speaker 4: is for when the stuff hits the fan, and we're
Speaker 4: not going to invest it until that time, and we're
Speaker 4: not going to charge any fees, and it's just commitments
Speaker 4: on the shelf. Because we'd like to have capital we
Speaker 4: can draw. And when Lehman went bankrupt on September fifteenth
Speaker 4: of eight, we had that eleven billion dollars. We had
Speaker 4: only invested about ten one billion. We had ten billion
Speaker 4: that we could call on, and so unlike most people,
Speaker 4: we didn't have to worry about where are we going
Speaker 4: to get money, or can we invest or our client's
Speaker 4: going to withdraw their money. Rather than we had commitments,
Speaker 4: we were sure we could draw and so we could
Speaker 4: plunge in and we started to invest Bruce. Bruce does
Speaker 4: the investing, and we developed our position jointly and we
Speaker 4: decided to get down to work. So the next week
Speaker 4: after the Lehman bankruptcy was Friday fifteenth. We started investing
Speaker 4: and he invested for that fund a loan four hundred
Speaker 4: and fifty million dollars a week on average for the
Speaker 4: next fifteen weeks, that seven billion in one quarter. Remember
Speaker 4: in an area where the biggest fund in history was
Speaker 4: two billions. Why because we had prepared mentally, we had
Speaker 4: noted the bad climate. We had prepared for a denoument,
Speaker 4: and we swung into action when it arrived. And I
Speaker 4: was very proud of him for taking that position, and
Speaker 4: people on the street have told me that in that
Speaker 4: quarter we were the only buyer. Well, that's how you
Speaker 4: get good deals. If you can buy where nobody else
Speaker 4: is buying, you get your pick of the litter at
Speaker 4: low prices. So that's I just gave you a four
Speaker 4: or five year I guess four year description of a process.
Speaker 4: But man, you have to be patient because in five
Speaker 4: to six we were doing nothing, just selling, and we
Speaker 4: were not rewarded in five or six for that behavior.
Speaker 4: The reward came at the end of eight. But you know,
Speaker 4: I think it's not everybody's in a position to apply
Speaker 4: that process to that extent, but I think it describes
Speaker 4: the process, and of course I use it as an
Speaker 4: example for one simple reason. It was successful.
Speaker 3: Always a good always a good outcome when you have
Speaker 3: a success from it. Obviously, fantastic story your latest memo
Speaker 3: which inspired us to reach out and want to chat
Speaker 3: with you on Bubble Watch, And as you mentioned, is
Speaker 3: the twenty fifth anniversary of the bubble dot com memo,
Speaker 3: and so twenty five year anniversaries are just probably a
Speaker 3: good time to go back. But on the other hand,
Speaker 3: there is also this moment that we alluded to in
Speaker 3: the intro of incredible enthusiasm really for like a handful
Speaker 3: of tech ai related names that's lifting the entire market up.
Speaker 3: Is this one of the moments? I mean, what is
Speaker 3: the temperature right now as you see it? You've mentioned
Speaker 3: you've had five moments sort of maybe five calls in
Speaker 3: your career. Is this a sixth right now?
Speaker 4: No, it's not okay because you asked before. Behavioral or numerical.
Speaker 4: The main observations today are numerical. The peaking ratio on
Speaker 4: the S and P five hundred is elevated relative to
Speaker 4: historic norms, and the so called Magnificent seven, the biggest
Speaker 4: companies in the S and P dominate its behavior. Are
Speaker 4: you going up or have been going up rapidly? And
Speaker 4: they're hot stocks, And when you see one group perform
Speaker 4: especially well, you have to ask whether it's a bubble.
Speaker 4: And the S and P, of course, has gone up
Speaker 4: more than twenty percent a year for the last two years,
Speaker 4: and it's only the I think the fifth time according
Speaker 4: to JP Morgan, the fifth time in history. So you
Speaker 4: have to ask these questions. But the troubling aspects those
Speaker 4: are numerical and what I say in the memo is that,
Speaker 4: in my opinion, it lacks the behavioral aspects.
Speaker 2: Of a bubble.
Speaker 4: And I talk about some of them, and I say
Speaker 4: that a bubble is not just a numerical it is behavioral.
Speaker 4: And a bubble is really it's not a rise. It's
Speaker 4: that's a bull market. It's not high prices. A bubble
Speaker 4: is a temporary MEMI in which people are so agog
Speaker 4: at things that they throw over all discipline, all caution,
Speaker 4: and I just don't. It just doesn't feel to me
Speaker 4: like we're there. We're high priced, I say, lofty, but
Speaker 4: not nutty. And the bubbles I've seen and I've lived through,
Speaker 4: starting with the day I joined this business in sixty nine,
Speaker 4: we had what we call was called the nifty to fifty.
Speaker 4: What you see going on is what they call in
Speaker 4: literature the willing suspension of this belief. You know, I
Speaker 4: know it's high, but if I don't go in, I
Speaker 4: could miss something. Or I know it's high, but I
Speaker 4: don't think it's going to end tomorrow. And by the way,
Speaker 4: it's if it ends, I'll just get out. And of course,
Speaker 4: as I mentioned in the memo, the real hole mark
Speaker 4: of a bubble is when people say it's so great
Speaker 4: this thing we're talking about, whether it's the nifty to
Speaker 4: fifty stocks in sixty nine or Nvidia today or TMT
Speaker 4: in ninety nine, they say it's so great that there's
Speaker 4: no price too high. And that was the official dictum
Speaker 4: in the money center banks in sixty nine. With God
Speaker 4: to the nicety fifty. It was the official victim. With
Speaker 4: regard to the Internet in ninety nine, what do people say?
Speaker 4: The Internet will change the world, and so for the stocks,
Speaker 4: there's no price too high. Well, guess what. The Internet
Speaker 4: did change the world. But because they bid up the
Speaker 4: stock so high, the people who invested in them lost
Speaker 4: almost all their money. So, you know, people become psychologically
Speaker 4: unhinged and not tethered to reality, and their portfolios slipped
Speaker 4: their moorings, and they think that they found the perpetual
Speaker 4: motion machine or a tree that'll grow to the sky.
Speaker 4: And I just don't see those psychological or behavioral aspects today.
Speaker 2: So one of the things that Joe likes to emphasize
Speaker 2: when it comes to well the tech bubble specifically, is
Speaker 2: the importance of stories or narratives. So one of the
Speaker 2: things that will drive this kind of behavior is you'll
Speaker 2: see a company come out with like this huge ambition.
Speaker 2: I think Joe's favorite example wasn't there like a car
Speaker 2: company that claimed to have found the cure to AIDS.
Speaker 3: That's right, this is a good story. This was nineteen
Speaker 3: ninety nine, and people were just so up mystic that
Speaker 3: they thought he used car dealership in Nevada head in
Speaker 3: their back office founding cure for AIDS.
Speaker 2: That never sees a story story.
Speaker 3: Yeah, well, I'll tweet out a link when this episode
Speaker 3: comes out.
Speaker 2: So nowadays, there's an argument that some people make that
Speaker 2: we have a faster tech cycle than ever, and that
Speaker 2: means more stories can be generated more quickly. And given
Speaker 2: that you're a veteran in the space, can you maybe
Speaker 2: compare and contrast the tech cycle now to previous history.
Speaker 4: Well, listen, Tracy number one, I'm not an equity guy.
Speaker 4: Number two, I'm not a tech person. I have no
Speaker 4: personal knowledge of the tech companies of today. I have
Speaker 4: an idea about AI. I've seen it do wonderful things.
Speaker 4: So far. Most of my direct experience is with what
Speaker 4: I would call parlor games. You know, I did an
Speaker 4: interview like this one with a Korean media company that
Speaker 4: I've worked with over the over the years. They sent
Speaker 4: me a video clip of it, and in the video clip,
Speaker 4: I'm sitting there speaking Korean. It wasn't titles, it wasn't dabbed.
Speaker 4: I'm speaking Korean, and not only it, and it's it's
Speaker 4: not somebody else's voice coming out of my mouth. It's
Speaker 4: my voice coming out of my mouth in Korean, and
Speaker 4: my lips are moving correctly. Now that's an incredible accomplishment.
Speaker 4: I don't know if it's a money maker, but so
Speaker 4: I guess what I'm saying is, I don't know exactly
Speaker 4: how AI is going to be used in the future,
Speaker 4: but I can imagine that it's going to have a
Speaker 4: significant impact when when computers can start thinking and doing
Speaker 4: things like that, it will change the world and jobs
Speaker 4: are going to be created, jobs are going to be lost,
Speaker 4: efficiencies are going to be created, maybe whole new products.
Speaker 4: But I listed the memo a couple of the mistakes
Speaker 4: people make, and I saw it with the nifty fifty
Speaker 4: by the way, so that in nineteen sixty nine, this
Speaker 4: was a list of roughly fifty companies the best and
Speaker 4: fastest growing companies in America, Companies that were so great
Speaker 4: that number one nothing bad could ever happen A number two.
Speaker 4: As I said, there was no price too high. And
Speaker 4: if you bought those docks in sixty nine, you held
Speaker 4: them for five years. As I recall, you lost about
Speaker 4: ninety five percent of money because the price turned out
Speaker 4: to have been to I, and it came down by
Speaker 4: ninety percent the pe ratio. And some of them ran
Speaker 4: into fundamental problems and had to be rescued, or went
Speaker 4: through bankruptcy or disappeared from existence. So people assume that
Speaker 4: the trends that are underway will continue. One is the
Speaker 4: trend toward the internet in ninety nine, another is the
Speaker 4: trend toward AI today, and that it will be of
Speaker 4: great consequence, and I'm sure it will. They also believe, however,
Speaker 4: that the companies that are successful today will continue to
Speaker 4: be successful, that they won't be challenged or disrupted or displaced.
Speaker 4: When the thinking really gets optimistic, they conclude that every
Speaker 4: company can succeed, and we know that that's highly unlikely.
Speaker 4: There are going to be winners and losers. We can't
Speaker 4: always predict which is which. If we find a company
Speaker 4: that's that's a leader today and dominant, and we pay
Speaker 4: a price consistent with that dominance, and they turn out
Speaker 4: not to be dominant. Price may turn out to have
Speaker 4: been excessive, and then ultimately people engage in what's called
Speaker 4: lottery thinking, or what I call lottery, which is, well,
Speaker 4: it's nowhere as a competitor in this new thing, but
Speaker 4: you know, maybe it has a two percent chance of
Speaker 4: being becoming a big one. Are in going up a
Speaker 4: thousand times? And if it could go up a thousand times,
Speaker 4: then I can pay a pe ratio of one hundred
Speaker 4: x because I'll still make money. So they will buy
Speaker 4: into things that have a very low probability of producing
Speaker 4: a very good outcome. And that's like buying a ticket
Speaker 4: in the lottery, and most lottery tickets are losers. But
Speaker 4: this is what happens in bubbles. Now. You asked me
Speaker 4: to differentiate. Since I'm not an expert on AI, I
Speaker 4: can't differentiate. But I think there's a very good comparison
Speaker 4: to the Internet. We expected the Internet to change the world.
Speaker 4: We can't imagine today living in the pre ninety five
Speaker 4: world without all the tech we have today. And yet
Speaker 4: the vast majority of internet and e commerce companies that
Speaker 4: were minted in ninety eight, ninety nine, two thousand are
Speaker 4: out of business and worthless. I'm not sure it's going
Speaker 4: to be the case with AI, but it has to
Speaker 4: give you a caution. That's all I'm saying. Just keep
Speaker 4: your eyes open and don't drop all reason in a
Speaker 4: rush to get in. And by the way, one of
Speaker 4: the great differences in a bubble is that usually people
Speaker 4: are afraid of losing money. But one of the hallmarks
Speaker 4: of the bubble is that people forget to worry about
Speaker 4: losing money and only worry about missing out FOMO. When
Speaker 4: Fomo takes over it, people say, you know, yeah, well,
Speaker 4: you know, the price seems high. But if my competitor
Speaker 4: or my golf buddy or my brother in law buys
Speaker 4: it and I don't buy it and it triples, I'm
Speaker 4: going to kill myself. So I got to buy it regardless.
Speaker 4: And you know, so, I think, I guess, maybe to
Speaker 4: sum up on bubbles, a great way to characterize that
Speaker 4: is that it's when say I gotta buy it regardless,
Speaker 4: and I would argue prudently that nobody should ever do
Speaker 4: something regardless.
Speaker 3: I guess I'm interested a little bit more in why
Speaker 3: you don't see those characteristics today, because all people talk
Speaker 3: about is AI we just had the president, you know,
Speaker 3: make this big announcement We're gonna spend half a trillion
Speaker 3: on data centers and so forth. It's, you know, just
Speaker 3: this dominant mode of conversation. You know, I'm sort of
Speaker 3: two minds of this, because you know, I've been hearing people,
Speaker 3: you know, regular people on the street talk about their
Speaker 3: speculations or their Robinhood accounts or their crypto accounts whatever
Speaker 3: for years now, and mostly the prices have been going up.
Speaker 3: It certainly feels to me like some of the indicators
Speaker 3: that you describe of fear of missing out and so
Speaker 3: forth currently exists in this incredible this incredible hype. I'd
Speaker 3: like to hear you talk a little bit more about
Speaker 3: why right now, Mostly you just see, yes, the math
Speaker 3: is expensive, the numbers are expensive, but you don't feel
Speaker 3: that sort of that sort of euphoria that has characterized
Speaker 3: past bubbles.
Speaker 4: Well, you know, I guess, Joe, part of it is
Speaker 4: that I don't I don't live in that world. You know,
Speaker 4: since I'm a credit guy and not a tech person,
Speaker 4: I don't spend much time talking to people who who
Speaker 4: are interested in AI stocks okay, or who are doing
Speaker 4: AI businesses. So it might just be that I'm missing that.
Speaker 4: So you know, some of the conditions, some are all
Speaker 4: of the conditions of a bubble might be present in
Speaker 4: a few stocks or in the AI and related niche.
Speaker 4: I'm just saying that I don't feel it across the world.
Speaker 4: And if you take the magnificent seven out of the equation,
Speaker 4: I think things are rich, but not crazy. I did
Speaker 4: read an article on that subject. I did read an
Speaker 4: article about a month or two ago which said that
Speaker 4: if you look at the S and P and leave
Speaker 4: out the magnificent seven, and you compare the S and
Speaker 4: P companies with their non US equivalent in something like
Speaker 4: the MSCI Index of Non US equities, you'll find that
Speaker 4: the US equities in every industry just about sell at
Speaker 4: higher PE ratios than their counterparts outside the US. So
Speaker 4: I think the US is more expensive than the rest
Speaker 4: of the world. Again, not crazy. And by the way,
Speaker 4: I'm convinced that the US has the best economy in
Speaker 4: the world. And you know all these questions, especially in
Speaker 4: the stock market, in the bond market where I mostly work,
Speaker 4: the credit market, you have an indicator of value, which
Speaker 4: is the yield, and you look at the promised return
Speaker 4: from a given investment, and you say, well, you know,
Speaker 4: I think that's sufficient to reward for the risk or not.
Speaker 4: In otherwords, I think the price is fair or it's
Speaker 4: not fair, or it's too cheap or too high. In
Speaker 4: the stock market, it's hard to do that because in
Speaker 4: the stock market you can enumerate the pluses and minuses
Speaker 4: of a given company or industry or a phenomenon like AI.
Speaker 4: But it's hard to say, you know, but the current
Speaker 4: price is fair or too high or too low. It's
Speaker 4: hard to turn the recitation of merit into the fairness
Speaker 4: of value. And so yeah, people may be too excited
Speaker 4: about AI, and that may result in prices that are
Speaker 4: too high for their stocks. And you know, I spent
Speaker 4: in twenty twenty during the pandemic. I spent a lot
Speaker 4: of time living with my son and his family. And
Speaker 4: one thing he talked me out of he says, Dad, Yoda,
Speaker 4: stop talking about things you don't know anything about. Only
Speaker 4: a son can say that to his father. But I
Speaker 4: think it's good advice. As we get more specific in
Speaker 4: this conversation and it goes from stock market to SMP
Speaker 4: to AI, you know, I become more reticent to say
Speaker 4: anything concrete, because I really don't have superior knowledge. And
Speaker 4: my hero John Kenneth Galbraith said that one of the
Speaker 4: shortcomings of the market is the species relationship between money
Speaker 4: and intelligence, and most people tend to look at somebody
Speaker 4: who's made money, and especially who's made money in the markets,
Speaker 4: and credit them with general intelligence, which is usually a mistake.
Speaker 2: Well, I just have one more question, and I guess
Speaker 2: it's about the aftermath of bubbles, and it's based on
Speaker 2: a conversation that you had with Mike Milkin at the
Speaker 2: Milking Conference, and both of you were on stage and
Speaker 2: reminiscing about your time in the markets, and one of
Speaker 2: the stories you were telling was about the bursting of
Speaker 2: the nifty fifty bubble and its impact on the development
Speaker 2: of the financial industry. And I think the idea was
Speaker 2: that all these people had put their money into things
Speaker 2: that were, you know, expected to be quite reliable, reliable stocks,
Speaker 2: stalwarts of corporate America, and then they lost virtually all
Speaker 2: their money. And that development ended up catalyzing the money
Speaker 2: management industry because if you could lose money on boring
Speaker 2: stuff like blue chip stocks, then why not you know,
Speaker 2: try high yield or some alternative credit instead. And I
Speaker 2: guess I'm curious, do you see any interesting developments in
Speaker 2: the finance industry right now? Perhaps not in the immediate
Speaker 2: aftermath of a bubble, but you know, maybe related to
Speaker 2: a paradigm shift like higher interest rates.
Speaker 4: First of all, I have been writing something about something
Speaker 4: called the sea change. I met Mike in seventy eight.
Speaker 4: That's when Citybank asked me to look into hio bonds,
Speaker 4: and I was very fortunate. It was maybe the luckiest
Speaker 4: day in my life that I got that called, because
Speaker 4: you know, that put me at the front of the line.
Speaker 4: That that's kind of the year that the hio bond
Speaker 4: market began and became very important. And here I was
Speaker 4: no fault of my own, you know, working there, And
Speaker 4: the higo bond fund that I started at City in
Speaker 4: seventy eight might have been the first one from a
Speaker 4: mainstream financial institution. And as Malcolm Gladwell said in his
Speaker 4: book Outliers, you know, it's great to be demographically lucky.
Speaker 4: So in nineteen eighty, the FED funds rate each twenty. Vulcar,
Speaker 4: as head of the FED, put the FED funds there
Speaker 4: to battle the inflation that was rampant at the time,
Speaker 4: and it worked, and I had a loan from the
Speaker 4: bank and I got a slip in the mail saying
Speaker 4: that the rate on your loan is now twenty two
Speaker 4: and a quarter, And that was eighty and in twenty
Speaker 4: twenty I was able to borrow at two and a quarter.
Speaker 4: So rates came down by two thousand basis points over
Speaker 4: forty years. I believe that was a paradigm shift and
Speaker 4: that it changed the whole world, and it made a
Speaker 4: lot of people a lot of money. But I published
Speaker 4: a memo in December of twenty two called seat Change,
Speaker 4: saying that it's over. We're no longer in an environment
Speaker 4: where declining rates and ultra low rates are going to
Speaker 4: be the rule. We're going to have higher rates and
Speaker 4: they're going to be essentially stable, not downward trending all
Speaker 4: the time. The other thing that you know is that
Speaker 4: prior to the meltdown of the nifty to fifty, the
Speaker 4: simplistic thought in investing was that it's responsible to buy
Speaker 4: a high quality assets and it's irresponsible to buy low
Speaker 4: quality assets, and the job of the fiduciary was to
Speaker 4: buy high quality assets. Well, here the best companies in
Speaker 4: America is lost almost all your money, and then I
Speaker 4: shifted to hijo bonds. Now I'm investing in arguably the
Speaker 4: worst public companies in America and making money steadily and safely.
Speaker 4: So it did occasion a sea change in how investing
Speaker 4: is done, and it was a very important lesson that
Speaker 4: I was happy to learn at the very beginning of
Speaker 4: my career. You know, I was twenty three years old
Speaker 4: when I started working sixty nine, and I lived through
Speaker 4: this whole collapse in my twenty and it's very important
Speaker 4: to learn your lessons early. And the lesson I learned
Speaker 4: was that successful investing doesn't come from buying good things,
Speaker 4: but from buying things well and if you don't know,
Speaker 4: and the difference, it's more than dramatical, and that it's
Speaker 4: not what you buy that matters, it's what you pay.
Speaker 4: The price has to be fair. And there is no
Speaker 4: asset which is so good that it can't become overvalued
Speaker 4: and dangerous, and there are very few assets that are
Speaker 4: so bad that they can't become cheap enough to be attractive.
Speaker 4: It was an epiphany for me, and I think it
Speaker 4: changed the whole world, and we no longer say is
Speaker 4: it a good asset or a bad asset or a
Speaker 4: good company or a bad asset. We say, is it risky?
Speaker 4: How risky is it? What return do we expect? Is
Speaker 4: the return sufficient to compensate for the risk? And that
Speaker 4: is the change that has dominated the investment world to
Speaker 4: the last I would say, forty seven years since seventy eight.
Speaker 4: And you know, we do so many things today like
Speaker 4: venture capital and private equity and transecurities which entail conscious
Speaker 4: risk bearing that couldn't have been done in the old
Speaker 4: world of good and bad or safe and risky.
Speaker 3: I just have one last question. I was gonna let
Speaker 3: Tracy have the last question, but you said one thing
Speaker 3: that's that hit something that's been on my mind. And
Speaker 3: you mentioned in the summer of twenty twenty being able
Speaker 3: to borrow money for two percent. One of the questions
Speaker 3: that's been debated the last several years is why haven't
Speaker 3: the interest rate increases that we've seen across the curve
Speaker 3: had a more dampening effect on the strength of the
Speaker 3: US economy. And one story that gets put out is
Speaker 3: that a lot of borrowing entities, whether their households like
Speaker 3: yourselves or various firms, locked in very low borrowing in
Speaker 3: those couple of years, and that the effect of higher
Speaker 3: rates therefore has been muted, hasn't transmitted to the real economy.
Speaker 3: Have we felt that adjustment yet? Is there something coming
Speaker 3: because those rates can't stay locked in forever, especially for
Speaker 3: shorter term borrowing. Have we felt the impact of this
Speaker 3: seed change yet on the economy or is there more
Speaker 3: to come downstream from this reversal of what may be
Speaker 3: a forty plus year trend.
Speaker 4: No, I think it clearly hasn't worked a twelve way
Speaker 4: through because when you borrow money, you borrow for a
Speaker 4: period of time, and if you borrow at a fixed rate,
Speaker 4: there's also a flooding rate borrowing. But if you borrow
Speaker 4: at a fixed rate, you fix your rate for a
Speaker 4: maturity of five or seven years, then even if rates
Speaker 4: go up, you're immune to it. You don't feel the
Speaker 4: impact until your debt matures and has to be rolled over.
Speaker 4: You know, people in this business are in the business
Speaker 4: world in general, are not brain dead. And many of them,
Speaker 4: as you say, rolled over their debts in twenty twenty
Speaker 4: or twenty one, and you know, locked up costs debt
Speaker 4: until twenty six or twenty seven, so they're fine. But
Speaker 4: you know, maybe they took on too much debt when
Speaker 4: debt was cheap and readily available, and maybe they won't
Speaker 4: be able to refinance all of it, or some of
Speaker 4: them may not be able to refinance all of it
Speaker 4: when it rolls over in twenty six or twenty seven.
Speaker 4: That's what we call a credit crunch, when you can't
Speaker 4: roll over your debts. Nobody ever repays their debts. They
Speaker 4: just roll them over, and sometimes you can't. You know,
Speaker 4: we believe that they're I mean, look there there are
Speaker 4: already some defaults, not many compared to the crises in
Speaker 4: the past, but you know, when maturities start coming due
Speaker 4: in twenty six, twenty seven, and if Wall Street or
Speaker 4: the banks are a little less generous and optimistic, maybe
Speaker 4: there'll be some difficulty rolling it over. And then you know,
Speaker 4: and it's just the cost of money. So you know,
Speaker 4: the federal government has a portfolio of debt. They don't
Speaker 4: own a portfolio. They owe a portfolio of debt, some
Speaker 4: of which is long and some of which is short.
Speaker 4: And you know, so they're paying the low rates on
Speaker 4: the long debts. But you know when that when again,
Speaker 4: when that comes due, they'll have to roll that over
Speaker 4: at higher rates, and it'll cost the money. And so
Speaker 4: if the interest rate merely stays where it is, the
Speaker 4: cost of capital to the US government will rise over
Speaker 4: time as they replace low rate, low cost debt with
Speaker 4: high cost debt. So this has not fully worked itself
Speaker 4: through through the economy yet, and there's more of it to.
Speaker 2: Come, all right, Howard marks, We could easily keep going
Speaker 2: for a couple more hours, probably longer than that, but
Speaker 2: this has been an absolute treat. Thank you so much
Speaker 2: for coming on the show.
Speaker 4: Well, thank you for your good questions, and I'd be
Speaker 4: glad to do it too, and let's do it again sometimes.
Speaker 3: Absolutely love to thank you so much those I.
Speaker 2: Guess Joe, I thought that was so interesting. So first
Speaker 2: of all, you know that I love just listening to
Speaker 2: like wartime financial crisis stories, so that was great. And
Speaker 2: then I thought one thing that was really interesting. Well,
Speaker 2: first of all, there aren't as many cross asset investors
Speaker 2: as you might think out there, and so it's really
Speaker 2: interesting to hear someone that is, you know, firmly in
Speaker 2: the credit space, but is also looking at other asset
Speaker 2: classes in order to judge current market conditions. And then
Speaker 2: the other thing I thought was the emphasis on action
Speaker 2: being sort of a spectrum of caution and risk. So
Speaker 2: it's not the tech bubble is about to come and
Speaker 2: you know, sell all your tech exposure. It's more like,
Speaker 2: maybe I should ratchet down a little bit, maybe start
Speaker 2: raising you know, some dry powder for a rainy day.
Speaker 3: That was really interesting the specific story this sequence, Yeah,
Speaker 3: raising that dry powder starting with the warning in two
Speaker 3: thousand and five that didn't get deployed or wasn't able
Speaker 3: to be paid off for years. But the idea of okay,
Speaker 3: if you see something coming down to the horizon is
Speaker 3: not enough to say, well, yes something there's going to
Speaker 3: be an opportunity. The idea of you know, raising one
Speaker 3: fund and then having that other fund on the shelf,
Speaker 3: cash that can be callable for the day that it comes.
Speaker 3: You know, there were a lot of people that probably thought, oh,
Speaker 3: there are really good deals to be had in September
Speaker 3: two thousand and eight or March two thousand and nine
Speaker 3: or whatever. But there's no good in having stuff being
Speaker 3: cheap if you don't have any cash available to buy it.
Speaker 2: Do people still call it patient capital? I remember people
Speaker 2: used to call you know, dry powder patient capital because
Speaker 2: the idea was you set it aside, and it might
Speaker 2: be a long time until you're actually able to invest
Speaker 2: in you.
Speaker 3: Also, you know, this also strikes me as where like
Speaker 3: brand value of a firm really matters, right, because you're
Speaker 3: not going to get billions and excess commitments into that.
Speaker 3: You know, you and I aren't going right. It's like
Speaker 3: Tracy and I was like, oh, we think AI is
Speaker 3: going to crash in a few years or want to
Speaker 3: get buy bill We want to buy data center real
Speaker 3: estate on the chief, so give us a billion. But
Speaker 3: you know that's the only that's a thing that you
Speaker 3: can monetize only after having you know, years of success.
Speaker 3: I thought it's interesting this idea of you know, there's
Speaker 3: a difference between expensive and a bubble, and that in
Speaker 3: his assessment, we're not there yet. And I really appreciate
Speaker 3: his perspective because it's easy for me to say on
Speaker 3: the day, oh, everyone's to talk about AI all the time,
Speaker 3: et cetera. I'm therefore, you know, we must be near
Speaker 3: the top or a bubble. But I don't have you know,
Speaker 3: experience in markets going back to the nineteen sixties of
Speaker 3: like what that actually feels like.
Speaker 2: Well, when a car company or car rental company in
Speaker 2: Nevada says that it's like a model.
Speaker 3: Yeah, yeah, that's going to start.
Speaker 2: I don't know that's going to revolutionize the world. Yeah,
Speaker 2: then maybe that's the time to be concerned.
Speaker 3: That's how well.
Speaker 2: No, all right, shall we leave it there.
Speaker 3: Let's leave it there.
Speaker 2: This has been another episode of the Audots podcast. I'm
Speaker 2: Tracy Alloway. You can follow me at Tracy Alloway and.
Speaker 3: I'm Joe Wisenthal. You can follow me at the Stalwart.
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