WEBVTT - Oaktree Capital Management's Howard Marks on Present Economic Moment

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>Thank you so much to our Bloomberg radio and TV audience.

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<v Speaker 2>We are incredibly lucky right now to get a chance

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<v Speaker 2>with a man on the thirtieth anniversary of the firm

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<v Speaker 2>he co founded, oak Tree Capital Management, which has since

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<v Speaker 2>grown into the world's biggest distressed debt investor. Mark joined

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<v Speaker 2>us on a day of turmoil, after putting out a

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<v Speaker 2>memo about a month ago where he wrote, the bottom

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<v Speaker 2>line is that credit presently offers a better deal than equities,

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<v Speaker 2>even if today's spreads. Credit isn't a giveaway today, but

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<v Speaker 2>it offers a healthy absolute returns and is fairly priced.

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<v Speaker 2>Howard joins us right now. Howard, you wrote that a

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<v Speaker 2>month ago. The world has changed. We have seen the

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<v Speaker 2>market sell off. We have seen tariffs implemented that are

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<v Speaker 2>the highest levels that we've seen going back one hundred years.

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<v Speaker 2>Does your thesis still hold?

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<v Speaker 1>The yields on credit are still very healthy, and in fact,

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<v Speaker 1>credit yields a little more now than it did six

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<v Speaker 1>weeks ago when I wrote that memo. Then iiO bonds,

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<v Speaker 1>for example, we're yielding around seven point two today they're

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<v Speaker 1>close to eight, which means they went down in price,

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<v Speaker 1>producing a higher prospective return. Of course, the stock market

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<v Speaker 1>is well down since then. I don't know, fifteen sixteen,

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<v Speaker 1>seventeen percent. I haven't done the math yet, and it

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<v Speaker 1>keeps moving. But you know, obviously the state of the world,

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<v Speaker 1>which equity prices depend on, is completely in flux and

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<v Speaker 1>has been radically changed. Most investors think for the worse.

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<v Speaker 1>That's why prices are down. The question, of course, is

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<v Speaker 1>whether they're down too much, just right, or not enough.

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<v Speaker 1>And almost nobody can say.

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<v Speaker 2>How do you start to even measure something like a

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<v Speaker 2>potential paradigm shift like the tariffs that were announced earlier

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<v Speaker 2>this week.

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<v Speaker 1>Well, first of all, of course, measure is the wrong

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<v Speaker 1>word because that suggests some quantification, which is impossible. There's

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<v Speaker 1>nothing to measure. But how do you gauge? How do

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<v Speaker 1>you think about the changes? And this is the biggest

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<v Speaker 1>change in the environment that I've seen, probably in my career.

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<v Speaker 1>You know, we've gone from free trade or world trade

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<v Speaker 1>and globalization to this system which implies significant restrictions on

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<v Speaker 1>trade in every direction and a step toward.

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<v Speaker 3>Isolation for the United States.

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<v Speaker 1>I believe that the last eighty years since World War

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<v Speaker 1>Two have been the best economic period in the history

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<v Speaker 1>of mankind, and one of the major reasons was the

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<v Speaker 1>growth of trade. And I think that we have truly

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<v Speaker 1>had a rising tide that lifted all boats, and trade

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<v Speaker 1>was a big part of that. And everybody in the

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<v Speaker 1>audience should understand the role of trade. Every country, for example,

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<v Speaker 1>does some things better and worse, and worldwide welfare is

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<v Speaker 1>maximized when every country does the things that does best

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<v Speaker 1>and cheapest, and then sells them to the countries that

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<v Speaker 1>need them, which do other things and sell them to

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<v Speaker 1>other people.

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<v Speaker 3>That's how trade works.

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<v Speaker 1>And well, I don't know if it's politically correct, but

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<v Speaker 1>the good news is that the Italians make the pasta

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<v Speaker 1>and the Swiss make the watches. But if we stop

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<v Speaker 1>world trade and the Swiss have to make their own

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<v Speaker 1>pasta and the Italians have to make their own watches,

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<v Speaker 1>the world will probably be well, maybe arguably, people in

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<v Speaker 1>both contries will be a little worse off.

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<v Speaker 3>That's what we're talking about here, and we should not.

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<v Speaker 1>Underestimate the benefits that we've gotten from globalization. And among

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<v Speaker 1>other things, there was a twenty five year period which

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<v Speaker 1>I cited in one of my memos ten years ago

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<v Speaker 1>in which the cost of durables in the US went

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<v Speaker 1>down by forty percent in inflation adjusted terms. That kept

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<v Speaker 1>a lid on inflation here. It made goods available cheaply.

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<v Speaker 3>To all Americans.

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<v Speaker 1>If we don't have world trade, we don't have that benefit.

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<v Speaker 1>And the tarifts are designed to encourage production at home.

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<v Speaker 1>But who could imagine that most things produced in the

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<v Speaker 1>United States will be as cheap as they are coming

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<v Speaker 1>from abroad. In other words, things will cost more.

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<v Speaker 3>If that's the.

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<v Speaker 2>Case, does that mean that you see the inflationary regime

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<v Speaker 2>as being something that is more persistant or reversal of

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<v Speaker 2>what we saw the disinflation of the globalization.

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<v Speaker 1>Well, I think so there were financial benefits from globalization,

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<v Speaker 1>including keeping a lid on inflation. And you know, if

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<v Speaker 1>we hadn't bought our TV sets and appliances from abroad

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<v Speaker 1>in that twenty five year period at declining prices, what

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<v Speaker 1>would inflation have been And the answer is considerably more,

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<v Speaker 1>maybe not two, but maybe three four five. And so

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<v Speaker 1>you know, tariffs are an increased cost. Somebody has to

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<v Speaker 1>pay them, and you know, most people think the consumer

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<v Speaker 1>will pay them. There's some possibility that the importer or

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<v Speaker 1>the exporter will pay them or the government of the

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<v Speaker 1>exporting country.

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<v Speaker 3>But it's an increased cost.

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<v Speaker 1>The proceeds from which we'll go to the government, and

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<v Speaker 1>you know, will society be better off as a result.

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<v Speaker 2>When you're measuring how to decide the risk and reward

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<v Speaker 2>of given asset classes in this type of environment, that

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<v Speaker 2>could go in a multitude of different ways. How do

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<v Speaker 2>you understand where there's value, what a return is that

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<v Speaker 2>would justify a risk at a time when you know

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<v Speaker 2>potentially you could get seven, eight percent, nine percent with

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<v Speaker 2>credit with stocks that have delivered more than ten percent

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<v Speaker 2>for the past number of decades.

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<v Speaker 1>But going forward, I want to respond first to your

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<v Speaker 1>last sentence. Stocks have delivered an average of ten percent

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<v Speaker 1>a year for the last hundred years, but not when

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<v Speaker 1>the PE ratio was nineteen, and the PE ratio today

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<v Speaker 1>is probably nineteen. The average return has been sixteen, So

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<v Speaker 1>we can say that when the PE average, when the

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<v Speaker 1>PE ratio averages sixteen, the return average is ten. But

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<v Speaker 1>when the PE ratio is nineteen. My guess is, if

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<v Speaker 1>you look at history, if you bought the the S

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<v Speaker 1>and P when the PE ratio is nineteen, historically you

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<v Speaker 1>probably made let's say one to six percent a year

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<v Speaker 1>or two to seven percent a year someday, but's certainly

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<v Speaker 1>not ten. And so you know, what you pay matters,

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<v Speaker 1>and the price of the S and P is elevated

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<v Speaker 1>relative to historic levels, so you shouldn't expect historic returns.

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<v Speaker 2>Whereas in credit, one of your arguments is you can

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<v Speaker 2>expect to get that return because the default risk isn't

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<v Speaker 2>as great as some of the excess spreads.

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<v Speaker 1>And what you're getting in all in Yale, well, you know,

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<v Speaker 1>with credit is a new fangled word for fixed income

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<v Speaker 1>or which was a new fangled word for bonds. In

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<v Speaker 1>nineteen seventy eight, I was moved at City Bank from

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<v Speaker 1>the equities department to the bond department. Nobody talked about

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<v Speaker 1>fixed income or credit. But with or bonds or fixed

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<v Speaker 1>income or credit, what you see is what you get.

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<v Speaker 1>You can read on the piece of paper what the

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<v Speaker 1>promised return is. And then the only thing you have

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<v Speaker 1>to wonder about is will I get it? That is

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<v Speaker 1>to say, will the issue or default or will they

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<v Speaker 1>keep their promises? And by the way, they promised you interest,

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<v Speaker 1>they promised you to pay your money back at the end.

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<v Speaker 1>That if they don't keep the promise, they lose the company,

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<v Speaker 1>so they have a lot of incentives to pay. I've

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<v Speaker 1>been in non investment grade credit for forty seven years,

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<v Speaker 1>and in our experience, roughly ninety nine percent of our

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<v Speaker 1>issuers have paid as promised.

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<v Speaker 2>You've thrived during your five decade career, almost five decade career,

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<v Speaker 2>during times of dislocation. Is this a time of dislocation

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<v Speaker 2>to play or not to.

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<v Speaker 3>Well?

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<v Speaker 1>It's a time of dislocation. Everybody has to judge for

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<v Speaker 1>themselves whether the reduction in asset prices so far is right, inadequate,

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<v Speaker 1>or excessive. If it's excessive, you should jump in with

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<v Speaker 1>both feet. If it's inadequate, you should wait until things

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<v Speaker 1>adjust further. And it's impossible to make that judgment qualitatively.

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<v Speaker 1>You use the word measure before I pushed back.

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<v Speaker 3>A little bit.

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<v Speaker 1>There's no place you can look, there's no analysis you

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<v Speaker 1>can do to determine whether today's asset prices are right

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<v Speaker 1>for the environment ahead. Now there never is. It's always conjecture.

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<v Speaker 1>It's always guesswork. That's in theory why the greatest investors

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<v Speaker 1>are great because they make those judgments better than most people.

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<v Speaker 1>It's excessively hard today because today we have no idea

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<v Speaker 1>what the future is going to be. Normally we think

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<v Speaker 1>we know what's going to happen in the future. We

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<v Speaker 1>normally assume the future will look mostly like the past.

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<v Speaker 1>We extrapolate and usually it works because the world doesn't

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<v Speaker 1>change that much.

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<v Speaker 3>But the.

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<v Speaker 1>World economy and the world order beyond economy, meaning geopolitics

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<v Speaker 1>and international relationships has been shook up like a snow

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<v Speaker 1>globe by the events of the last days, and nobody

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<v Speaker 1>knows what it's going to look like.

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<v Speaker 3>Nobody knows. I dare say, if you tell me that

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<v Speaker 3>you the what our rules will be.

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<v Speaker 1>Six months ago, six months from now, I'll bet you

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<v Speaker 1>you're wrong.

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<v Speaker 3>This is in flux.

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<v Speaker 1>And if you think it's in flux, then by definition

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<v Speaker 1>you know know what the future holds. And then even

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<v Speaker 1>if you know what our country's going to do and

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<v Speaker 1>it's going to be that way six months from now,

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<v Speaker 1>we don't know what other countries are going to do, what.

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<v Speaker 3>The ramifications will be.

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<v Speaker 1>And so you know, I always inveigh against forecasting. I

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<v Speaker 1>don't believe in macro forecasting, my owner, other people's and

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<v Speaker 1>we know much less today than usual.

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<v Speaker 3>Now. People who who like to run their lives according

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<v Speaker 3>to forecasts.

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<v Speaker 1>They say, well, this is going to happen in the future,

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<v Speaker 1>so I'm going to do this, And this is going

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<v Speaker 1>to happen in the future, so I'm going.

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<v Speaker 3>To do that.

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<v Speaker 1>What you really need, if you like to work with forecases,

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<v Speaker 1>you need two things, not just a forecast. You need

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<v Speaker 1>the forecast, but you need an estimate of the probability

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<v Speaker 1>that your forecast is correct. And today, whatever your forecast

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<v Speaker 1>may be, you have to say, the probability that I'm

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<v Speaker 1>right is lower than ever, because the probability that we

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<v Speaker 1>know what the future is going to look like is

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<v Speaker 1>lower than ever.

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<v Speaker 3>And that's how I feel.

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<v Speaker 2>Is this a time to be fearful or greedy?

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<v Speaker 3>You know what you have to say.

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<v Speaker 1>Bloomberg's offices, you have to think in terms of your neighbor.

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<v Speaker 3>The department store, Bloomingdale's. Bloomingdale's.

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<v Speaker 1>Bloomingdale's just put everything on sale. Prices have come down

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<v Speaker 1>for the S and P eight percent in the last

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<v Speaker 1>two days and much more in the last six weeks.

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<v Speaker 1>It's on sale. That should encourage people to think about buying.

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<v Speaker 1>Will they go down further? Nobody knows. Are the prices fair?

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<v Speaker 1>Nobody knows, But everybody runs from the market when prices

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<v Speaker 1>go down because they think it connotes risk. It's just

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<v Speaker 1>stuff going on sale, And of course it takes well

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<v Speaker 1>I was going to say a pro, but it takes

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<v Speaker 1>a pressing pro of which there aren't many to know whether, as.

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<v Speaker 3>I keep saying, the discounts.

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<v Speaker 1>Are adequate or appropriate. But certainly you have to look.

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<v Speaker 1>And it doesn't make any sense to say, just a minute,

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<v Speaker 1>I did XYZ when the price was one hundred. Today

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<v Speaker 1>the price is ninety, So I'm going to boycott it.

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<v Speaker 1>That doesn't make any sense on its face. You have

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<v Speaker 1>to take a hard look.

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<v Speaker 2>Do you still think that the US is the best

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<v Speaker 2>place to invest?

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<v Speaker 1>I think it's probably still the best place, but it's

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<v Speaker 1>less best than it used to be, because I think that,

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<v Speaker 1>you know, if you think about the things that made

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<v Speaker 1>it the best place, one of them was the rule

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<v Speaker 1>of law, that may be less the fact today. One

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<v Speaker 1>of them was the predictability of outcomes that may be

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<v Speaker 1>less today. One of them was, well, the worst thing

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<v Speaker 1>about it investing in the United States for many years

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<v Speaker 1>has been our fiscal situation, our deficits and debts, and

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<v Speaker 1>the US has behaved like somebody who has a golden

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<v Speaker 1>credit card where there's no credit limit and the bill

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<v Speaker 1>never comes, So of course you can spend more than

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<v Speaker 1>you make.

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<v Speaker 3>And that's and.

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<v Speaker 1>If somebody has a golden credit card, well what would

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<v Speaker 1>you do? Well, you might buy a nice car, but

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<v Speaker 1>what the hell, you might as well buy all the cars.

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<v Speaker 3>Because the bill's not going to come.

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<v Speaker 1>And that's the way we've behaved, and that's the way

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<v Speaker 1>Washington has spent money. But can the events of the

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<v Speaker 1>recent days change that. Can they cause there to be

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<v Speaker 1>a credit limit? Can they cause a bill to be

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<v Speaker 1>presented at some point in time? And if the answer

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<v Speaker 1>to either of both of those questions.

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<v Speaker 3>Is yes, that's a real risk.

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<v Speaker 1>If people don't like the dollar, don't like investing in

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<v Speaker 1>the the United States, don't want to hold an unlimited

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<v Speaker 1>number of treasuries. If we just make people mad and

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<v Speaker 1>say the US is still a great credit, but I

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<v Speaker 1>don't want to hold their debts because look how they're

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<v Speaker 1>treating me, the fiscal situation will be very complicated.

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<v Speaker 2>Howard marks, We have to leave it there. That was

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<v Speaker 2>oak Tree Capital co chairman Howard Marx. Thank you so much,