PodcastsThe Memo by Howard MarksThe Insight: Conversations – Full Return World with Howard Marks and Armen Panossian

The Insight: Conversations – Full Return World with Howard Marks and Armen Panossian
The Memo by Howard MarksWed Nov 01 2023
Howard Marks' Memo on Sea Change:
- Howard Marks wrote a follow-up memo to his original C-Change thesis due to client discussions and ongoing interest in the topic.
- The sea change refers to a significant, lasting development in the investment landscape related to interest rates.
- Marks believes that the era of declining and ultra-low interest rates since 1980 may not continue for the next decade or so.
- This sea change has implications for GDP growth, ease of financing, defaults, bankruptcies, and prospective returns.
Armen Panossian's Key Takeaways:
- Armin highlights that while some investors view the current economic environment as not bad due to factors like consumer performance and low unemployment, risks are building up.
- Higher interest rates are impacting businesses' cash flows and their ability to meet debt obligations. Refinancing capital needs and maintaining cash flow coverage will become challenging over time.
- Caution is necessary as weak borrowers are increasing within the market, with EBITDA over fixed charges of one times coverage or less entering a risk category known as the "tail."
- Private credit markets may face challenges for highly leveraged transactions made during periods of low interest rates.
Impact on Capital Allocation:
- Debt instruments offer potential equity-like returns with higher yields and contractual nature compared to equities.
- Debt investments have less volatility and uncertainty than equities, providing contractual returns through interest payments and principal repayment.
- Tying up capital in lending or fixed income investments becomes more beneficial as interest rates rise.
Opportunities for Opportunistic Investors:
- Credit pickers can find opportunities in high yield bonds issued by larger companies with lower leverage ratios and extended maturities trading at discounted prices due to market factors rather than fundamental weaknesses.
- Newly issued private credit presents buying opportunities as banks reduce lending activities and direct lenders accumulate troubled assets on watch lists.
Surprises from This Year:
- Armin is surprised by how resilient the economy has been, with cracks forming later than expected due to significant stimulus measures.
- He believes that cracks are now appearing in certain consumer-facing businesses and increasing credit card charge-offs.
- Howard Marks is surprised by the optimism among stock market investors despite concerns about cracks forming in the economy.