Further Thoughts on "Sea Change":
- Howard Marks wrote a follow-up memo to Sea Change in May, arguing that the trends highlighted in the original memo represented a sweeping alteration of the investment environment and called for significant capital reallocation.
- Sir John Templeton's warning about investors rationalizing high valuations with "This Time It's Different" was cited, but he acknowledged that things might really be different 20% of the time when something fundamental changed with significant implications for investing.
- Marks believes that given the pace of developments today, especially in technology, it is possible that things might genuinely be different more often than they were in Templeton's day.
- While many people agree with individual observations from C-Change (the original memo), few have expressly agreed with Marks' overall conclusion about a significant and possibly lasting change in the investment environment.
The Backdrop:
- The Federal Reserve took the Fed funds rate to zero in late 2008 to rescue the economy from the global financial crisis, leading to easy times for businesses seeking profits and financing. Even money-losing companies had little trouble obtaining loans and avoiding default and bankruptcy.
- Low interest rates made it a great time for asset owners as lower discount rates made future cash flows more valuable. Borrowers also benefited from lower borrowing costs, while bargain hunters and lenders faced challenges.
Asset Allocation Today:
- Marks suggests that credit instruments should represent a substantial portion of portfolios, perhaps even the majority, due to their competitive expected pre-tax yields compared to historical returns from equities. These contractual returns are less dependent on market behavior and offer potential protection in case of market shutdowns or illiquidity.
- Credit instruments have risks such as individual defaults and price fluctuations but can provide competitive returns compared to equities in the current environment.