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How Worried Should We Be About Howard Marks' Market Caution Warning?

By Chris Hill – Sep 30, 2018 at 6:00PM

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The Oaktree Capital cofounder is concerned that too much money is flowing into questionable deals and assets these days.

In this Market Foolery podcast, host Chris Hill has a special guest -- Foolish investor-at-large Tim Hanson -- and they lead off with a discussion of the annual letter, released Wednesday, from billionaire investing guru Howard Marks of Oaktree Capital (OAK). In it, Marks expressed concern about the number of questionable deals happening in this low-interest environment, as an excess of optimism and high risk-tolerance send capital toward assets it should probably shun at current prices. Then Chris and Tim respond to a podcast listener who's wondering whether he should keep holding on to his General Motors shares. Beyond that, there's a timely retrospective on Tim's time at the Fool, and an equally timely debate on a divisive and controversial question: Are fun-size Halloween candies "fun" or a travesty?

A full transcript follows the video.

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This video was recorded on Sept. 27, 2018.

Chris Hill: It's Thursday, Sept. 27. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, it's the investor at large, Tim Hanson. Good to see you!

Tim Hanson: Hey!

Hill: It's been a while! You've been busy. 

Hanson: Yeah!

Hill: We've all been busy. 

Hanson: It's been a busy time of year. Back to school. 

Hill: Back to school, busy time of year.

Hanson: It won't stop raining here in Virginia. That keeps everybody busy. 

Hill: Did you see that little chart that The Washington Post published the other day? It was basically like, here's traditionally rainy cities. This year, D.C. has gotten roughly twice as much rain. 

Hanson: We're No. 1! [laughs]

Hill: Yeah. Didn't need to see that. We're going to dip into the Fool mailbag. We're going to talk IPOs again. And Halloween is just around the corner. Longtime listeners know what that means when Tim Hanson is in the room. But let's start with Howard Marks. When we talk about annual letters, Warren Buffett's rightly gets attention; Jeff Bezos is starting to get more attention. Howard Marks from Oaktree Capital, for as great an investor and as respected an investors Howard Marks is, his annual letter doesn't really get the same buzz as the others. But I know it is must-reading for you.

Hanson: It's like the critically acclaimed independent record relative to the Warren Buffett pop-single hit. The Howard Marks letters are routinely excellent. He had a new one out yesterday. He tends to be a little bit more measured in his observations of the world, which I think, at a time like this in the market cycle, 10 years of party times, it's a perspective worth considering and keeping in mind for people who are making asset allocation and capital allocation decisions.

Hill: In terms of highlights from the letter, it's nice that he basically said, as you said, the cautious optimism. He's basically like, "Yeah, there are some prices that are high. They're not bananas. Valuations across the board are not nuts."

Hanson: The message in the letter that I think people should be interested in is, what kind of decisions are you making about your amount of risk you're taking on in your portfolio? Are you being properly compensated for the risk you're taking? For example, they have a list of bullet points of questionable deals that they've seen done this year. That may point to the fact that, in a low-interest rate environment, people are stretching and aren't going to get the returns in the future that they expect. One of those, for example, this is near and dear to my heart, as a former emerging market stock analyst, is the fact that some pension fund manager somewhere made the decision to buy $10 billion of Turkish lira-denominated corporate bonds that yielded 6%. There's not a world where I would invest in lira-denominated anything for 6%, let alone, you've got the currency on top of, now not a sovereign debt, a corporate debt in Turkey! Six percent!

Hill: What if we put a zero next to that? What if it was 60%?

Hanson: I mean, that's closer to what you would want to demand. I think people have seen the lira volatility this year. That trade has gotten crushed. It probably lost half its value at this point. I just started looking up some random sovereign debt rates this morning, as you do on a Thursday.

Hill: [laughs] Just another Thursday.

Hanson: [laughs] Bolivia has a five-year bond out there with a coupon of 4.7%. Bolivia!

Hill: How can you not jump at that?

Hanson: There was a time in 1999, not that this will ever happen again, but I think you could get Treasury inflation-protected securities --

Hill: TIPS.

Hanson: TIPS. In the U.S. We have our problems, still probably the world's No. 1 credit. I think the real yield was like 4.5%. You're locking in, at that point, an equity-like long-term return with very little risk. And now, Bolivia and Turkey, local currencies have the same yields. It's wild! It just goes to show that it's always worth taking a step back. Sometimes you should evaluate things on relative term. You can't get a great yield on a U.S. Treasury right now. But should you really reach for 6% on a Turkish lira-denominated corporate bond?

Hill: Well, do you think that's at least a little bit of what continues to drive the bull market here in the U.S.? That a lot of institutional investors, a lot of pension fund managers, hedge fund managers, are looking around the world, and they're not really seeing the types of opportunities, so they say, "It's not sexy, but yeah, I'm going to put some more money into the FAANG stocks."

Hanson: I think that's right. It's a little bit hackneyed to say people don't like this bull market. You see that from time to time, that it's the most hated bull market or whatever. But I do think one of the reasons why people haven't been super enthusiastic about this bull market to the extent they haven't been is because, yeah, as you suggest, it's a product of relativism rather than, "Man! I love that company at that valuation! This stock is going up!" It's more like "Well, that's better than that thing."

Hill: Yeah. Last thing on Howard Marks' letter. Was there anything that you read yesterday that made you rethink anything you're doing as an investor? Or made you feel better about yourself as an investor?

Hanson: I can say, personally, over the past year or so, I've been accumulating more cash, just because I haven't been finding absolute opportunities where I'm like, "Yes, I love that!" And I'm a little bit more cautious about saying, "I'll do it because it's better than doing nothing." I actually think there's a lot of value in doing nothing a lot of the time. [laughs] I wrote an article about that not long ago.

The idea that he was looking back -- there's a funny quote, which is like, "The market has 10-year cycles, but bankers only have five-year memories." That's amusing. He was saying, he started to get more cautious in 2006 and 2007 relative to what he was seeing in the marketplace, because he saw bad deals being made. And it took a few years before everything collapsed. But the trade-off between being wrong for a couple of years, versus being prepared when the opportunity's there, I think is a worthy one.

I think there's a lot of fear of missing out in the world today, both in the financial marketplace, but also in social circles, brought on by social media and what have you. I think that can be very dangerous force. If you can be comfortable doing nothing, or comfortable missing out, COMO, that might be a healthier way to look at the world.

Hill: When you look at, as was referred to, in the letter, too much money chasing bad deals --

Hanson: Too little return.

Hill: -- weak deals, I know the example you used was emerging markets. I'm wondering if you could also say the same about IPOs. Matt Koppenheffer was in here yesterday, and one of the things we were talking about was, essentially me scratching my head at things like Survey Monkey going public and the stock popping 70% at one point. Last week, Eventbrite. Not to hate on Survey Monkey or Eventbrite.

Hanson: Lovely people.

Hill: [laughs] Lovely people, and fine businesses. But not the type of businesses that you would think would warrant that sort of thing. You mentioned to me this morning an IPO coming next week that maybe seems like it's a little bit more tempered, but still possibly a solid business.

Hanson: We'll see what happens next week, but Upwork is coming public. Upwork, for people who don't know, is a platform where freelancers can connect with companies that need software development and other work done. It's one of those platforms that has real network effect possibilities. It's been around for a long time, almost 20 years at this point. The business has solid revenue streams. If it's not generating cash, it's almost generating cash. Not booking huge losses. It's going to have a solid cash position. And I think it's going to go public at $1.3 billion, which would be about 5 times sales. That's not classically cheap, but on a relative basis, that is more interesting than some of the other businesses that are out there. Obviously, network effects can always be a very durable source of competitive advantage, and the gig economy is growing. 

I think it's going to be an interesting one to look at. I never buy IPOs out of the gate. You always want to see how a company behaves as a public company before you get into it, particularly as a lot of companies are notorious for dressing themselves up before they initially public offer. We'll see how it behaves in its first couple of weeks as a public company. 

As you said, I think there's a lot of speculative stuff coming public because it's a good time to cash in. But that doesn't mean that it's all speculative. We'll see.

Hill: It's a good reminder, and I think you were the one who first made this point on Market Foolery years ago. I don't even remember the company we were talking about that was going public. You hammered on the point that was essentially, "You have to remember, when a company is getting ready to go public, they're making their books look as good as they possibly can. They are pulling every lever they can to make that prospectus look great."

Hanson: Yeah. I think it was Arcos Dorados, the Latin American McDonald's franchise. I haven't looked at their books recently, but at least as of not too long ago, I think the best year in the company's history was the year before they went public.

Hill: [laughs] Well, and on the flip side, if someone's getting ready to go public, and you look at the prospectus and you're like, "Eh," wow! That's a big red flag, if they can't make it look good then.

Hanson: [laughs] Yeah, that's true. Now, obviously, there are some businesses that do great things after they go public, or we wouldn't be talking about it.

Hill: Our email address is [email protected]. Question from Sean Lee, who writes, "I'm pruning my stocks, and I always get stuck on General Motors. I purchased the stock around two years ago because of their electric vehicles and their plans with Lyft and Uber. I was wondering if you could talk a bit more about GM's business and their place in the market these days."

Hanson: GM is an interesting stock right now. Sean is in good company, owning GM stock. It's a big position at Berkshire Hathaway. David Einhorn at Greenlight owns quite a bit of it. I think the idea is under, Mary Barra, the company has gotten rid of some unprofitable divisions. They've really doubled down on investing in quality metrics, like return on invested capital, growing their profit margin, and not just trying to grab market share. That was the strategy at the company not long ago, which is a good way to destroy value over time. Additionally, as Sean alludes to, they actually are -- quietly, relative to somebody like Tesla (TSLA -1.37%) -- building a very interesting electric vehicle and autonomous car business. So, from a relative valuation perspective, yeah, I think you're a lot better off in GM than you are in Tesla. 

Having said that, the automotive industry is cyclical. It's capital-consumptive. It might not strike me as the world's greatest sector to be investing in, given that there are a lot of pressures out in the world. Particularly competitive pressures. In addition to Tesla and GM, obviously, you've got Ford, you have BMW, and so on and so forth. You have that new crazy company in China that's making the bullet car or whatever it is. 

If you're a believer in autonomous driving, you think there's a lot of economic opportunity there, and in electric vehicles, and you're looking for something that does not cost on a valuation basis as something like a Tesla, and appears to be a little bit better run and more generous with shareholders in terms of capital allocation and dividends, I would say, yeah, GM is interesting. Like I said, you're in good company. 

Hill: You're saying Mary Barra doesn't have a Twitter (NYSE: TWTR) account? She's not spending three hours going on Joe Rogan's podcast?

Hanson: I have not seen her smoke dope. I will say that. That's not to say she hasn't.

Hill: [laughs] As I said a couple of weeks ago, to me, it wasn't even the smoking dope. 

Hanson: Was it that it was a waste of time?

Hill: "Here's a good use of three hours of my time!" 

Hanson: Yeah. I saw a story yesterday where Tesla owners are volunteering at Tesla service centers to handle customer service for the company so they can try to sell more cars, and answer questions about how the car works, and so on and so forth. To me, that speaks so elegantly to both the bull and bear cases for Tesla. Yeah, they have rabid customers who are willing to drop what they're doing to come help our business out. Great! Can't fault Tesla for the vision. On the flip side, what is wrong with your business that you need a volunteer workforce?! [laughs] Something is wrong in the back office that it's come to that! Now, it's great that you have it. I don't think there'd be thousands of people lining up at McDonald's to start flinging burgers if they got into trouble. But they don't need to!

Hill: I think you're right. If it hasn't already, that data point is showing up in bull cases and sell-side analysts.

Hanson: [laughs] Right! Both sides! "Told you so!"

Hill: Before we get to the Halloween story, a little bit of sad news for our dozens of listeners, particularly longtime listeners, which is that you're moving on, after a decade plus at The Motley Fool.

We can't say where at this point. I don't want to step on anyone's toes, in terms of the official announcement that will be coming. But I will say that everyone can continue to follow Tim Hanson on Twitter, and they should. He's a great follow!

Hanson: [laughs] Thank you, I appreciate that! It's been awesome here! Yeah, going to do something different. 

Hill: I'm going to share one Tim Hanson highlight from Market Foolery going back. By the way, we are closing in on our 1,500th episode of Market Foolery. When I think about you on this podcast, the first thing that comes to mind is the name Len Riggio. Do you remember Len Riggio?

Hanson: Barnes & Noble (BKS).

Hill: Barnes & Noble. Here's a little throwback story. Bear with me. I think this was the first year we were doing Market Foolery, which meant it was 2011. I think you and Charly Travers and I were in the studio, and we were talking about GameStop. Len Riggio, heads up, Barnes & Noble, but I think he was the CEO and/or founder of GameStop. 

Hanson: I think that's right. 

Hill: I don't remember exactly what we said, but we were not bullish on the future of GameStop, having to do with bricks and mortar, how many locations -- for perfectly valid reasons. And the next morning -- I remember specifically, this was after the trading day had started -- the next morning, I get an email from Len Riggio. He had apparently listened. Did not like what we had say. Held me responsible.

Hanson: As you do.

Hill: Yes. It wasn't profane. But it was very direct that he did not agree with anything that was said, and in particular, called me out for asking uninformed questions. After showing this to our legal team and saying, "Can we talk about this? Because I kind of feel like we need to talk about this on today's episode." They said, "Just make sure it's actually from him." So, I got in touch with someone at Barnes & Noble, who confirmed, yes. And that was my only question. "Can you just confirm this is Len Riggio? Can you confirm that, during the trading day... " Having just talked about Elon Musk deciding to spend three hours going on Joe Rogan's podcast, I felt the same way about Len Riggio. Like, really? You're running Barnes & Noble, and you've decided to spend time listening to this podcast and sending me an email? 

So you came back in the studio, and I read the email and handed it off to you to respond to the pushback that he had on the numbers. And the first thing that you said was, "Well, the first thing I'd like to say to Mr. Riggio is, if Chris isn't allowed to ask uninformed questions, that doesn't really leave him much room for anything else." Which is one of my all-time favorite lines. Thank you for that! That's what I think of when I think of you.

Hanson: [laughs] Well, hey, here we still are! The model hasn't changed! [laughs]

Hill: Exactly! Hey, if it works! If it ain't broke!

We're a month away from Halloween. An estimated $2.6 billion is going to be spent this year in America on Halloween candy. I would argue that the overwhelming majority of that $2.6 billion is going to be spent on what is referred to as "fun-sized" candy. You are as outspoken an advocate against fun-sized candies as anyone I've ever met.

Hanson: I didn't realize this was a controversial position until you sent me that article from The Atlantic this morning defending fun-sized candy. My feeling is, it's just an euphemism for small. What's fun about small candy? If you get a big chocolate bar, you share it with your friends. That, to me, is fun. Fun-sized being small, I just don't get it.

Hill: I didn't think it was a particularly controversial position you were taking, either, until I started doing some research this morning, and yes, came across this column from last year. The headline of the column is, "Big Candy Bars Have No Place on Halloween." The subheading is, "They ruin the fun of the fun-sized treat."

Hanson: I don't get that. Maybe it's just the disproportionate amount of opportunities you have to get a full-sized candy bar versus a small candy bar is what makes it fun. When I got one as a kid, my eyes lit up. It was like, "Oh, that's the house!" That was awesome!

Maybe if everybody were doing it, it would just be a commodity and, we're in an arms race toward fun-sized, and all of the sudden there's four-foot Wonka bars rolling around the neighborhood as kids stumble home, trying to shoulder the burden. But, for me, the Smarties and the little things? No! I mean, the kid dressed up, they're out there with their bag, they're working hard. What's fun about small?

Hill: You're absolutely right. I could still tell you, and it's been more than four decades since I was trick-or-treating in Maine, I can still walk you to the house --

Hanson: I bet it's cold in Maine!

Hill: Oh, yeah. But I could still walk you to the house that was known for, "That's the house that gives out the big bars." Let's bring in producer Dan Boyd. Dan, I'm assuming you have thoughts on this. 

Dan Boyd: Well, Chris, you know, there's a reason we call him Tim "Wrong About Everything" Hanson around the office. 

Hanson: It's your last shot to take shots at me, Dan! Last time! 

Boyd: Oh, I'm taking them! Fun-sized candy is wonderful. OK, you're right about, when you were a kid, you're going to go around trick or treating, and there's the one house that gets the full-sized bars, and you're like, "Oh, this is great!" But as an adult.

Hanson: Wait, are you considering yourself an adult?

Boyd: That's a good point. As I've aged, I have discovered that eating a full-sized candy bar, like a full-sized Snickers, I can't even finish one.

Hanson: But can't you just wrap it up and save it for later? Share it with a friend?

Boyd: What -- wrap? What are you talking about? Wrap up a candy bar and save it for later?! Come on, dude!

Hanson: [laughs] All right, so, your argument for fun-sized is portion control, which, again, portion is not a lot of fun.

Boyd: OK.

Hanson: You can defend smaller portions, but I wouldn't call them fun. Maybe healthy sized.

Boyd: We can take this analogy a little further -- a quadruple cheeseburger is better than a single cheeseburger because it's got four patties instead of one. Who doesn't want one of these stupid fun-sized cheeseburgers? Come on, man! Sometimes too much of a good thing applies!

Hanson: But it's still more fun to have five patties! I'm not saying you should do it all the time. It's more fun to shave with a five-bladed razor, right? 

Hill: Absolutely!

Boyd: OK, you know what? I think that you're getting a little hung up on the idea that fun-sized is what we should call it. It's just what we call it. You can't have it all, man! You can't do it!

Hanson: Your argument that there should be smaller portion sizes available to people, I agree with. Whether you call it fun or not, maybe we're into semantics. 

Hill: Certainly, Tim, you can see the business side of this. If you're running Hershey?

Hanson: Oh, sure! On a cost per ounce, you're killing it. That's all margin.

Hill: Yeah, it's totally margin.

Hanson: Most of those companies -- to take a somewhat crazy argument that we're having and bring it back to the real world -- those companies that make commodity products, like Coca-Cola, beer, chocolate, they make a lot of their money on package innovation. The way that you package that stuff up and put bells and whistles on it, that's where you get a lot of your margin. 

Hill: Whoever came up with "Let's take the fun-sized candy bars and let's put seasonal wrapping on them," whoever that person is, they have to be in the Confectioner's Hall of Fame, don't they? 

Boyd: Or the fun-sized candy bars with different types of fun-sized candy bars in the same bag to mix it up a little bit? That's fantastic!

Hill: I guess the only thing I'd say additionally about fun-sized -- because we've clearly beaten this topic to death -- is that my experience is that -- 

Hanson: We're just reporting on our investigations of important issues. 

Hill: Look, Bloomberg has plenty of podcasts that people can listen to. That's all I'm saying.

Boyd: They're not getting this. You're not getting this on Bloomberg.

Hill: You're not getting five-plus minutes of fun-sized debate on Bloomberg. All due respect to Bloomberg.

Boyd: This is the discussion people want to hear. This is the one that people have. 

Hanson: We're going to get emails about this, I suspect. I won't be around to answer them. Good luck to you two! [laughs]

Hill: The only other thing I'd say is that there are some candy bars that don't deserve to be full-sized. There are some candy bars where I'm like, "I'm not looking for more than just one bite out of you."

Boyd: Like what?

Hill: Baby Ruth. If you tell me you've got fun-sized Baby Ruth at your desk, I'm going to be at your desk in about three seconds. If you like say, "I've got full-sized Baby Ruths," good for you!

Boyd: There's a reason they dropped a Baby Ruth in the pool in Caddyshack, is all I'm saying.

Hanson: [laughs] I don't think I could need a full-sized white chocolate bar. But as a little thing with your coffee? Maybe that is fun. Maybe Dan turned me. I don't know. I'll have to think about it.

Hill: [laughs] Drop us an email, [email protected]. We need the dozens of listeners to weigh in on this debate. Maybe to Dan's detriment, or maybe to his victory, you won't be around to deal with it. Tim Hanson, don't be a stranger!

Hanson: Thank you, man!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you next week!

Chris Hill has no position in any of the stocks mentioned. Tim Hanson owns shares of Berkshire Hathaway (B shares) and McDonald's. The Motley Fool owns shares of and recommends Oaktree Capital, Tesla, and Twitter. The Motley Fool owns shares of GameStop and has the following options: short January 2019 $16 calls on GameStop. The Motley Fool recommends Berkshire Hathaway (B shares) and Ford. The Motley Fool has a disclosure policy.

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