In this podcast, Howard Marks, founder of Oak Tree Capital Management, joins Motley Fool CEO Tom Gardner, Chief Investment Officer Andy Cross, and senior analyst Buck Hartzell for a conversation about:
- How investors should think about the deficit.
- Investing in human emotion.
- The inescapability of risk.
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A full transcript is below.
This podcast was recorded on June 15, 2025.
Howard Marks: Most people are subject to emotion and that emotion causes people to buy high and sell low, then what you got to do is you got to tie your hands and not do it. Now, we run funds. They're institutional funds. They're not open to the public, but in many of our funds, you lock up your money for 10 years. You can't get out, and it's like Odysseus tying himself to the mast when he had to sail past the sirens.
Mary Long: That's Howard Marks, the celebrated value investor and founder of Oaktree Capital Management. Earlier this week, Marks joined a Motley group of fools, including CEO Tom Gardner, Chief Investment Officer, Andy Cross, and senior analyst Buck Hartzell on our livestream, Fool 24 to discuss the state of the market. We're replaying the conversation in full here on Motley Fool Money in case you missed that live version.
Tom Gardner: Buck and Andy, great to have you both here. I was reflecting a little bit on all the many things that we've studied and learned from Howard Marks and from Oaktree over the years, and then I was thinking, I wonder, and we'll ask Howard as he joins us. I wonder if it gets a little annoying for Howard and his team of many, many great investors that they're probably referred to as Oak Worth, Oak Bridge, Oakmont.
Andy Cross: There's a lot of Oaks out there.
Tom Gardner: There are a lot of oaks out there, but there's one Oaktree Capital Management that specializes in distressed debt and alternative assets, and we are joined by its co founder and co chairman, Howard Marks for this hour. Mr. Marks, thank you so much for spending this hour with us.
Howard Marks: Mr. Marks is my father. It's great to be with you, Tom.
Tom Gardner: As well. Do you often hear different phrasing of your company name? Like, you all are so great over there at Oak Hill?
Howard Marks: Well, of course, that happens. By the way, we started up 30 years ago in April, and a couple of months later, I saw an ad or something about Oaktree, this or that, and I said, That's ridiculous. We're going to sue those people, and then it turned out that there's an oak tree in just about every city. An Oaktree investment management firm in just about every city, and we're the last, not the first, so no loss.
Tom Gardner: Well, I won't give a detailed story of the time I met Nikki 6 from Motley Crew, and he playfully threatened to sue us for that, and that was an enjoyable moment that we had. Howard, this is how we want to spend the hour together if you're willing to take this journey with us. If you'd like to edit any of the major themes that we're heading toward, please do so. But we thought we would start with debt and the markets today, then investing in human emotion and then designing a great investment process and then what you've learned in business to close.
Howard Marks: That'll be a good hour. I'm looking forward to it.
Tom Gardner: Yeah. What is the debt market telling us today about the equity markets?
Howard Marks: There hasn't been that much change, except that when the whole tariff thing occurred, the yield on the tenure jumped by about 50 basis points, half a percent. That basically, I think you can say that people demand higher interest rates when they're more aware of risk, and, of course, most people think that the tariffs introduced new risks, and it's reflected in bond prices and as it should be.
Andy Cross: I'd like to ask about one other form of debt, and that's for our country. You talked about tariffs. Well, debt to GDP is probably about 124% right now. We've had a really high profile divorce from the leader of Doge Elon Musk who is headed back to Tesla, and a big, wonderful bill making its way through Washington right now, but I just wonder, from your investment standpoint, how big of a deal is that deficit? Am I the only one worried about it, or how should investors think about $2 trillion deficits as far as the eye can see right now?
Howard Marks: No, I don't think it's a non issue. The US was given by the world a golden credit card, the way I describe it, where there's no credit limit, and you never get a bill, and the interest rate is one of the lowest in the world, and we got that because of our leadership in many areas, including economic, but also the fact that the dollar is the reserve currency of the world, and that has permitted us to spend more than we bring in in taxes for I don't know, I think, let's say, 41 out of the last 45 years, and, of course, that's the rational behavior for somebody who has a golden credit card. Why would you possibly live within your means if you can do what I described. But the question is, can we lose that status? That's really the question. If the world decides to impose a limit on our credit card, as you can see with what's going on now, it'll be very hard to go back to living within our means. Exactly what that means is hard to say. If the world worries about us and they raise the interest rate, then that'll increase the cost of our debt service, and that'll add further to the deficit and the debt. As we spend more on interest, it adds to the deficit and the debt balloons, and so it seems like a spiral.
It has it seems uncontrollable because you can't imagine, I guess one of you said mentioned $2 trillion deficits as far as the eye can see, it doesn't seem possible to get it under control. Where does this lead? Hard to say. Warren Buffett at the Berkshire Annual meeting, said, This is going to be a problem, but nobody knows if it's two years or 20 years. Somebody mentioned that, maybe it was Andy mentioned that our debt is 120 odd percent of GDP, which sounds like a lot. Is that a problem? Where does the problem set in? Nobody knows. In Japan, it's 200. Maybe 120 is not a problem, but the golden credit card sounds too good to be true. There was an economist once named Herbert Stein, and he's famous for saying one thing. If something cannot continue, it will stop, and I agree 100%, and if you can't spend two trillion more than you bring in in taxes every year forever, then it will stop, and what happens? Hard to say.
Andy Cross: There are two choices. You can spend less or you can raise more in the form of revenue, and neither of those are politically very attractive to folks.
Howard Marks: What we need is elected officials who for whom not getting elected isn't the worst thing in the world. I'm writing a memo about this and it'll be out within a week or 10 days, and I touch on it, and I say, What we need is austerity. The trouble is austerity isn't fun, and if you want to get re elected, then what you want to do is you want to entertain the voters, and they're not going to be amused by austerity, and so far we have let that dominate the discussion. As you say, they say, Well, I'm all for a balanced budget. I just don't want to increase taxes or cut spending.
Andy Cross: And I would say, two years ago, at the Berkshire meeting, when Warren was asked about selling Apple, which he sold over 600 million shares eventually of and he said basically taxes are going up. That was the reason that he gave for selling it. It wasn't he didn't believe in Apple. Of course, Apple was trading at a higher multiple than when he acquired those shares, too.
Howard Marks: I think that you talked about percentage of GDP. I think that our taxes at the federal level now are 17% of GDP, which is unusually low, and the top rate on the federal, I think, is 37, if I'm not mistaken, and that's unusually low. When I was a boy, it was 95, so 37 is a bargain. But you have to have some spine, and you have to say, you have to say, it's not OK to spend more than we make. We have to get it under control. An interesting thing to note is nobody ever pays their debts. No company, no country, very few people ever reduce the amount they owe. They just roll it over and usually add to it. We're not talking about erasing the 36 trillion of debt. We're only talking about bending the curve a little so that it grows slower than GDP. We're not even saying it shouldn't grow, but if it ever started to grow slower than GDP, everybody would celebrate.
Andy Cross: What would be the Howard Marks plan in terms of raising revenue and cutting spending? 50/50, 70/30?
Howard Marks: I'm not astute enough to know. The trouble is a large percentage of Americans don't pay any federal taxes. It would be hard to start them on it. You can't get that much more out of the people in the top few percent. You have to hit the middle class. The people who make probably 100,000 and 100,000 or 100 and 200,000 let's say a year. I was doing some research for this memo I'm writing, and it turns out that the baby boomers, of which I'm about the oldest, he had to be born between '46 and '64, and I was born in '46. The baby boomers, they estimate were 38% of the voters in the 2020 presidential election. It's a very, very populous group, and you don't want to antagonize them.
Tom Gardner: Howard, how about on the corporate debt side, distressed debt? I mean, balance sheets seem to be pretty strong. At least at the S&P 500 level, you mentioned that you don't really pay down your debt. Some do, but you typically companies roll it over and just continue to pay even now, relatively low interest rates. But the status of the corporate distressed debt market, how are you thinking about that today?
Howard Marks: The typical company, I think, is not too leveraged. What happened, however, is that in the last 20 years, something called private equity, leveraged buyouts was tapped as the silver bullet, the Sure solution, and money flowed into it like water, and those companies are highly levered. Those companies have basically, let's say, $3 of debt for every dollar of equity or something like that, and a lot of them were purchased in the last 10 years, and a lot of them purchased when the Fed funds rate was zero or close to it, and so they were saddled with capital structures, highly levered capital structures that they did not anticipate a world where interest rates were 4 or 5% higher and that are going to be hard to refinance when they come due, and leverage is not as easy to get anymore and not as cheap, and that will be an issue. We don't usually think about ordinary S&P 500 companies going bankrupt. We think about good companies that were bought by the private equity industry, saddled with too much debt, get into a low spot or have trouble refinancing, and then we tend to get involved. Good company, excuse me, [inaudible] , Andy, is good company, bad balance sheet. If you have a good company with a bad balance sheet, it's easy to fix. It goes through bankruptcy, they reject a bunch of their debt, and they emerge with low leverage. If you have a bad company, it's hard to fix. You have to be a magician, and we don't claim to be.
Andy Cross: Can I ask one more quick question about debt, and this relates to retail investors. We've seen a lot of changes in people's ability to buy stocks, from discount brokers, and I get this question a lot from people. Why can't individual retail investors just go buy their own bond? The market is so opaque and it's difficult. You got to know the QCIP number, and even if you can, the spreads are wide, why hasn't there been much evolution in that market for the retail investor?
Howard Marks: I'm sorry. Which market?
Andy Cross: The bond market. If I want to buy my own corporate bond or I want to go do that, it's just out of the reach for most retail investors, it seems.
Howard Marks: I'm not an expert on the subject. I don't know. It just never has developed. People go into the stock market because historically, the stock market has made people rich. The S&P has returned 10% a year for the last 100 years, and that was enough to turn $1 into something like 14,000 15,000. Everybody wants to get in the stock market, and you hear all these stories about this company went up that much. You don't hear those stories about bonds, so bonds never have been that popular, and you just don't see people going out and buying bonds one at a time and managing their own portfolios. You never know anymore what sayings are PC or not, but we used to say kissing your sister, and I think most people view bond investing as kissing your sister.
Howard Marks: But it's not that exciting, so it doesn't have the allure of the stock market. But today, you can go into a high yield bond fund, and high yield bonds pay before fees, which matter and before potential defaults, which are bound to occur once in a while. Today, they yield 7.5%. That's not bad. If you have $1 million, you can get $75,000 a year of income, with very little uncertainty and in cash in the hand. I think that's pretty good, especially at a time when the stock market is historically expensive.
Andy Cross: What do you advise an equity investor if you were? For example, I know I've watched you reference occasionally the dynamic between you and your son in the different ways that you invest. Somebody in the equity markets who's looking at we could look at any number of factors. We could say the Buffett market cap to GDP. We could look at the 200 week moving average of the SME is now something like 25% above PE ratios, etc. Are you somebody who generally thinks you should reduce your equity exposure and pay the tax, or you should be looking for larger cap, lower Beta, dividend paying, underfollowed, unloved, because we're certainly getting into a period now where people are beginning to celebrate the winners and see the concentration of the attention around those winners. How do you suggest an investor reacts in scenarios like this?
Howard Marks: Well, I'm not a professional stock market investor. Clearly, nobody should take my advice on that. Now, having gotten that out of the way, that doesn't keep me from giving advice. What do we know? You alluded to some of it. The statistics on the valuations of something like the S&P are above average. The PE ratio, the ratio of price to earnings on the S&P 500 companies looking out for the next 12 months is around 22. The historic average is 16. Twenty-two is high. It's not crazy high. It's somewhat high. Back in 2000, I think, was 32. That was crazy. The people who bought the stock market at that level, the S&P, in short order, I think we're probably down half. This is not that kind of thing, but it's lofty nevertheless. I tend to think of things as either rich, cheap, or fair. In the middle is fair, and if it's rich, you might think about reducing your exposure. If it's cheap, you might pile in. In the middle ground, I don't think there's that much to do. I don't make great distinctions within fair because historically hasn't paid off. If something's a little expensive, things go from a little expensive to a little more expensive to a bunch expensive to somewhat expensive, and if you get off them, just because they're a little expensive, you've missed a lot.
I think when the market is in fair territory, you shouldn't do anything, and I inveigh against hyperactivity. By the way, who was it? Bill Miller has this saying that it's time in the market, not timing the market, that makes you rich. I think that's generally true. Now, of course, if the markets at an extreme, you might like to know it. You might like to take some chips off the table, but as you say, you do have to pay taxes, and then you have to remember to get back in when it cheapens. Charlie Munger used to talk about market timing like that as a two decision problem. You have to decide when to get out, and you have to be right. Then once it goes down, rather than just congratulate yourself, you have to remember to get back in, and most people don't do that because they're so thrilled with the fact that they got out. But JP Morgan put out a chart around the end of last year, and it showed for every dot on the chart was a month end between the period of 87-14, I think. That's 27 years. There was a plot of PE ratio versus 10 year average annual return over the next 10 years. It was a very strong relationship. Not surprising. The higher the PE you paid, the lower your subsequent return was, what your pay matters. According to that chart, every single time you bought, if the PE was 22, your return over the subsequent 10 years was between -2 and +2% a year.
Andy Cross: Much different than the 10% that you quoted here.
Howard Marks: Yes. What you would say, don't hang up me on the numbers, but if you buy at 16, which is the average PE, you'll get the average return, which is 10. If you buy at a PE of 22, which is high, you get two to minus two, which is low. If you buy at eight, which is low, you might get a return of 15-20, which is high. The higher the price you pay, the lower you return, makes sense. But of course, if you're a real long term holder and indifferent, you just strap yourself in and you hold for the long run and you hope once you get past your period of overpricing and underperformance that you regress toward 10. But if you bought in 2020, which I mentioned I think you made no money for the next 12 years. That was an extreme overvaluation, but valuation matters.
Andy Cross: Well, you've written about how investing patients is so important and pivoting over now to investing in human emotion. I just wanted to maybe get your thoughts on risk preparation, you said that you can't predict, but you can prepare. You've written about that a few times, and I think we all respect that. But as investors are thinking, whether it's equities or distressed debt or wherever it is, how do you think about when you're in that 80% range and you're saying, OK, well, in general, allocating capital fully in, but trying to balance a time when it should be a little bit more opportunistic or a little bit more cautious based on whatever metrics you're looking at. But mentally, there is a time when you have to start to make that change. I guess, just over your experiences, any guidance you can give us to managing that temperament when things are getting a little bit extreme or when your outperformance or the performance is actually not so good in your portfolio, but you're just waiting to see better days in the market.
Howard Marks: Well, first of all, Andy, I'd like to give a commercial for myself. During this discussion, once in a while, I'll say, I wrote a memo, this or that. I hope that people, if they're interested, will read the memos, you go to oaktreecapital.com under the heading the Insights. It says memos from Howard Marks, I think. You can click on it and you can subscribe to it. I heartily recommend it. But the one thing I'm sure of is that the price is right, because it's free. People can read whatever they want. There's 35 years worth there, so it'll keep you busy. But I wrote a memo, as you say, called You Can't Predict, You Can Prepare, and I think it was 2002. Now I sold that line as I do most lines. That was the tag line of the MassMutual life insurance company. I saw it during a football game. I thought it's a great line. Now, what is investing? Investing is positioning your capital to benefit from future events. How can you prepare for the future events if you can't predict the future events? It sounds like an oxymoron. But the truth of the matter is, you can prepare for an uncertain future. I don't believe in forecasts. I inveigh against predictions wholeheartedly, macro predictions, economy and markets and rates and currencies and that kind of thing.
What am I sayings is, we never know where we're going, but we're sure as hell ought to know where we are. I think you can get a sense for the climate we're in. The question is, is everybody ecstatic and optimistic and thrilled with the way things are going and generous and paying high prices? In which case, the market is risky. Or is everybody chastened and pessimistic and downcast and paying low prices, in which case, the market can be above average in attractiveness, or is it in between, in normal territory. I think it's possible to get a sense for the environment and thus what you should do. Now, when I say what you should do, the main thing that matters is the balance in a portfolio between offense and defense. Do you want to have an offensive portfolio that might get you to lose some money in the bad times, or do you want to have a defensive portfolio, which might cause you to miss some gains in the good times? That's your choice. Or do you want to balance them, absolutely. People should make a choice based on their own risk tolerance. But you can figure out, is this a time when the market's depressed and that's a time to be aggressive or when the market's elated, which is a time to be defensive. Buffett said, the less prudence with which others conduct their affairs, the greater prudence we must conduct our own affairs. That's about right. When other people are carefree, we should be terrified. When other people are terrified, we should turn aggressive. That's the way I try to live.
Andy Cross: Howard, do you find that is a skill that most investors can learn? Because buying into pessimism, I think, for many, is rather difficult. Maybe that's the opportunity of an investor like yourself or those who are really optimistic to take advantage of distressed securities. But it's a learned skill, I think, and any guidance you have to learning that skill, I would love to hear.
Howard Marks: Well, now I'll make a commercial for something that costs money, which is my books. But in 2011, I wrote a book called The Most Important Thing. There's 21 chapters. Each one says the most important thing is, and it's a different thing because there are so many things in our business that are important. But there's a chapter which says, the most important thing is contrarianism. That's what we're talking about here. Number 1, you can learn about the importance of contrarianism at the extremes, not all the time. But then the question is, can you do it? Can you learn to do it? The trouble is, as you say, it goes against human nature because what you have to do is you have to be sober when everybody else is elated. You have to be stable when everybody else is suicidal. But if you can do those things, obviously, you can be an above average investor, because the average investor is excited at the high and buys, which is wrong and depressed at the low and sells, which is wrong. You want to be a contrarian to the extent you can, but it's not easy. None of these things are easy. In my last memo, or well, I think it was in my last memo. I quoted a chartist.
Remember that word chartist, technical analyst called Walter Deemer? I hadn't heard of him before. I was reading Doug Kass' newsletter, and he quoted Wally Deemer, and it's the title of his book. The quote is, "When the time comes to buy, you won't want to." In just 10 words, this captures so much truth. What creates the great buying opportunity? What creates them? What creates it is that the economy is not doing so great. The companies are reporting poor earnings. The stock market is declining. Most people want to get out. They've lost money. Their main concern is not losing anymore and they just want to. That's the time when the greatest buying can be accomplished. But as Wally says, when the time comes to buy, you won't want to, because you will also see poor economy, poor earnings reports, declining stock prices and heavy volume on the down days. You'll say, I want out, too. The point is, everybody is subject to the same influences. Everybody reads the same headlines and hears the same stories on the news and on the podcasts. How many people can say, you know what? The world is a mess, and I think that means it's time to buy.
Andy Cross: Oh, sorry, Howard.
Howard Marks: No, I just want to say, it's just not that easy. There are very few of us who could do it. One of the main requirements seems to be that you have to be unemotional. If you look at some of the great investors, I think that unemotionalism has been one of the common threads because emotion will get you to, my mother said, Howard, you should buy low and sell high. But emotionalism gets you to buy high when things are going great and sell low when things are going badly, and that's a formula for disaster. You have to be unemotional.
Tom Gardner: I'd like to hear any guidance you have for investors in setting their time horizon as an investor. It could be their overall time horizon or position by position at The Motley Fool, what we have advocated now for 31 years is to make your minimum holding period for average holding period for your stock something like five years. Then you will see business performance through most of our cycle. Obviously, trading activity has increased dramatically with all of the technology and access to information. But one of the things we've also said is, if everyone doubled their average holding period, they would be richer. That was just a default that everyone. If you hold a stock four days now, make it eight days. If you hold three years, make it six years. If you hold 10 years, make it 20 years. Chances are your returns will increase. But people have a difficult time knowing what that average anchor should be. Then, of course, the news and crisis and different dynamics come in, but they often don't have that anchor. How might somebody spend that anchor?
Howard Marks: Well, first of all, there's no solution. There's no number which right for everybody. Everybody's number is different. But along the lines you're talking about, Tom, which I think is I think this is one of the most important subjects we can tackle on this podcast. I wrote in one of my memos, and I'll tell you which one I think it is that they did a study, and they found that fidelity that the best performing accounts belong to people who are dead. Now, apparently, fidelity can't find the study, and nobody else can find the study, so my guess is the study doesn't exist, but I still like the idea because it tells you a lot. Obviously, if it's true that most people are subject to emotion and that emotion causes people to buy high and sell low, then what you got to do is you got to tie your hands and not do it. Now, we run funds, they're institutional funds, they're not open to the public. But in many of our funds, you lock up your money for 10 years. You can't get out and it's like Odysseus tying himself to the mast when he had to sail past the sirens. It's the same thing as you're saying, Tom. If you go into a fund that will no matter how you kick and scream when the markets down 50%, they're not going to let you get out. They're doing you a favor. I think that lengthening your holding period is very important. Now, if I can get the listeners to listen to one thing, or to read one thing.
I'd love you to read a memo that I wrote in October of 2022, called What REALLY matters and I'll bet you guys haven't read it either, because nobody read this memo. I can always tell from the response, who read it and who liked it, and I didn't get much response on this. I think that this memo probably had the highest ratio of value to responses. What really matters? I start off I think you'll enjoy it. I start off by talking about five things that I think don't matter. Short term events. I talk about the fact that you go through these periods of time, like 2017, '18. I would travel the country as I do and speak to audiences or clients, even, and I would get one question. What month will the Fed raise interest rates? That's all they ask me. What month? I would say, why are you asking me? What does it matter? If I tell you May, what are you going to do? And if I call you back and I say, no, not May, August, what are you going to do different? Those are short term events. They don't matter and by the way, it's interesting to note that what are the most what were the most forceful short term events of the last, let's say, 20 years, global financial crisis, pandemic downgrade of the US credit rating, things like this. If you got out in advance of all those things and forgot to get back in, you left a lot of money on the table. Number 1, short term events, Number 2, short term trading in out. Nobody has almost nobody has been successful at that and certainly not the amateur investor. Well, let's say almost nobody. Number 3, short term performance. How did you do last month? How did you do last quarter? It doesn't matter. I have a news bulletin. Last quarter is over. What matters is how you're positioned for next quarter. But yeah, every investment committee I sit on, when they have a meeting of the investment committee, they spend the first hour discussing last quarter's performance. It's over. That's Number 3. Number 4, hyperactivity. I say that when I was a kid, we used to have a saying, don't just sit there, do something. My suggestion is, don't just do something, sit there. You'll be a lot better off and Number 5 is volatility and when things are volatile and they fluctuate a lot, people get spooked. But Buffett says, I'd rather have a lumpy 15 than a smooth 12. Just tie yourself to the mast, make some good investments, strap yourself in, and live through the volatility.
Hopefully, if you've made good fundamental decisions, it'll produce a good long term return and the volatility in the short term doesn't matter if you've made a good fundamental decision. I think this is really in line with what Tom said, and I think that you have to be patient and think about the long term. This memo grew out of a conference we had for some investors in June of '22 and I was on the stage, and all they asked me was, when are the rates going to go up? When are they going to stop going up? When is the recession going to start? When is it going to end? How bad will it be? I said to them, This is all short term stuff. What really matters? This is stuff that doesn't matter. What matters is two things. Do you buy into companies that grow and do you lend money to companies that pay you back? That's all that matters. If you watch the shows, there's an enormous preoccupation with what the market did today and what it's going to do tomorrow and it doesn't matter. I once wrote a memo in January, February of '15, I think it was. Well, in January, I wrote one called On the Couch, because I think every once in a while the market needs a trip to the shrink and then people were asking me, well, the market's down. Isn't that a warning system. Then a couple days later, I wrote a memo called What does the market know? I think the market doesn't know anything. If you want to outperform, you have to take advantage of the market's manic depressive behavior. You can't you can't act as if the market is a sage and tells you what to do. You have to say the market's a manic depressive, and when the market makes a mistake, we're going to be on the other side. We're not going to take its advice. Anyway, that was a long answer to one of my favorite questions, Tom.
Tom Gardner: Yeah, no, that was a great answer. We try and tell folks, I think most recently with the tariffs that were announced, and we had extreme volatility for several days in the market that on those big down days, if you sell out of stocks, the biggest up days in the market tend to be very close in proximity to the biggest down days, and that halves your return from 10% to 5%, so selling out on those down days can look smart for a day or so, but usually it doesn't look smart in the rear view mirror.
Howard Marks: Well, and I would add one thing. You bought something yesterday and you paid 100. Tomorrow, a bad piece of news comes out like a tariff, and it falls to 90. If you had decent reasons for buying it 100, shouldn't you buy more at 90 and not sell? Most people just do not have what it takes to extract the significance of these events, and they should just ignore them.
Tom Gardner: Something you've mentioned is you said the people make the biggest mistake that investors make is they project whatever happened most recently long into the future and I think regression to the mean is something that's really important to you in Oak tree. Can you talk a little bit to investors about that?
Howard Marks: Well, you're going to get another long answer. I only have long answers. Nothing in our business is simple. Nothing in our business permits a short answer. But when I was a kid, and I mean 73 or four, somebody gave me a gift, and it was the first of the great adages that I ever learned. Somebody said, I'm going to tell you about the three stages of the bull market. The first stage in the bull market is there's been a crash or a crisis or some loss of confidence and stocks are on their rear end and nobody's interested in the market and only a few smart people realize things could get better. In the second stage, most people understand that improvement is actually taking place. In the third stage, everybody assumes that things can only get better forever. This tells you most of what you have to know. If you buy in the first stage when nobody's optimistic, you get a bargain. If you buy in the last stage when everybody's optimistic and has pushed prices up, you often overpay. Again, it's desirable to have a sense for where we are in the market. Certainly, you should never sell something just because it's down or buy it because it's up, people buy things, they see it's up, they say, I better get on because it could keep going up and I might miss it, and then I'll have to kill myself. In bad markets, people are overly concerned about losing money because they take the bad news as portending continued bad news, not regressions.
The fear of losing money drives people out. But in the good times, an even stronger force, in my opinion, takes hold and that's FOMO, the fear of missing out. When the stock market is rocking and rolling and it's going up every day, and you see headlines about Joe Blow turned 10,000 into 15,000 in a day. People say, Oh, my God, I feel so terrible. I've been missing this everybody else is getting this. I got to get on this. I can't stand to miss out. I better get in. Now, they may not know what the thing they're doing is or why. By the way, they may have decided not to buy it when it was 100, but now that it's 200, they say, I got to get in or I'll keep missing out. All these things, this is all emotion. You have to stand against these things. There's a book called I think it's called Panics, Manias, and Crashes, if I'm not mistaken, by Kindleberger and in a later edition, it has a great line. It says, There is nothing so injurious to your mental well being as to watch your friend get rich and it's really true. That's human nature for you. You have this guy who has the locker next to you at the gym. He's not that smart. He's a nice guy. Good to have a drink with once in a while, but you don't think he's not that smart. He starts telling you about the money he's been making. You say, that's silly stuff. You don't even know what you're doing back in the .com bubble. People would say, I'm buying your stock. It's coming public yesterday. They say, what's the symbol? Is it LBR. He says, well, what's the name? I don't know. Well, what does it do? I don't know. But I hear it's going to double, so the next day, you see the person, you say, did you buy that stock? He says, yeah, I did.
He says what happened? It's tripled. After you hear five of these, then the first time you heard it, and the guy says, I'm buying it, but I don't know the name or what it does, you think he's an idiot. But after five of them, you say, I got to get in on that and that's the way this thing works. You have to you have to get away from excessive fear of losing money. Excessive respect for fluctuations and especially, you have to get away from this fear of missing out. When you're in the third stage of the bull market, when things have been rocking and rolling for a couple of months or a couple of years and everybody's getting rich, that's when people capitulate and get in at just the wrong time because the market has it is the fact that the market has risen a great deal that attracts you, but that's not a reason to buy.
Tom Gardner: Howard, do you live in a world of balanced stoicism? Do you view the world as a market and when others are getting excited about something unrelated to the capital markets, you start to see a reason. I was at the New York Knicks playoff game, and I looked down over to my left, and there you were at the game I saw you. Are you somebody who says, well, we've had a good first quarter in the game, but I'm not going to get too excited because there's another three quarters to go. Is that a general stance for you or a particular?
Howard Marks: I think it is. I think that people who are that way might describe themselves as level headed. People who aren't that way might describe us as dead from the neck up or something. But I think, you just can't get too excited about the good moments or the bad moments. Investing is hard enough and if you let your emotions run wild and get you to do the wrong thing at the wrong time, it becomes infinitely harder. It's hard enough to find a good company with a great future and buy the stock.
Howard Marks: But then if you let the short term fluctuations of the market drive you in and out, it becomes infinitely harder.
Andy Cross: One of my favorite memos of yours was the indispensability of risk because as investors, we think a lot about risk. This is how you ended this piece that I want you to just guide us on this. You shouldn't expect to make money without bearing risk, but you shouldn't expect to make money just for taking the risk. You have to sacrifice certainty, but it has to be done skillfully and intelligently and importantly, with emotion under control. I love that thinking about because investing especially in the equity market, well, really, anywhere almost takes this notion of managing emotions with risk and balancing those two out.
Howard Marks: Well, you see, Andy, most people say, why are you in the stock market? You say, I want to make money. Well, don't you think everybody else does, too? Why should you be the one who gets to make money or what do you have to do to make money? The answer is, you have to bear uncertainty. If you do very safe things, you shouldn't expect much of a return. In our business, we talk about something called the risk free rate, and that's the interest rate on 30 day T bills. There's no credit risk, and there's no time risk because you get your money back so soon, and it's absolutely safe. But because it's absolutely safe, it pays the absolutely lowest return of anything. Then if you say, no, you know what? I'm not interested in that. I'm going to take some risk. I'm going to lend money to some great corporations. If you do that today, rather than 4.5, maybe you can make 5.5. But you've taken credit risk, because every once in a while, a corporation goes bad, and defaults or goes bankrupt. You may say, well, I don't know, 5.5, not so great. I have to pay taxes. I'm only left with 2.75. I want to have a higher return. Well, then you can go into high yield bonds. High yield bonds, you can get today 7.5. But that's because they have a real possibility of default. I've been involved in them for 47 years, and on average, something like almost 4% of all the bonds outstanding have defaulted every year.
Four is not a huge number, but it's not zero. Basically, you have to think of high returns as being the compensation for bearing risk. But as the quote says, because risk actually entails danger and occasional loss, you don't want to bear risk passively and without investigation, you want to do it intelligently and knowledgeably. It's not easy. It introduces and you can get safe returns absolutely dependably, but they're not that interesting. But to try for a return that is interesting, you have to do some things that aren't easy. Simple as that. Now, most people look at a chart. When I went to University of Chicago, they had just developed the capital market theory, and I don't know. I can't do it backwards, but there's a line that goes like this. On this axis, you have return, on this axis, you have risk.
There's a line that points up like that. When we see a line that points up like that, we say the two factors are positively correlated. There's a positive relationship between return and risk. Now, what people say erroneously, when you say, what does that mean? That upward sloping line? A lot of people say, what it means is that risky assets have higher returns. That is a terrible trap to fall into. Because if risky assets could be counted on to produce high returns, then by definition, they wouldn't be risky, so that can't be right. What it means that upward sloping line is that investments that appear to be risky have to appear to offer high returns or else nobody will make those investments. That makes perfect sense, but they don't have to deliver. It's from the possibility that they won't deliver that the risk comes in. The more you go out on the risk curve, the higher the expected return is. But the wider the dispersion of possible returns and the bad returns get worse. Risk is a real thing. It's not some academic concept, and every person has to figure out the right level of risk for them. It's not easy, and of course, then once they do, they have to figure out how much risk there is in the things they're contemplating, and that's not easy. None of this is easy.
Tom Gardner: Given our predilection to take on risk in our lives, often under researched risk, I wanted to cite a couple sources and see what you think of this in terms of a process somebody might embrace in scratching the itch of taking on a lark. I'm thinking of Walter and Edwin Schloss, the father and son, wonderful money managers who when asked at a particular shareholder meeting, why do we have 150 holdings when maybe 20 of them make up 85% of the portfolio, and one of the Schloss' answered. Because if we don't buy new, unknown risky things, we won't learn about the world ahead. We'll get comfortable with our 17 companies and not realize that their competitive advantages are being eroded. Then I'm thinking about a book entitled The Zurich Axioms, a book I really enjoyed by Max Gunther in which he articulated I'm remembering correctly, maybe graduates of business school trying to put together an investment club to make extreme wealth. Now, let's figure out a few stocks to buy, but how does one make $30 million? How does one make $50 million in life? One of their concluding principles was, you have to be willing to embrace small risk continually to learn more about the world around us. Any reflections on that?
Howard Marks: Well, it makes sense. It happens, by the way, not to be my approach. Again, I'm not a stock market investor. But if you will only buy, what are the things some people might do to improve their probability of success? You buy things that have obvious merit, great products, great management, great history of profits, and things that have gone up in the past. If you think about it, those things are easy to buy. Everybody's attracted to the things that have obvious merit, which means that probably a lot of buying has taken place and the price has been driven up. By the way, if you want to be an average investor, it's really easy, and I recommend for most people that average is very good. You just have to tie yourself onto an index bond and stay with it for the long term. If you buy an S&P index fund, you're guaranteed S&P performance, whatever that might be. You're not guaranteed good performance, but you're guaranteed S&P performance. But if you want to go beyond that and have better performance than the index, you're going to have to do something that's not obvious to everybody else because the things that are obvious to everybody else, they've already done. You might have to buy a small company, an obscure company, a company that has not demonstrated greatness yet, a company whose product is on the come, unknown.
It might be a stock that's down a bunch, which scares everybody else. But among other things, it might mean that it's on the bargain table, having been marked down. Above average success can never lie in doing the obvious. That's really just a simple rule. Now, you have to study and you have to read up on things like contrarianism to get to the point where you can understand that question. I guess what I'm saying is that maybe the viewers or listeners should ask themselves if they get that. Above average success can never lie in doing the obvious. I would say, if you want to be an above average investor, read and study until you can really explain why that sentence is true.
Tom Gardner: Buck, you will have the final question of our hour with Howard Marks.
Buck Hartzell: This is great. It's a privilege, and I have enjoyed your books and your memos throughout the year, so I do recommend people go to Oak Tree and check those out because there's a wealth of information there. I'm going to ask you about something that's a little bit maybe contrary. I know forecasting, you have your six principles, and you don't rely on macro forecasting and those things. But there's a wonderful book called the Superforecasters. I don't know if you're familiar with that with Philip Tetlock and Dan Gardner wrote that. But it turns out they build a group of people that could do forecasting good. Now, not really long. They've learned it's easier to do a shorter term than it is to do long term forecasting. But those group of people came from a variety of different backgrounds, but they had some things in common. They were open minded, they were humble people, they were willing to update their beliefs, and they used a variety of sources of information. Whenever they got new facts, they changed their forecast so they would update them all the time. I would just say sounds to me a lot like Oak Tree. I would just like to know about some of the processes at Oak Tree and just when you hire people there, do you hire a certain type of person, or do you train those people to think along the lines of your principles and emotional intelligence and those types of things?
Howard Marks: Well, I think, Buck, I like to believe both because just like in selecting a marital partner, it's not a good idea to select somebody who is the opposite of what you want in the expectation you can make them what you want. A lot of sweat and tears have resulted from that. What we try to get is independent thinkers and people who can think different from the crowd and who will see things that others don't see or take a chance on a Maverick point of view. Then they invariably have to be highly intelligent, but also have this streak of independence. In my book, I say, the most important thing is second level thinking which means thinking differently from the crowd and better. What the crowd knows is already in the stock price. If you only know the same as the crowd, you can't improve on the stock price. You can't tell when the stock price is higher or lower than it should be and do something about it. We need people who are capable of second level thinking, thinking different from others, but also better. If you think different from everybody else and worse, all you'll do is lose money. By definition, relatively few people have the possibility of thinking different and better, and probably even fewer can actually do it. But you have to understand the essential nature of contrarianism.
You have to understand what I said before that success can't lie in the obvious. It can't lie in agreeing with what everybody else knows. Now, most of the time, what everybody else knows is pretty correct. Disagreeing with them for the sake of disagreeing is not a good idea. But on the other hand, if you think the same as everybody else, that's not a very good formula for having above average performance. You have to be able to find those times, and they may be few when you have a view which is different from that of the herd and it's correct. But if you never have a view that's different from the herd and correct, then you just can't be an above average investor, and you should buy an index fund and just hold on.
Tom Gardner: A lot of this has reminded me of a line I've heard from my father over my handful of decades and his 87 year life. I don't like to be wrong, so I don't make predictions. [laughs]
Howard Marks: Well, and that's right for many people. That's not dumb. Well, maybe I'll close it out by citing my favorite fortune cookie. I once got a fortune cookie, and it said inside the cautious seldom error or write great poetry. I think it's great. Because it can be read two ways that if you're cautious, you'll seldom error, which is good. But you'll also never write great poetry, which is bad. If your goal is to write great poetry, you have to take a chance of being incautious and occasionally erring. But there's no sure formula for doing so. There's no algorithm you can follow or no machine you just have to turn the crank on. When I got through writing, the most important thing, I had lunch with Charlie Munger, who worked in the building next to us in Los Angeles. I got up to go, and he says, just remember, none of this is easy. Anybody who thinks it's easy is stupid. That was Charlie. But it's true. If everybody wants to make money, it can't be easy to make an above average amount of money. You have to take risk and you have to excel in some way. You have to know something that not everybody else knows.
Tom Gardner: Howard Marks, thank you so much for this hour. What would be your estimated length of time on an interview if say you were willing to come back again and have the Motley Fool interview you on all of your memos?
Howard Marks: One at a time.
Tom Gardner: One at a time.
Howard Marks: Well, let's do it again in the year.
Tom Gardner: Love it. Thank you very much for what a wonderful hour, and thank you, Andy, and Buck, as well.
Howard Marks: Well, I've enjoyed this, and your questions are knowledgeable, and that's the most important.
Mary Long: 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. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For the Motley Fool Money team, I'm Mary Long. Thanks for listening. We'll see you tomorrow.
