One Line
Oaktree Capital Management, L.P. provides strategies and products to investors in an environment of higher inflation and interest rates, with the Fed's rescue plan leading to an extended economic recovery and bull market.
Key Points
- Oaktree Capital Management, L.P. offers a range of investment products and provides educational resources to its clients.
- Interest rates and inflation have been higher than in the past 40 and 13 years, respectively, and are likely to remain so for the foreseeable future.
- The Fed has increased its balance sheet from $4 trillion to almost $9 trillion due to its bond purchases and is attempting to slow the economy.
- The FOMO mentality of 2009-2019 has been replaced by risk aversion due to the Ukraine conflict in 2022 and Covid-19 pandemic.
- The long-term decline in interest rates led to an increase in stock prices, low-interest financing, and a "wealth effect".
- Michael Milken's idea of non-investment grade bonds being investable revolutionized the investment industry.
Summaries
164 word summary
Investors must adjust to a new environment of higher inflation and interest rates. Oaktree Capital Management, L.P. provides strategies and products, including private equity, real assets, listed equities, and credit, to public and other investors. From 2009-2021, investors took on more risk and stock prices surged due to low interest rates and quantitative easing. The Fed implemented a larger rescue plan during the pandemic leading to an extended economic recovery and bull market. Inflation and interest rates have been the dominant considerations influencing the investment environment, with yield spreads on high yield bonds rising. To regain credibility, the Fed will need to slow the pace of its rate increases and withdraw liquidity from the economy. Howard Marks identified two major sea changes in the past, with the third beginning with Paul Volcker's appointment in 1979. This led to an increase in asset values, a "wealth effect," and a dramatic rise in the S&P 500 Index. Leverage has made it easier to make high returns.
413 word summary
Sea Change is a program that opens in a new window and links to an external site. Howard Marks, with 53 years of experience in the investment world, has identified two major sea changes in the past: the Nifty Fifty stocks of 1969 and the introduction of non-investment grade bonds in the 1970s. The third major change began with Paul Volcker's appointment as Fed chairman in 1979, which ushered in a four-decade period of declining interest rates. This has led to an increase in asset values, a "wealth effect," and a dramatic rise in the S&P 500 Index. Investors have benefited from this decline, as it has made it easier to make high returns with leverage. The analogy of standing still on a moving walkway was used to describe the effect of this long-term decline in interest rates. The period from 2009 to 2021 saw investors take on more risk and stock prices surge due to low interest rates and quantitative easing from the Fed. Corporate profits were boosted by strong economic growth and lower interest costs, resulting in a positive economic outlook. When the pandemic hit, the Fed implemented a larger rescue plan, leading to an extended economic recovery and bull market. Inflation and interest rates have been the dominant considerations influencing the investment environment, with yield spreads on high yield bonds rising and banks taking losses due to hung bridge loans. The Fed has kept interest rates at 2.5%, but inflation of the last two years has been attributed to one-off events related to the pandemic. To regain credibility, the Fed will need to slow the pace of its rate increases and withdraw liquidity from the economy, though no one can predict the timing or extent of the decrease. We have moved from a low-return world to one with potentially higher returns from credit instruments. Investors need to adjust their strategies to the new environment, which is characterized by higher inflation and interest rates than in the past 13-40 years. The Fed is likely to keep interest rates high to provide room to stimulate the economy if needed. Oaktree Capital Management, L.P. is an investment firm providing various strategies and products, including private equity, real assets, listed equities, and credit. These products are available to public investors and other investors such as Brookfield Oaktree Wealth Solutions, Oaktree Acquisition Corporation, and Oaktree Specialty Lending Corporation. Oaktree also provides educational resources such as memos from Howard Marks and market commentary to its clients.
1238 word summary
Oaktree Capital Management, L.P. is an investment firm with a range of strategies and products, including private equity, real assets, listed equities, and credit. These products are available to public investors, as well as to other investors such as Brookfield Oaktree Wealth Solutions, Oaktree Acquisition Corporation, and Oaktree Specialty Lending Corporation.
Oaktree is committed to providing educational resources, such as memos from Howard Marks and market commentary, to its clients. It is important to note that any information provided by Oaktree should not be used for any purpose other than educational and should not be construed as an offer to sell or solicitation to buy any securities or related financial instruments. We have moved from a low-return world in 2009-21 to one with potentially higher returns from credit instruments. Investors may need to adjust their strategies to suit the new environment which is significantly different from the past 13 and 40 years. Inflation and interest rates are higher today than they have been in the last 40 and 13 years respectively, and may stay at these levels for the foreseeable future. The Fed would likely prefer to keep interest rates high enough to provide room to cut if it needs to stimulate the economy in the future. The Fed has kept interest rates stimulative for the past decade and most recently the rate was estimated at 2.5%. The Fed would prefer to normally maintain a “neutral interest rate” and reduce its role in capital allocation. Inflation of the last two years can largely be attributed to one-off events related to the pandemic. To regain credibility and keep inflation in check, the Fed will need to slow the pace of its interest rate increases and withdraw significant liquidity from the economy. The Fed faces the challenge of what to do with its balance sheet which grew from $4 trillion to almost $9 trillion due to its bond purchases. Investors believe that inflation is easing and the Fed will soon pivot back to stimulative policies, leading to lower interest rates and a healthy economy. However, no one can predict the timing or extent of the decrease. Inflation and interest rates are likely to remain the dominant considerations influencing the investment environment for the next few years. Yield spreads on high yield bonds have risen, and new security issuance has become difficult. Banks have taken losses due to hung bridge loans, and investors are anticipating a recession. This has caused pessimism to take over from optimism, and risk aversion is high. The Fed is attempting to slow the economy, but a soft landing is unlikely, adding to investor uncertainty. The Ukraine conflict in 2022 caused a decline in stock and bond prices, leading to higher interest rates and lower p/e ratios. This caused FOMO to dry up and fear of loss to take its place. From 2009-2019, Oaktree focused on credit and value investing, but the market was an asset owner's and borrower's market, with good economic growth and cheap capital. This made it a frustrating period for lenders and bargain hunters. The period from 2009 to 2021 was marked by optimism among investors and low inflation, allowing central bankers to maintain generous monetary policies. Yield spreads and interest rates were at all-time lows, creating a wide-open credit window and a lack of risk aversion. This led to a FOMO mentality, complacent holders, and eager buyers, resulting in a positive economic outlook and a highly stimulative Fed behavior. When the Covid-19 pandemic caused the economy to shut down, the Fed implemented a larger version of its GFC rescue plan, leading to the longest economic recovery and bull market in history. Globalization and limited armed conflict contributed to economic growth, few defaults, and low-interest financing under less-restrictive documentation. The markets' strength in the period between the Global Financial Crisis and the onset of the pandemic encouraged investors to take on more risk and drove stock prices up. Low interest rates and quantitative easing from the Fed had a dramatic effect on asset prices, and the S&P 500 increased from 667 to 3,386 in February 2020 for a compound return of 16% per year. Corporate profits were bolstered by strong economic growth and lower interest costs.
In a recent visit with clients, an analogy was used to describe the effect of the prolonged decline in interest rates: standing still on a moving walkway makes life easier for the weary traveler, but walking at one's normal pace results in rapid movement over the ground. This effect has been felt by investors over the last 40 years, with their success due to not only the growth of the economy and associated companies, but also the tailwind generated by the massive drop in interest rates. As an example, a private equity investor who initially took on a loan at 8% now finds he can roll it over at 5%, resulting in a 25% levered return. A buyer analyzes a company, concludes that he can make 10% a year on it, and decides to buy it. He borrows 75% of the money at 8%, which would allow him to earn 10% on three-quarters of the capital.
Declining interest rates have had several effects: they reduce the prospective returns investors demand, increasing the prices they’ll pay; they increase asset values and reduce borrowing costs; they create a “wealth effect”; and they make it cheaper for consumers to buy on credit and for companies to invest in facilities, equipment, and inventory.
The long-term decline in interest rates in the 1980s gave rise to optimism among investors, the pursuit of profit through aggressive vehicles, and an incredible four decades for the stock market. The S&P 500 Index rose from a low of 102 in August 1982 to 4,796 at the beginning of 2022, for a compound annual return of 10.3% per year. Paul Volcker's appointment as Fed chairman in 1979 marked a major turning point in macroeconomics. His determination to raise the fed funds rate to 20% led to a decline in inflation and ushered in a four-decade period of declining interest rates. This was the second major change in the investment world, following the OPEC oil embargo of 1973-74 which drove up the cost of goods and triggered rapid inflation. This, in turn, created a new risk/return mindset among investors, which led to the development of new investment types such as distressed debt and mortgage-backed securities. It also allowed for the growth of leveraged buyouts and the private equity industry. The U.S. high yield bond universe has grown from $2 billion to $1.2 trillion since this change began. In the 1970s, Michael Milken and a few others had the idea that non-investment grade bonds should be investable if they offered enough interest to compensate for the default risk. This was revolutionary, as these bonds had previously been off-limits to fiduciaries.
In 1969, when Howard Marks joined the investment industry, the focus of many banks was on the "Nifty Fifty" stocks of very successful companies, which were thought to have no price too high. However, by 1974, these stocks had lost over 90% of their value, showing that perceived quality wasn't synonymous with safety or successful investment.
Marks remembers two sea changes in his 53 years in the investment world and thinks we may be in the midst of a third one today. Sea Change is a program that opens in a new window and links to an external site.