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• Billionaire Howard Marks says markets are in the middle of the third “sea change” of his 53-year career. 
• Previous changes were in risk appetite and in the interest rate environment. 
• Today, the post-crisis era of low returns is over, and “full returns” are possible but old investing strategies will be tested. 

Howard Marks in his letter to investors said that financial markets are in their third “sea change” he’s seen in his 53-year career, and that the strategies that worked well for decades may be tested amid upheavals in the investing landscape. 

The billionaire founder of Oaktree Capital says that the previous two changes he’s observed earlier in his career were the shift in investor mentality when it comes to risk appetite, noting that the rise of high-yield bonds completely altered the conventional wisdom of investing in only “safe assets”. The second change came during the era of Paul Volcker’s leadership of the Federal Reserve, which ushered in a 40 year period of declining interest rates and an equally long boom in the stock market. 

In this latest change, market conditions are radically different, and less ideal compared to the post-crisis years. His biggest takeaway is that the the previous era of low returns from 2009-2021 has now become a “full-return world,” and investors may not have to lean as heavily on risky investments to meet return requirements, though they will need to change how they invest compared to previous decades. 

Here are the investor’s six best quotes from the memo, lightly edited for length and clarity:

1. On the sea change in risk appetite:

“Now risk wasn’t necessarily avoided, but rather considered relative to return and hopefully borne intelligently…Young people joining the industry today would likely be shocked to learn that, back then, investors didn’t think in risk/return terms. Now that’s all we do.”

2. On the sea change in the rate environment: 

“The long-term decline in interest rates began just a few years after the advent of risk/return thinking, and I view the combination of the two as having given rise to (a) the rebirth of optimism among investors, (b) the pursuit of profit through aggressive investment vehicles, and (c) an incredible four decades for the stock market.”

3. On the third and most recent sea change: 

“The bottom line for me is that, in many ways, conditions at this moment are overwhelmingly different from – and mostly less favorable than – those of the post-GFC climate described above. These changes may be long-lasting, or they may wear off over time. But in my view, we’re unlikely to quickly see the same optimism and ease that marked the post-GFC period.

We’ve gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21. And importantly, if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.”

4. On the staggering difference in previous interest rate environments versus today:

“I received a notice from the bank each time my rate changed, and I framed the one that marked the high point in December 1980: It told me the interest rate on my loan had risen to 22.25%! Four decades later, I was able to borrow at just 2.25%, fixed for 10 years. This represented a decline of 2,000 basis points. Miraculous!”

5. On his outlook for interest rates:

“[I] believe that the base interest rate over the next several years is more likely to average 2-4% (i.e., not far from where it is now) than 0-2%. Of course, there are counterarguments. But, for me, the bottom line is that highly stimulative rates are likely not in the cards for the next several years, barring a serious recession from which we need rescuing (and that would have ramifications of its own). But I assure you Oaktree isn’t going to bet money on that belief.

And later on in the memo: “Lastly, there is a forecast I’m confident of: Interest rates aren’t about to decline by another 2,000 basis points from here.”

6. On the outlook for the rate of debt defaults:

“No one can foretell how high the debt default rate will rise or how long it’ll stay there. It’s worth noting in this context that the annual default rate on high yield bonds averaged 3.6% from 1978 through 2009, but an unusually low 2.1% under the “just-right” conditions that prevailed for the decade 2010-19. In fact, there was only one year in that decade in which defaults reached the historical average.”