Howard Marks: A Once in a Lifetime Financial Event is Here

Last 14 years were really quite idyllic, um, in the economy and in the market. We had the longest bull market in history, the longest economic recovery in history. Uh, we set a lot of records in many ways. Living was easy, interest rates were low, and companies can get all the money they wanted. There were very few defaults or bankruptcies. You know, easy times.

And I don't believe in forecasts, especially my own. Uh, Oak Tree, as I mentioned, does not invest according to forecasts. But in general, we think that living will be a little less easy in the months and years to come. Billionaire investor Howard Marks is warning about a once-in-a-lifetime financial event that is occurring right now as we speak. This quote-unquote sea change is decades in the making and will surely send shock waves throughout every corner of the economy and stock market.

Make sure to stick around to the end of this video because we're going to cover what exactly Howard Marks is seeing, why this shift is occurring, and most importantly, what you must do to protect yourself from what's to come. Now let's listen to what Howard Marks had to say.

So what happens now that we're moving from an ultra-low rate environment to what our next guest says is a more normal one? Joining us here on set is Oak Tree Capital Management co-chairman Howard Marks. It's great to have you here.

It's great to be here, Sarah. Carl, so you have done a lot of writing lately. I read all your memos about the ultra-low interest rates as sort of a setup for where we are now. What's the big takeaway?

Well, uh, you know, the Fed took the Fed funds rate to zero at the beginning of ‘09, kept it there until the end of ‘21 when they gave up on inflation being transitory. The rate was zero for half that 13-year period, and I think it averaged about a half a percent over the whole 13-year period. So, you know, interest rates are like adrenaline; they're stimulative. Low rates, and I think that the rates were artificially low, which meant that the economy and the markets were artificially stimulated.

And, uh, after 13 years of that, people start to say, well, that's normal. That's the way it's always going to be. My belief is that it's not normal and it's not the way it's always going to be. And if rates will be higher, but still not high in the coming years, then it seems to me that most assets will be worth less than they would in a low-rate environment and that the economy will not be as stimulated.

So where we are right now with these, I would say, higher rates— you would say elevated?

Well, higher—historically higher, just not high. Just not high. You know, I mean, today where we're going to settle? You know, I think we'll settle lower, uh, because today's just—as those rates were artificially low to stimulate the economy, today's Fed funds rate at 5 and a quarter, 5 and a half, is artificially high to cool it off, constrain it.

But, you know, one of these days we'll declare victory against inflation, and then the Fed will be able to bring rates down from this, I would say, emergency rate to something more normal. So, you know, I believe that over the next 10 years the Fed funds rate, currently 5 and a quarter, 5 and a half, will average somewhere between, let's say, three and three and a quarter.

Where do you think the neutral real rate is? Does it have a three?

Um, it's—it's around there. That's why I'm picking it, right?

Yeah, uh, you know, it's the kind of thing that we know it exists, but you can't find it. There's no place to look it up. Uh, people talk about two and a half, so two and a quarter, three, three and a quarter. I think inflation will be a little higher over in the coming years than it was in the last decades, largely because the gains from globalization will slow, and I think that labor is getting a little bit of the upper hand in this country today.

So if inflation is two plus, and if you want to have a real Fed funds rate, then you would think that the Fed funds rate would be three plus.

Take a look at this chart here of the US Fed funds rate dating back to 1954. The Fed funds rate is a proxy for interest rates in the broader economy. As crazy as it sounds, this simple chart is one of the single most important things when it comes to understanding what has happened in the economy and stock market over the better part of the last 50 years.

And according to Howard Marks, it will help determine what's in store for the future. As we can see here, interest rates peaked at nearly 20% in the early 1980s. Over the next roughly 30 years, interest rates had their fair share of highs and lows. Interest rates fell and rose, but as you can see, each peak was lower than the previous one.

This downward trend in interest rates occurred for years until rates could finally go no lower. 0% interest rates were hit in 2008 and remained there for the better part of the next 15 years. It was nearly universally accepted that these incredibly low interest rates were going to become a permanent fixture in the economy moving forward.

That was until one ugly, evil, terrible nine-letter word entered the picture—the villain in our story: inflation. After decades of being incredibly low, inflation skyrocketed to multigenerational highs in 2021 and 2022. Inflation even hit a peak of a staggering 9.1% in June of 2022.

In an attempt to get inflation under control, the US Federal Reserve was forced to raise interest rates with alarming urgency. You see, inflation happens when there is too much money chasing too few goods, or put another way, there is more demand than there is supply.

What happened with inflation in 2021 and 2022 can be explained with this simple graph here. This line represents the demand in the economy for a particular good or service. Demand is not only just the number of buyers in the market but also how much these buyers are willing and able to pay. For the sake of this example, let's say we're talking about new cars.

So our demand line here represents the number of people and businesses looking to purchase a new car and how much they can afford to pay to make that purchase. This line here represents the supply of a particular good or service available to be purchased at that specific point in time. For this example, picture the number of cars sitting on a car lot waiting to be purchased.

The point at which these two lines cross represents the price for that good or service. So in our case, the price of a new car. In the face of potential economic collapse, both the government and Federal Reserve took drastic steps to support the economy. These actions included things like cutting interest rates and sending money directly to citizens through stimulus checks and enhanced unemployment benefits.

All of this resulted in people and businesses having more money to spend, pushing our demand line out to the right. You can see that our supply and demand lines now cross at a higher price point. This is inflation in action.

Ruling this back to new cars, the lower interest rates made it much less expensive to borrow money to purchase a vehicle. Additionally, people had more money in their pockets and were looking to spend it on material goods since they weren't really able to travel or go on vacation.

At the same time, car manufacturers were suffering from supply chain challenges that limited their ability to produce new vehicles. As you can see on this graph here, all of these factors combined to make the price of a new car skyrocket.

This supply and demand imbalance went far beyond just cars; prices went up significantly for essentials like housing, food, and seemingly everything else. Because of inflation, the United States economy has been forced to leave behind the period of 0% interest rates, likely for the foreseeable future. This is the once-in-a-lifetime financial event Howard Marks is talking about.

From 1980 to 2020, interest rates were steadily declining, ultimately ending up at 0%. This period of consistently lower and lower interest rates created a massive tailwind for the economy and stock market. Now there is a massive shift underway; for the first time in generations, interest rates are headed the opposite way.

According to Howard Marks, gone are the days of easy money and low interest rates. While this may not sound like much, the ramifications of higher interest rates will be wide-reaching and could be felt for decades to come.

To truly appreciate Howard Marks's comments, you first must understand the relationship between interest rates and asset values. In this context, the word asset is just a nerdy way of saying things people own as investments. Examples of assets include things like stocks, bonds, and real estate.

The value of any asset is determined by the cash that asset will generate over its lifetime discounted back to the present day using an interest rate. I know that may sound extremely complicated, but trust me, it's actually quite simple. You'll see in just a second.

Let's say you buy a stock that produces $30 a year in cash for you every year for 10 years. At the end of the 10 years, you then sell that stock for $300. You now know how much cash the stock will generate.

So the last step in determining how much this stock is worth is discounting those cash flows back to the present day. The reason you have to discount the cash flows is because a dollar today is not worth the same as a dollar 10 years from now.

To demonstrate what that means, here is a simple thought experiment: Would you rather be given $10,000 today, or would you rather receive that same $10,000 10 years from now? Well, of course, you would choose to receive that money today.

In investing, this is a concept referred to as the time value of money. For the sake of this example, I'm going to start out by using an 18% interest rate. Using that 18% rate gives us a stock price of $192 per share. But watch what happens as the interest rate decreases.

If we bring that interest rate down to 14%, the stock is now worth $237. Taking the interest rate down to 10% makes the price rise ever further, all the way to $300. Now let's get really wild and take the interest rate all the way down to 5%. The stock price continues to skyrocket all the way to $416.

Notice how the amount of cash the stock produces stays exactly the same. The only thing that changed was the interest rate. The declining interest rate was powerful enough to push our stock price up from $192 all the way to $416. The stock price more than doubled without the stock generating even as much as a single penny more in cash. This example shows why Howard Marks called declining interest rates the single most powerful force in the economy over the last 50 years.

However, things are different now. Interest rates are rising, and Marks thinks these higher rates are here to stay. Listen to him explain why and what he recommends people do.

If you came into this business since 1980, which covers almost everybody, you've only seen either declining interest rates or ultra-low interest rates. You have to go back into the 70s to have seen a different climate, which I fortunately did.

Um, and I believe that this monotonic decline of interest rates is over. Number one, there's not much room for a further decline, and number two, I think the Fed probably understands that it kept rates too low too long and that there was a negative consequence, certainly in terms of inflation.

So, uh, you know, I think the important thing is that, uh, and I said in my memo "C Change," which was published in December, that, uh, I don't believe in forecasts, especially my own. But I'm willing to say that for the next decade, the Fed funds rate is more likely to be between two and four than between zero and two. That's as far as I can go.

And I only say that directionally to indicate my belief that the period of ultra-low rates is over. And let's assume that's correct. Do I have any business then being in the equity market? What does it mean for— not so much investment strategies, but you know where you want to park the bulk of your money?

Because equities have been rewarded substantially, yes, over the last 15 years. Yes, um, look, you— as Warren Buffett always says, you don't want to desert the U.S. or the U.S. economy, or I think the corporate sector. And, uh, you know, the S&P has given a 10.2% return every year on average for the last century.

You don't want to give up that. Right now, it looks like you can get equity-type returns from credit— a little below 10 for what we call liquid credit stuff that's tradable every day and well above 10, perhaps for, uh, private credit, which is not tradable.

Um, the point is that, um, you know, uh, 21 months ago today, high-yield bonds yielded in the nines. Uh, 21 months ago they were in the fours. Uh, when they're in the nines, you can invest in them with high expectations competitive with equities and more than sufficient to meet most organizations’ needs.

We talked earlier about why high interest rates are a significant headwind for the stock market. However, these higher rates do create a potentially lucrative new opportunity for investors to take advantage of, according to Howard Marks. For the first time in decades, investors can now generate decent returns by investing in bonds.

Bonds are issued by the government and corporations when they're looking to borrow money. By buying a bond, you're essentially loaning your money to the borrower. In exchange, the borrower is contractually obligated to pay back the original loan amount plus interest.

Bonds are generally safer investments than stocks due to what is known as a capital stack. A capital stack of a company shows the order of who gets paid back their money in the event of bankruptcy. Bondholders sit at the bottom of the capital stack, meaning they have to be paid back in full before stockholders get a single dollar.

Here's an analogy to demonstrate this concept: Picture two cups sitting next to each other— one for bondholders and one for shareholders. There's a limited amount of water to go around in this picture right here. In order for the stockholders to get a single drop of water in their cup, the cup for the bondholders has to be filled completely to the brim. If the bondholders' cup is even as much as a single drop short of water, the stockholders' cup will go completely dry.

This analogy helps explain why bonds are generally considered less risky than stocks. If a company gets into financial trouble, owners of the company's bonds get preference over the company's shareholders. To account for this lower risk, bonds have historically generated much lower returns than stocks.

This was especially true in recent years, as we can see here. The yield, aka the interest rate on 10-year US government bonds, was as little as half a percentage point in the summer of 2020. However, now that interest rates have increased, bonds are starting to have interest rates that are more similar to returns that investors could typically expect from the stock market.

As Mark mentioned in the clip, there are now bonds that are yielding 7, 8, even 9% interest rates. These rates of return are pretty much on par with the long-term US stock market return of 7 to 10%. For individuals, investing in bonds is not as simple as buying a stock.

Additionally, individuals don't have access to the wide range of bond deals that Howard Marks and his firm, Oak Tree, do with its over $170 billion in assets under management. One simple way individual investors can get access to investing in bonds is through a bond ETF. ETFs are as easy to purchase as a stock but provide investors access to a diversified portfolio of bonds.

Some popular bond ETFs include the iShares Core US Aggregate Bond ETF ticker AG, the Vanguard Total International Bond ETF BNDX, the iShares Investment Grade Corporate Bond ETF ticker LQD, the iShares High Yield Bond ETF ticker HYG, and the JP Morgan Ultra Short Income ETF ticker JPST.

I'm not sponsored by any of these providers, and this is certainly not an investment recommendation, but I just wanted to highlight a handful of the most common bond ETFs available. The prices of these bond ETFs do fluctuate, so they're not without risks.

If you're looking for a more guaranteed high rate of return, you can check out a high-yield savings or money market account. The trading brokerage Mumu is actually offering a very impressive 8.1% APY on your uninvested cash if you sign up using my link in the description of this video. Mumu is a member of SIPC, which ensures up to $500,000 in customer accounts.

Additionally, you can receive five free stocks just by signing up and making a deposit into your account. Who doesn't like free money? Howard Marks is a billionaire and one of the most respected investors on Wall Street. However, he will be the first person to tell you that predicting the future is a risky proposition.

There is one thing that is highly likely, though: the era of easy money is probably over for good, or at least for quite a while. The next 40 years of investment returns won't benefit from constantly declining interest rates, so make sure you prepare your portfolio accordingly.

So there we have it. I hope you enjoyed the video, and make sure to hit that like button and subscribe to the channel because it's my goal to make you a better investor by studying the world's greatest investors. Talk to you again soon.