High-profile investor Howard Marks warns that the next 10 years might not be smooth sailing, especially when it comes to equity markets.
For the past 45 years, interest rates have been on a steady decline, which has been good for financial markets. But it also means very few people can remember when interest rates hovered around the 20 per cent mark and this gives a false sense of security that we will never see those levels again.
Howard Marks, Co-founder of Oaktree Capital Management, warned earlier this month that the period of ultra-low rates that we’ve seen since the Global Financial Crisis (GFC) is unlikely to be the norm in the decade ahead and that equity markets will face tougher times.
“Nobody in the business today who came in since 1980 has ever seen anything other than declining interest rates or ultra-low interest rates. Nobody. Forty-five years. So anybody who’s much less than 70 has never seen anything else in their working careers,” Marks said during a presentation at the JANA Annual Conference in Melbourne earlier this month.
“The Fed funds rate went from 20 (per cent) to zero over the same period. And … I think this was the most important event of the last half century in the world of finance and investment.
“Now, people would say: ‘Oh, no, no, no. Global Financial Crisis, bankruptcy relief, the pandemic, collapse of the Nifty Fifty, the bursting of the tax bubble, Black Monday, 1987.’ No. All of those were typical events. They took place in a day and they were all forgotten two years later. The decline in interest rates was lasting and had a major impact, but I think it went largely unrecognised.”
Marks spoke about a sea change that is taking place, where the investment environment has been fundamentally altered. It is likely we will see tougher times for corporate profits, for asset appreciation, for borrowing and for avoiding default.
We haven't had a normal cyclical recession in 15 years. We really haven't had a bear market of consequence in 15 years
“If I’m right and if rates are not going back to zero, or a half, or one, and instead rates will be roughly steady in the threes for the next decade, there should be certain effects, which are that the economic growth may be slower, the profit margins may erode, investor psychology may not be as positive, ownership interests, stocks may not appreciate as reliably, the cost of borrowing won’t trend down consistently, leverage is unlikely to add as much to returns as it did … businesses may not find it as easy to avoid default and bankruptcy, default rates may head higher,” he said.
“In other words, I think we’re going back to normal, but normal is different from what we saw over the last 40 years.”
He even floated the idea that a recession could be around the corner.
“If you think about it, it’s been 15 years since we had a real recession. We had a bad month in the pandemic and then it recovered the next quarter, and they called that a recession. But, you know, we haven’t had a normal cyclical recession in 15 years. We really haven’t had a bear market of consequence in 15 years,” he said.
At the very least, default rates in high-yield bonds are likely to increase in the next 10 years.
“From 2010 to 2019, the default rate on high-yield bonds was a quarter of the long-term average. And we’ll go back to something closer to the long-term average, in my opinion,” Marks said.
Investors would do well to adjust the asset allocation of their portfolios to the new environment, he argued, and should rethink their split between equities and bonds.
“Equities probably won’t do quite as well. Debt won’t do quite as badly. And so I think that should be returned to portfolios,” he said.
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