Howard Marks: "It Isn't Just A Windfall, It's A Warning Sign"

Tyler Durden's picture

Despite the all-knowing Alan Greenspan confirming there is no irrational exuberance currently, Oaktree Capital's Howard Marks is less convinced. Though he is not bearish, he lays out rather succinctly the current pros and cons for equities - based on the various 'valuation' arguments, discusses the folly of the equity risk premia, and highlights the dangers of extrapolation and what history can teach us... "appreciation at a rate in excess of the cash flow growth accelerates into the present some appreciation that otherwise might have happened in the future... it isn't just a windfall but also a warning sign."

Via Oaktree Capital's Howard Marks,

The problem with basing a pro-equities argument on the yield comparison is that most of equities’ current attraction on that basis comes from the lowness of interest rates. Just about everyone knows (a) interest rates are artificially low because of central banks’ efforts at stimulus and (b) rates will be considerably higher at some point in the intermediate term. In that case, rising rates would render stocks less attractive.

The Other Pros and Cons of Equities

There are many ways to view valuation, and many elements in the current debate over equities. Here are a few of them (I?ll start by reiterating the above for the sake of completeness):

  • The differential between the S&P earnings yield and the risk-free rate or the yields on bonds – and their ratio – makes stocks look extremely cheap. PRO
  • The attractiveness of these relative valuation parameters is highly dependent on interest rates staying low. CON (or LESS PRO)
  • Relative to normal post-WWII p/e ratios, stock prices are average to slightly low as a multiple of projected earnings for the year ahead. PRO
  • Robert Schiller?s cycle-adjusted p/e ratios are gaining increased attention, and they suggest full rather than fair valuations. CON
  • Arguably earnings growth in the years ahead will be slower than that which prevailed in the decades following WWII. Thus the post-war valuation norms are too high under the changed circumstances and should be discounted. CON
  • The outlook for earnings is restrained by the questionable macro environment, including the challenges in restarting growth and the dire prognosis for the federal deficit. These problems may not be easily solved. CON
  • Among the things keeping earnings high – and thus making stocks seem attractive – are some of the highest profit margins in history. If profit margins were to move toward normal levels, this would bring down earnings, either taking stock prices down with them or lifting p/e ratios and thus reducing stocks? attractiveness. CON
  • Corporate cash hoards are high, implying some combination of safety, potential for stock buybacks, and possible dividend increases. These are all good for shareholders. PRO
  • Investor attitudes toward stocks remain tepid (see below). PRO
  • However, with the S&P 500 up 16% last year and 10% so far this year, it can?t be argued that stocks have been overlooked and or that attitudes towards them are still mired in the doldrums. CON

What History Can Teach Us...

In the mid-1970s I was fortunate to happen upon one of the first of the time-worn pearls of wisdom that contributed so much to my education as an investor. It described the three stages of a bull market:

  • the first, when a few forward-looking people begin to believe things will get better,
  • the second, when most investors realize improvement is actually underway, and
  • the third, when everyone?s sure things will get better forever.

In “The Tide Goes Out,” written in March 2008, several months before the lows of the financial crisis, I applied the same thinking to the converse – the three stages of a bear market:

  • the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won?t always be rosy,
  • the second, when most investors recognize things are deteriorating, and
  • the third, when everyone?s convinced things can only get worse.

Hindsight always makes it clear what was going on at a particular point in time. It?s a snap now to say the second quarter of 2007 marked the third stage of a bull market: no one could think of a way to lose money. And in the fourth quarter of 2008 (for credit) and the first quarter of 2009 (for equities), we were certainly in the third stage of a bear market: most people thought the financial system was about to collapse, and securities that had halved in price could do nothing but halve again.

And On The Dangers of Extrapolation...

To me, the answer is simple: the better returns have been, the less likely they are – all other things being equal – to be good in the future. Generally speaking, I view an asset as having a certain quantum of return potential over its lifetime. The foundation for its return comes from its ability to produce cash flow. To that base number we should add further return potential if the asset is undervalued and thus can be expected to appreciate to fair value, and we should reduce our view of its return potential if it is overvalued and thus can be expected to decline to fair value.


In other words, appreciation at a rate in excess of the cash flow growth accelerates into the present some appreciation that otherwise might have happened in the future. Or to paraphrase Warren Buffett, “when people forget that corporate profits are unlikely to grow faster than 6% per year, they tend to get into trouble.” I doubt he intended anything special about 6%, but rather a reminder that when assets appreciate faster than the rate at which their value grows, it isn't just a windfall but also a warning sign.

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francis_sawyer's picture

Whatever you do... 'PRICE' & VALUE it all in 'joobux'... It's your only hope... You know ~ to get RICH...

bonderøven-farm ass's picture

Wealth measured in fiat there really any other way?

francis_sawyer's picture

none... If you don't believe me, Just ask Mila Kunis...

McMolotov's picture

Lemme roll over and ask her.

krispkritter's picture

In your McDreams McShlongotov... ;)

McMolotov's picture

The outlook for earnings is restrained by the questionable macro environment, including the challenges in restarting growth and the dire prognosis for the federal deficit. These problems may not be easily solved.

Also, these problems probably will not be solved. At all. So sorry.

Devils Advocate's picture

Could not have said it better myself


tenpanhandle's picture

The only thing holding the house together is the paint job...CON

NoWayJose's picture

The problem with a Goldilocks market is that the Bears eventually come home...

ihedgemyhedges's picture

Hey now, that's a game that my wife and I used to play......

Banksters's picture


Forget the politicians. The politicians are put there to give you the idea that you have freedom of choice … you don’t.

You have no choice. You have owners. They own you. They own everything. They own all the important land. They own, and control the corporations. They’ve long since bought, and paid for the Senate, the Congress, the state houses, the city halls, they got the judges in their back pockets and they own all the big media companies, so they control just about all of the news and information you get to hear.

They got you by the balls.

They spend billions of dollars every year lobbying … lobbying, to get what they want … Well, we know what they want. They want more for themselves and less for everybody else, but I’ll tell you what they don’t want … they don’t want a population of citizens capable of critical thinking.

They don’t want well informed, well educated people capable of critical thinking. They’re not interested in that … that doesn’t help them. That’s against their interests. That’s right. They don’t want people who are smart enough to sit around a kitchen table and think about how badly they’re getting fucked by a system that threw them overboard 30 fuckin’ years ago. They don’t want that.

You know what they want? They want obedient workers … Obedient workers, people who are just smart enough to run the machines and do the paperwork. And just dumb enough to passively accept all these increasingly shittier jobs with the lower pay, the longer hours, the reduced benefits, the end of overtime and vanishing pension that disappears the minute you go to collect it, and now they’re coming for your Social Security money. They want your fuckin’ retirement money. They want it back so they can give it to their criminal friends on Wall Street, and you know something? They’ll get it … they’ll get it all from you sooner or later cause they own this fuckin’ place. It’s a big club and you ain’t in it. You and I are not in The big club.

By the way, it’s the same big club they use to beat you over the head with all day long when they tell you what to believe. All day long beating you over the head with their media telling you what to believe, what to think and what to buy. The table has tilted folks. The game is rigged and nobody seems to notice. Nobody seems to care.

Good honest hard-working people … white collar, blue collar it doesn’t matter what color shirt you have on. Good honest hard-working people continue, these are people of modest means … continue to elect these rich cocksuckers who don’t give a fuck about you. They don’t give a fuck about you … they don’t give a fuck about you. They don’t care about you at all … at all … at all, and nobody seems to notice. Nobody seems to care. That’s what the owners count on. The fact that Americans will probably remain willfully ignorant of the big red, white and blue dick that’s being jammed up their assholes everyday, because the owners of this country know the truth. It’s called the American Dream cause you have to be asleep to believe it …


RIP George Carlin


IridiumRebel's picture

Fuck Yeah! Let's Rock!............





but first let me set my DVR.......

McMolotov's picture

We're all in as long as the revolution is done before March Madness starts.

hapless's picture

The politicians are put there to give you the idea that you have freedom of choice … you don’t.

Just as well.  People make crappy choices anyway

IridiumRebel's picture

But I thought taking out 120K in student loans for a masters in Philosophy from University of Phonics was smart......

debtor of last resort's picture

Fuck them. And fuck the (i will polish your car for another $200,- indoctrinated middle management company car cocksuckers) others too.

Bingfa's picture

One things for sure, they're fighting like a MF'er to keep this whole Matrix afloat....

and I'm lovin every minute watching them.

               we are about to witness the most historic of times.....

MeelionDollerBogus's picture

Everyone's watching for black swans...

did anyone yet notice seeing the same black cat twice? I think I have....


Rainman's picture

Uncle Warren's 6% lecture was for the idiot pension fund managers thinking they can hit a 7.75% mark annualized. Now they've hired brilliant PE managers to make it so in a ZIRP world. Projection is FAIL !

Peter Pan's picture

The appreciation of equities is not only outstripping cash flow of equities, it is also (more importantly) outstripping the growth in wage earnings.

Then again the im might be to bring the earnings of shares down to the same rate as the earnings on a bank account. And they may in turn hope that the same will happen to property returns.

So we will end up in a bizzaro world of high capital gains and virtually no income.

The enigma still remains why people can't see the advantage of holding gold and silver under such a ridiculous paradigm.

azzhatter's picture

Because Alan Pondscum and Berfucksticky have been right so often. Cowardly cocksuckers, hope they both get cancer and die in excruciating pain.

Have a nice weekend.

Fix It Again Timmy's picture

"All-In" Greenspan - who still listens to this dried-up, shriveled old fuck?

ebworthen's picture

Yeah, and no "irrational exuberance" at the FED either, despite having blown $6+ Trillion of taxpayer money, and $85 Billion per month to keep the Ponzi going - oh no - perfectly rational behavior there and in the Equities markets, uh-huh.

Instead of being put in a straightjacket in the looney bin section of a prison he's interviewed on the Television.

SKY85hawk's picture

-The FED is buying $85 billion of Garbage MBS bonds each month.  This QE3 is perverting normal market forces.  I can’t wait ‘til they look under the covers and try to figure the true value of their INVESTMENTS. 

The main-stream-media conveniently omits the fact that these ‘bonds’ are the same crap that wrecked the economy in 2007 – 2009;

Under legal tests stretching from 16th Century UK law to the Uniform Fraudulent Transfer Act of the 1980s, virtually none of the mortgage backed securities deals of the 2000s met the test of a true sale.  Under the UFTA standard, for example, any transfer which is intended to leave the transferor with insufficient capital is a fraud which converts a “sale” into a “secured borrowing” by the transferor;

 Who hopes that some Bankers might be jailed after this?

Ya, I know, silence.

START MOVING MONEY TO ROTH ACCTS.  Don't pay taxes for the rest of your children's lives .. .. ..

Yen Cross's picture

 Bears and Bulls playing Chinese checkers, just before it all comes crashing down.

ebworthen's picture

The U.S.S.A. has never been here before.

Never have there been so many on government assistance who couldn't grow an ear of corn or raise a chicken to save their life, much less cook a meal.

Never have we had so little production of necessities, been so reliant on foreign trade for them, built a house of cards in agriculture completely dependent upon oil for tillage, planting, fertilizers/pesticides, harvesting, and processing.

Never before has the U.S. faced a larger senior population with decreasing birth rates, cannibalistic corporations in league with government to crush the middle class, waning infuence and power worldwide, with other continents rising.

Never before has the Constitution been so blatantly subsumed for the sake of expediency and oppression, the legislative branch so completely bribed and bought that they represent citizens in name only, the Judicial branch bent on assisting the plutocrats and kleptocrats and enriching their lawyer brethren's income and power.

Never before has the U.S. had such an insurmountable un-payable level of debt and unfunded liabilities.

The U.S. has faced some versions of these challenges in the past, but NEVER, EVER, has the confluence of all these tragic realities been seen before.


Comparisons to the past are completely moot, and either a fool's delusion or a propagandist's tool.

Bingfa's picture

+1...Honestly I think the whole thing will be over in a couple months....

It's going to be swift and brutal to watch...

Winston Churchill's picture

don't think so.

It will stumble along a little longer,probably till the end of 2014(the dollar),the

stockmarket not so long.The only question is whether war destroys everything before

the Bernanke.

Bingfa's picture

I was referring to once the SHTF...

2nd amendment issues and Obamacare issues are game changers

ebworthen's picture

Obamacare is going to hit families and employment like an out of control freight train.

Insurance companies are already saying they are going to have to significantly raise premiums next year.

Bingfa's picture

+100   Every single person I know that pays their own insurance (myself included) has already been hit with big increases, I was told to expect more end of summer.

Friends that own businesses are already lowering hours under 30 per week and exploring other ways to get around, one friend is going to close up shop and go underground.

We're just getting started with this mess.


Titan Uranus's picture

That's OK.  He makes tears run down my cheeks when he gives a speech...

Wave-Tech's picture

Although the Anglo/American Empire has never been here before, the Roman Empire has.

The decline and fall of the Roman Empire took four centuries to unfold.  As such, it is reasonable to consider that the decline and collapse of the Anglo/American Empire may or may not occur in our lifetimes.

Hedge All Bets – Silver Update – Collapse of Empires


WillyGroper's picture

When corporations start fraudulently charging $30 recurring monthly on bills, tell you that you must have ordered it, you know this place is in deep shit. My sister was whacked for 6 months before she caught it. 

I had a magazine subscription that I did not renew. Bombarded with snail & email with the ever so special rates. Time Warner up & arbitrarily billed me on my CC for renewal & had the balls to say that I agreed to it.

Both these fuckers have DEEP pockets. It's just never enough. 

We're in trouble. Deep trouble.

riphowardkatz's picture

geez louise, relative to total money stocks are not low. quit hating greenspan, actually listen to what he says. he knows he can be honest because there are so many haters/idiots.

Yen Cross's picture

 Even the most 'ponzi' estimates are 16:1  trailing earnings. You are a shill/ dipshit! In 2007 that figure was around 15:1.

SKY85hawk's picture

I met a magic genie today, and he said he would grant me one wish.


"I want to live forever," I said.


"Sorry," said the genie, "I'm not allowed to grant wishes like that!"


"Fine," I said, "then I want to die right after Congress gets their heads out of their asses!"


"You crafty bastard," said the genie.


Titan Uranus's picture

I must have met his brother. 

He said, "Whatever you wish for, Bernanke will get twice as much." 

So I said, "Please beat me half to death."

augustus caesar's picture

I do feel there is going to be a correction, but I honestly can't even try to predict by how much.

khakuda's picture

It is summed up by the final comments. When stocks outperform eps growth year after year, it means you're getting less value for your money. At some point, that is a problem.

I look at my dividends because they tend to be more stable. If I buy a stock, I assume that the dividend growth rate is the real return I am earning. Payout ratios tend to be stable and managements hate dividend cuts. If the stock is going up at 15% a year for a couple years but the dividend is rising at 8%, I start to worry. Long term, my portfolio dividend growth rate has approximated my earnings growth rate.

dadichris's picture

darn, i thought is was the other Howard Marks.  I'd rather hear his take on all of this...