Podcast Review | On Bubble Watch - The Memo by Howard Marks

On Bubble Watch - The Memo by Howard Marks

Many readers will know of Howard Marks, the founder of Oaktree Capital, which specialises in credit opportunities. He is well known for writing his monthly investor memos, which he has been writing for over 35 years.

One of Marks’ most well-known letters is the Bubble.com memo, which was written exactly 25 years ago.

In this memo Marks discusses what creates a bubble, signs that we are in a bubble, and then how they unravel. At the beginning of the memo, he makes a timely and valid point that in his experience being too far ahead of your time is the same as being wrong.

Two bubbles that Marks has invested through are:

• The Technology Media & Telecom (TMT) Bubble in the late 1990’s and subsequent bust in the early 2000’s.
• The sub-prime mortgage crisis in the late 2000’s.

Some notable comments about today’s market:

• The seven top stocks or the magnificent seven now represent >32% of the entire S&P-500 at the end of October (double the leaders share just 5-years ago)
• At the height of the TMT bubble this was just 20%.
• US stocks represent 20% of the MSCI Index, the most since 1970.

The characteristics of a bubble:

• A state of mind not a quantitative calculation.
• Highly irrational exuberance.
• A belief that companies can’t miss.
• There is no price too high.
• Fear of missing out.

The three stages of a bull market:

• Coming out of a market crash.
• People accept that improvement is taking place.
• Everyone now concludes that everything will be better forever.

Some other general observations of what tends to occur in a bubble:

• General households are investing heavily in asset classes that are not historically the norm (i.e. Bitcoin)?
• Investors believing that “this time it’s different” to justify valuations.  
• Who is willing to be the wet blanket in times where strong returns have been generated for a long period of time and appear to be a dummy?
• Investors tend to assume success across an entire field of innovative companies.
• All the bubbles he has lived through have been driven around innovation.

Finally, Howard made some pertinent comments on market valuation and structure:

• When the Nifty Fifty bubble burst in 1973-74 the average P/E fell from 60-90x to just 6-9x and many investors lost ~90% of their capital.
• It’s not what you buy it’s what you pay i.e. buy things well no matter what it is.
• When you pay a PE multiple of 16x for a business it’s more like 20x when you discount back these future earnings.
• The average PE of the S&P-500 post WW2 has been 16x.
• PE’s today are not at the highs of previous bubbles i.e. Nvidia is circa 33 times forward earnings.
• Of the magnificent 7, just 1 of them (Microsoft) was in the top-20 24 years ago.
• Corporate profits tend to grow at 7% p.a. so for stocks to rise significantly higher than this over the long-term valuations need to rise significantly.
• There have only been 4 times where the S&P-500 has risen +20% two years in a row with the last 2-years being the 5th time. All bar one of these times the market has been down for the following 2-years.
• Automated buying via ETF’s has no regard for valuations.
• Higher starting returns lead to lower longer-term returns.
• The S&P-500 PE today is in the top decile of its valuation range.

At the end of this podcast (and just as he did 25-years ago) Howard does not provide a conclusion as to whether he believes we are in a bubble or not. All he wants to do is to assist people in how they should think about the market today given the current circumstances. Howard stopped analysing stocks over 40 years ago and through listening to him throughout this podcast you can see why.

‍Link to Podcast

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