Billionaire Investor Howard Marks Advises to Buy Stocks Now
Oaktree Capital’s Howard Marks is known for his great timing, specializing in buying stocks when they are beat up. He believes that the market is in that situation now.
Howard Marks may be far from a household name among investors, and his net worth of $2 billion pales in comparison to the big money out there, but Marks has made all of his money from trading stocks, and has done pretty well for himself over the years, with long-term gains averaging an impressive 19% per year.
There are various strategies that can be used successfully to make money in the stock market, and Marks’ stock in trade is buying distressed stocks and looking to ride their recovery. Another way to put this is that Marks buys companies whose stocks have been beat up beyond what he thinks they should have been, and looks to capture the difference between how they are valued at the time of purchase and how he expects them to be valued as the company recovers from whatever mess they are in.
This is not an easy task at a company level, as you really have to get into the nitty gritty of their fundamentals, and not only compare them to where the market has these priced, you also need to foresee a change in mood with the market toward the company as well. This is far from the easiest way to make money in stocks, but this strategy can be quite lucrative in the right hands.
Marks, with his over 50 years of experience doing this, has shown that he knows what he is doing with this approach, and when it comes to wanting to listen to someone who is at home with looking to capture back value from depressed stock prices, we at least need to be open to listen to what he wants to tell us.
There are two main forces that drive stock prices, which are value and momentum. We can break these down by timeframe, where seeking value envisions the price of a stock higher beyond the horizon, where momentum just seeks to follow the current trend, without wanting or needing to consider what may be beyond it.
We have a perfect example of how these forces intersect when we look at our current downward move due to our fierce battle with the aftermath of our recent economic shutdown. The dynamics of this current situation is actually pretty unique among bear markets due to the more temporary nature of this crisis, given how artificial this is, much like holding back a line to an event when you expect to remove the barriers soon and see the line move once again in a more normal fashion.
What this is serving to do is to preserve the better part of the value part of this equation, more so than we would normally see during a big pullback in stock prices, where economic forces are more held back than during the crisis of 2008 where the problems were more organic. We did see a gap between momentum and value even then though, because we beat down stock prices considerably more than they deserved, but not in a way that did not make sense at the time, because the move down wasn’t about value, it was all about momentum, getting out to seek greater value later when the move ends.
While the 2008 financial crisis was plenty significant economically, it just wasn’t anywhere near as bad as to cause companies to lose over half of their long-term value for a time. Investors who waited to buy these stocks at their depressed prices due to the forces of momentum were rewarded handsomely once the momentum ended and we started to look more toward the value side, which in itself created quite a bit of momentum in the other direction that ended up lasting for over a decade.
We can never take momentum out of the equation though, because it always speaks, and when it speaks as loudly as it has lately, nothing else matters, as concerns of value simply get set aside. Those who do not understand this get stuck, those who think that their stock will be worth more than it is now in spite of its price falling dramatically, but if people are fleeing it, it will just go down until they are finished regardless of what you may think about it.
As it declines from people exiting, from the downward momentum that it is under, the value of a stock remains, where value is understood here as where it will be further out, well past the point of whatever is putting things down now. It is important, if we wish to profit from these scenarios, to be out while this momentum plays out, because this is where our opportunities to profit from the move will come from, from seeking the additional value that has been created by our shorter-term departure from it.
Fleeing declining stocks is therefore a value play in itself, only in reverse. We’re getting out because there is value in doing that, and the amount of the decline that we miss represents this additional value, where if a stock is to rise to a certain point in the future regardless, getting back in at a lower price increases the spread.
We looked at GM stock yesterday, and this is a good example of how this strategy can even be used with stocks that we have no business even considering normally. GM probably won’t even get back to where it was before this, as the business has been hurt at least a little from this and the forecasts for the sector are at least a little dimmer now, but it’s likely to go up from here, with the potential value of the play representing where it is now and where it’s probably headed in the near future.
GM is up another 9% since our call, in just one day, and even traders would be happy with that much of a profit in one day. A lot of investors would be satisfied with that kind of gain in a whole year and would love to average this. When you play these crises the right way, you should be making more money while others are just stuck with losses.
Those who held it throughout will probably only be realistically hoping to recoup some of their losses from this, and when things do get back to normal, they probably will still be behind where they were. Those who exited once the trouble started now have an opportunity to get back in if they wish at a much lower price, and have now turned their expectations with this stock over this time from negative to positive as the stock recovers at least somewhat as the downward momentum subsides and the stock moves more towards its longer-term value.
When downward momentum is running the show though, as it did for over a month, it does not make sense to be in during these moves, even if you are a long-term investor. This was not a scenario that should have had us wondering where the market was headed, and the combination of this unusual level of certainty together with the gravity of the situation should have been completely persuasive, as there may never be a time in our lives where we were more certain of a significant market move than with this one.
Correctly Predicting the Extent of the Outbreak Has Been Key to Profiting from It
We have been very much focused on the outbreak that has been behind all this, even though we are purely a financial site, but this issue affected the financial world in a profound way. This wasn’t just a matter of looking to foresee how this will play out on the virus side of things, it also required that we pay close attention to how the market is seeing it, when they were finally ready to say enough is enough and it’s time to get back in.
From a financial perspective though, it was very important to understand that we weren’t going to see this develop into the biggest health crisis mankind has ever faced, with millions of deaths and so on, because if this were likely to happen, there’s no telling how much worse this could have been, for both the world and its stocks.
This issue is not over yet by any means, but our control of this outbreak has taken a turn for the better, as we have been telling you all along that it would, and when you strip away all of the hyperbole, the stock market at least is coming to appreciate how much the risk here has been overstated.
We have been comparing COVID-19 to a flu outbreak all along, long before President Trump dared to, and haven’t waffled on this like he has. According to the World Health Organization, the range of deaths per year worldwide from influenza is in the range of 250,000 to 500,000. Given that we are still only at about a third of the low range of this with things appearing to start to crest now, more and more people are coming to see the validity of this, including the stock market, who have been turning their attention gradually away from this outbreak for a while now.
We can only hope that a real lesson will be learned from all of this, where we need to get clearer on when it is actually appropriate to use such dire measures, when the situation does indeed become dire enough to warrant it. Hopefully, when we view the ultimate economic cost of this, we will confine our lockdowns going forward to outbreaks that are at least of a greater magnitude than the normal outbreaks that we see year after year, as the threat has to be significantly larger to warrant anything of this sort, for the sake of consistency if nothing else, as we don’t normally lock down the country for the annual flu outbreak.
There will be many who may think that the prognostications of doom would have happened if we did not take such extreme measures, but we do have areas that have not taken such actions, and hopefully we will recognize that they did not meet their end by doing so, and have fared pretty well overall in comparison. This is important scientific evidence that we cannot ignore in favor of modelling that has shown itself to greatly overestimate this threat at every turn.
Hopefully, this will also cause us to rethink whatever approach in forecasting that led to these extreme numbers, which have always been at odds with the reality of how this outbreak has developed right from the start.
We finally have some more reasonable forecasts, and seeing the projected number of deaths drop all the way to 60,000 now, the same number we had from the flu two years ago, looks much more realistic. Our intention was never to look to minimize the risk here, only to better understand it, and as investors with a lot of money on the line here, understanding the real risks our portfolios face from this crisis is not just important, it is paramount.
We were looking for a couple of things in order to tell us that the end of this was near, which was seeing the value players start to jump in with both feet, along with seeing the market become less and less concerned about the escalating case and death numbers that this outbreak has produced.
Two weeks ago, we told you that the buyers were starting to overtake the sellers, and this gets back to the interplay between momentum and value. This requires that we see the momentum-driven selling pressure subside, together with a real desire for funds to buy the dip, to jump in and lock in prices that will surely be higher once this is all over.
After a brief pullback lasting for only 3 days, we’ve now resumed our upward course and the market is up 15% over these past 2 weeks. While many are predicting another retest of those lows, meaning that we’d give back this 15% gained since then and then some, the overall mood has certainly improved by then and it’s all about the mood.
Investors Need to Avoid Being Too Picky on When to Get Back In
We may want to be careful once the earnings calls start coming in, but at the same time, no one is deluded here and we know the damage that we have done to ourselves will be quite severe. At the same time though, all this momentum selling still has us a long way from where we have started, and the funds that have propelled us up this 15% aren’t the sort to just trade these moves, as they need to be committed for longer-terms than just the duration of this shutdown and its economic aftermath.
There are no sure things with investing though, and the best we can do is go with what is more likely to happen than not. Those with the appropriate trading skills may be in a position to react a lot more to changing circumstances, but we realize that most investors prefer not to have to act at all, and especially do not wish to be moving in and out of positions too often, even if it is to their benefit overall.
It’s too easy to get this wrong if you don’t know what you are doing, and this especially applies to investors trying too hard to pick a bottom, which is what is concerning Howard Marks at this point in time.
Investors who have sold into big downturns like this do need to pick their spot, but don’t tend to be very good at this, and certainly do not want to set their conditions of re-entry too stringent. Those who have waited over the last 2 weeks have missed out on this 15% move already, and continuing to wait risks chasing this rally even further. We want to be out during the declines, to avoid paying the price of waiting, but we should not be so concerned about the timing of getting back in that we pay a big price waiting to get back in.
Marks believes that “waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer’s simple: if something’s cheap — based on the relationship between price and intrinsic value — you should buy, and if it cheapens further, you should buy more.”
We don’t want to just ignore the momentum side of this though, as future value is not the whole deal here. Marks has been telling people this not only during the rebound, but during part of the fall as well. If you really are seeking value here, where you buy always needs to matter to some extent, and chasing moves down as some have during this decline only serves to reduce the amount of value that we will get from these trades in the end.
However, his point of people waiting too much for the bottom is indeed folly. Picking bottoms is not something that investors are equipped to do, and this is a difficult enough task for professionals, but those who do know what they are doing will follow the big money as we suggested that we do a couple of weeks ago.
We therefore should never approach this in a haphazard manner as Marks counsels, just looking at value without a sense of where prices may be headed, but this value seeking does make perfect sense when it is accompanied with a change in momentum such as we have seen.
What is important for investors is to base their decisions upon probability and then stick with them, and not try to trade this market because it’s difficult enough for real traders to do. With the amount of volatility that we are still seeing, where we can be up or down by 3% or more on any given day, this puts a big premium on skill and is as far away from the buy and hold world as you could get.
While we cannot make sense of just holding positions regardless, and there are times, such as recently, where it is imperative that we have risk controls in place, a line that gets crossed where it becomes simply foolish to hold stocks on the long side, the advice that we are given must take our situation into account enough, which for investors will mean not venturing into the world of trading beyond what they have the ability to do well.
We’ve been in a situation for a little while now where the advice of just jumping in and holding again would be pretty sound, and sounder than just holding off for another bottom or whatever else may cause investors to continue to pause.
Marks is right by pointing out that there is a lot of value with most stocks right now, value that we should be eager to lock in at today’s still depressed prices, even if we end up dropping from here along the way there. By entering at a 21% discount over where prices were before this event clobbered us, we’re 21% ahead of those who hung on all this time, and we’ll be 21% better no matter where this all ends up.
This is why we need to wait for the value, to wait for the downward momentum to peter out, but once the fever does break, this is not the time to wait and hope for better, as you will end up sorry more often than not. The iron has been hot for a couple of weeks now, hot enough to strike, but it won’t be forever.
Editor, MarketReview.com
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