India has the potential to "become an efficient and good place to do business if it can get its act together", according to Oaktree Co-Chairman and Co-Founder Howard Marks.
"I am a believer in India," Marks told BQ Prime's Niraj Shah on the show World View. "The financial community has said for many years that India is going to be a great place for investing when they get their act together. From time to time, we hope that the time has come."
"Morgan Stanley put out a very positive report on India," Marks said. "I am persuaded by its arguments, but they have to come true. Digitisation, power, renewables... India's got the potential, it's got the human resources, and it should get there."
India requires a good government that is free of corruption and has less red tape and bureaucracy, he said.
"Look what happened to China... around 30 to 40 years ago, India was ahead of China," Marks said.
"We had millions of people starving to death in China, but China figured it out—this is the kind of economic miracle that can be produced."
Watch the full interview here:
I am starting off this conversation with a reference to the latest memo that you wrote, wherein you talked about this sea change and how declining interest rates for nearly four decades was the second sea change and the latest one was a complete reversal of the conditions from 2009 to 2021. How do you think these impacts 2023 and the years ahead, both for the Western world and subsequently the Emerging Market world?
Howard Marks: Well, a sea change, for those who don't know, is an idiom used to describe a major transformation—a total change—and I think you know that this is not an occasional cyclical fluctuation, but a major change. I think we may be going through one of those, as you mentioned. The first one that I lived through occurred in the years between 1980 and 2020. In 1980, for those who don't remember, interest rates in the United States reached over 20%. When Paul Volcker became Chairman of the Fed, he had to raise rates to snuff out inflation and inflationary thinking. Inflation is a real menace, and it must be brought under control, and you do that by slowing the economy, and so Volcker did that. As I said, I had a loan outstanding from a bank at the time; the rate on the loan hit 22 and a quarter in 1980. Forty years later, I was able to borrow at two and a quarter. So, in other words, interest rates came down by 20%, or what we call 2000 basis points. This has been a very strong tailwind, supporting asset ownership, subsidising borrowers, enriching owners of assets, and penalising savers and lenders... So, this was a tremendous tailwind that benefited certain strategies and penalised others, and it had other effects. Of course, it did. It produces risk-taking because very safe instruments, like treasuries and cash, yield close to zero. Nobody wants zero, so they must go out on the risk curve to get the kinds of returns they do want, and they must take risks to get that. So that's one form. There were many, many ramifications. It was people who were eager to lend to risky companies, which meant it was very easy for risky companies to grow. That's another effect. So, I think that I am not calling for a return to 20% interest rates. You know, right now, the Fed Funds rate in the United States is about four and a quarter percent, and I think it'll stay in this vicinity. Maybe it'll go a little higher next year. They have indicated that there will be some more rate rises, but nothing major. My main point is that it's not going back to what it used to be. You know, to fight the global financial crisis, the Fed dropped the Fed funds rate to zero at the end of a wave in 2008 and kept it there for seven years. So, people started to think, 'Oh, I guess zero is the normal interest rate.' Well, the point is, it's not, and when you have a very strong economy, aided by low interest rates, then you don't have defaults and bankruptcies. That's not normal. It's not normally so easy to raise money if you are a low-quality company. That's not normal. So, my point is that we are going back, in my opinion, to normal times in which things are not so great for borrowers and asset owners and not so bad for savers and lenders.
What are the implications for asset allocation in such a scenario, both for the Western world and for emerging markets, where presumably the spectre of growth could be slightly higher than what we might see elsewhere, at least in the very near term?
Howard Marks: From October of 2012 until February of 2020, I gave a speech. I changed the speech from time to time, but I didn't change the title. The title was ‘Living in a Low-Return World or Investing in a Low-Return World.’ The point is that most of what Oaktree does is invest in debt, bonds, loans, fixed income, and credit. There are a lot of different names for it, but it's basically lending. The interest rates on lending were very low, and, as I said before, a cash yield is zero. But in the bank, you get zero; in some parts of the world, you get negative. You bought treasuries, you got one or one and a half percent, and so forth. So, nobody wants those kinds of returns. I recently saw a graph of the holdings of debt in one of the major investment banks, the high net worth group, and it basically went from 30% to 20%... I think, of course, that debt is much safer than equities. Equities have upside, debt doesn't have upside, but debt has a guaranteed return assuming that the issuer is money good, and it has stability. You have a promise of repayment, and it has safety. I think now there is a much better place for debt in asset allocation than there was one, two, or five years ago. A year ago, you know, one of the things that we dealt with was 'high yield bonds.’ Those are the bonds of companies that are below investment grade. The investment grade is a triple A, double A, single A, or triple B. Everything below that is not investment grade or speculative, starting with double Bs, single Bs, the Cs, the Ds, the Fs, etc. Oak Tree is a pioneer in high-yield bonds. We have been at it for 44 years, which goes back to the beginning of that business. A year ago, high-yield bonds yielded around 4% or something. Most of my clients need 7% returns from their pension funds, endowments, or insurance companies... They can't make much use of things that yield 4% with no upside. So, it was very difficult for them and for us. Today, those bonds yield 8%. Now they have a real use in our portfolios. That's just an example. I think that you know that if you can get the returns you need with a heavy allocation to credit or debt, you don't have to go into risky strategies. People had to do that in their teens because, as they used to say, ‘Tina: There Is No Alternative’ to stocks. I used to call those people handcuff volunteers. They were going into risky investments not because they wanted to, but because they had to get the returns they needed. Now they don't have to do it to get the returns they need. I think this is going to change. You will probably have less money in equities and less money in alternatives such as private equity.
Yes, somebody that we were talking to coined this, not coined but spoke about this term that it’s time to move from Tina to Tara. There are reasonable alternatives.
Howard Marks: Very good. Very good.
I am just wondering if emerging markets would have enjoyed the flow of liquidity because money had to grow to high yielding assets, like EM, EM debt and maybe even EM equity. Do you reckon it might be a headwind for European markets because money may find its space, in safety in U.S. credit, for example?
Howard Marks: I think that is a reasonable conclusion on your part. I think that, you know, we have the safe assets, where you can get a steady return with assurance, though that return is now what I would call adequate. Then you have the other things that people went to to get the returns when they couldn't get them safely and easily, and emerging market equities were among those. So, by implication, it should be harder for the emerging markets to get finance. Now, one of the things that happened in the last 20 years… The U.S. stock market went down for three years in a row, the first time since 1938, and people were really disaffected in terms of stocks… They were turned off to the stock market, and the Fed dropped bond rates very low to fight the recession that ensued. If people were turned off to stocks and bonds that had low rates of return, then that's why people were forced to go outside the risk curve into so-called alternatives, and one of the things they went into was emerging market stocks and debt. The flow of capital to emerging markets enhanced, enabling lot of emerging market countries to issue debt denominated in dollars. This is not normally the case because these are countries that don't produce dollars. So, repaying a USD debt can be very challenging. But if you can borrow in dollars, which these countries were able to do, then you pay lower interest rates. So that was a benefit for them at that time. The challenge now is that it is going to come due, and they are going to have to pay it off in dollars. Many of them don't produce dollars in the normal course of business, or they do it through imports. But if we have a recession throughout the world, then people will probably buy less from the emerging markets. They will do fewer exports, in which case they'll bring in fewer dollars. I think that the outlook for dollars is similar when I say that we are going into normal times in which life is not so easy. I think the emerging markets would be among those that feel that revision. Life is just not going to be as easy as it was, you know, for most of the last 20 years.
Do you think investors in general, even currently, under appreciate the combined effects of this sea change coupled with the withdrawal of liquidity that central banks are undertaking currently?
Howard Marks: That's a great question, Niraj, and I think the answer is no. First of all, as I said, we have the basic conditions—the ease of getting money, running companies, growing, etc., and freedom from defaults and bankruptcies, etc. We have had that since the end of the global financial crisis in 2008-09… A lot of people can't remember anything earlier than let's say 2008 and then, of course, the interest rates have been declining for the last 40 years, or actually 42 years because the peak was 1980, 42 years ago... Very few people remember financial conditions before 1980. So yes, I think many people feel that the conditions of the last 13 years in particular are normal and that we are going to go back to normal. I don't really believe in the ability to foretell the future, including my own ability to foretell the future. I do this with great trepidation. But it's just my feeling that, you know, as I said, the Fed kept interest rates at zero for seven years. I don't think they were happy to do that. I don't think they are happy to go back there. There were a lot of reasons why zero rates are not a good idea. It does encourage inflation. It does make it too easy for borrowers and too bad for savers. One of the ways the Fed solves problems when they arise in the economy is by reducing interest rates. Well, if your interest rate is zero, you can't reduce interest rates, and zero interest rates tend to keep companies alive that shouldn't stay alive. One of the beauties of capitalism is that it is Darwinian. It's survival of the fittest. But in a zero-rate environment, the unfit can stay alive. That's not a good thing. You know, I once said in one of my memos that fear of bankruptcy is to capitalism what fear of hell is to Catholicism. People should have to make difficult capital allocation decisions and not get money for nothing… In the memo, ‘Sea Change,’ there's a long list of the salutary effects of low interest rates and a list of the reasons why we shouldn't go back to zero. I think that the last thing I will say is that most people in the financial community are optimistic by nature. Charlie Munger, Warren Buffett's partner, always quotes the philosopher Demosthenes, who said, "For that which a man wishes, he will believe!" So, there's a lot of wishful thinking. I think that people are holding to optimism and belief that we are going back to the ways of the teens when I think we were not…In the memo… I say they're going to stay between two and four, not zero and two. That's the whole difference, and we will see. I mean, if they go back to zero, then I am wrong, but of course, if they go back to zero, I'll make a lot of money because financial assets become very valuable. But that's really my point of departure.
If indeed inflationary pressures have helped a little bit, and with these layoffs that we are seeing, if indeed the stubbornly high wage inflation also shows signs of cooling, could there be a pivot? And could risk assets like U.S. equities for example, start looking attractive at a particular valuation simply because they have had a very tumultuous 2020 to any which ways?
Howard Marks: Sure… I say in the memo that the inflation is caused by too much money chasing too few goods, that's the classic definition and thanks to the pandemic, we have too much money because the government gave out a lot of money to ease people’s sufferings, and they couldn't spend it so they put it in the bank and so there's too much money in people's savings accounts, and too few goods because the supply chain has started up a little haltingly and those influences will abate over time. The extra money will get spent and the supply chain will catch up. So yes, inflation will abate. Whether it goes right all the way back to less than two again, we will see. But if it does abate then I think, by definition, we'll have fewer interest rate increases than we otherwise would have had right now, you know, in his last pronouncement, Fed Chairman Jerome Powell said we are going to have more increases, but smaller than people had thought over a longer period of time than people had thought. He gave the impression that rates will be going up throughout 2023. But you are right, if inflation abates, then they can pivot and become less hawkish…
My question was: does that make, at some valuation, the U.S. equity markets attractive as well because they have had a bad 2022?
Howard Marks: Well, declining interest rates tend to increase the value of assets. The value of an asset is the discounted present value of the future cash flows, and if you discount the future cash flows at a lower interest rate, they are worth more. So, there's a direct influence, and, you know, all investors and all markets get very happy when they see interest rates coming down. It could happen and as you say, in the U.S. stock market if interest rates start coming down, there's some point some valuation at which it's extremely attractive. I don't think it's quite there yet because the valuations are basically what's called the price-earnings ratio, and the price-earnings ratio right now is higher than it historically has been on average. So, they are not cheap. The other thing is that most people think we are going to have a recession, thanks to the Fed's actions, and that recession will cause earnings to decline, which by itself causes the price-earnings ratio to increase, making them un-cheap. So, you know, a lot of things must happen for stocks to perform extremely well.
How could the construct be different for economies like India or markets like India because the risk-free rate is not 8%, tax rates are 30% on a 7.5% debt, and income and earnings growth in equities may be early double digits, at least if not more? So therefore, can there be a more constructive case built in an otherwise different world for risk assets of the 2000 period, which was like the 2009–2021 period? Can India or some other economies like that be slightly different from the normal case being built for equities?
Howard Marks: Well, now is my time, Niraj, to give my disclaimer: I am no expert on India, and you know, I don't claim any particular expertise other than the fact that I have been working in the financial markets for a long time. I am a believer in India. We have said for many years, and the financial community has said for many years, that India is going to be a great place for investing when they get their act together. From time to time, we hoped that time had come. We hope it's here now. As you know, Morgan Stanley put out a very positive report on India. You know, I am persuaded by its arguments, but they must come true. You know, things like digitisation, power, renewables, and things like that. India's got the potential; it's got the human resources, and it should get there. It must have a good government, no corruption or less corruption, and good organisation—not too much red tape or bureaucracy... It should work well. Now, there have been times in the past when I have heard people say that China is a communist country that functions like a capitalist country, and India is a capitalist country that functions like a socialist country. If it can get its act together, if it can become an efficient and good place to do business, Now, as I say, not too much red tape or too much complexity. Why shouldn't India have great growth? Look what happened to China! I mean, I think I am not an expert, but I imagined that 30 to 40 years ago, India was ahead of China. You know, in China, you had millions of people starving to death and eating grass, but China got it together. So, this is the kind of economic miracle that can be produced. I would love to see it happen in India. I like India. I have friends there. I visited there in 2017, I think, and, you know, I wrote some of my latest book in India on that trip. I talked about, I think, being in Udaipur, lying in bed at night, and getting ideas. I am all for it. I would love to see it.
One final question, and which is more from the perspective of how the earnings growth led arguments in certain EMs would it be compelling enough in a world that we are talking about, wherein money would want to flow through risk free assets like the U.S. debt or U.S. equities, simply because they are offering value. However, there is growth in select markets. So, do you think value will triumph and continue to triumph overgrowth in 2023 and beyond as it had done in 2022 or is it difficult to make the point right now?
Howard Marks: Well, you know, from time to time, talking about the emerging markets or in general.
Emerging market, or any market in general?
Howard Marks: You know. Growth Investing—investing, based on the expected rapid growth of earnings of the companies—is an optimistic activity. You know, obviously people operate those stocks when they are confident that the growth is going to be there. They take them down when they get worried. So, it reflects a lot of the psychological mood, and that mood fluctuates a great deal with regards to the emerging markets. I think there is somewhat of a low ebb now and in particular, of course, the pace of business in the emerging markets is largely affected by the pace of business in the developed world. Most of the developed worlds that are in a recession or projected to go into one within the next year or so. So that reflects badly on the EMs but that's why they are down now, and EMs stocks had a very poor year, they were down 30%. One of these days, number one, the facts will improve and number two, people's view of the facts will improve. So, that will be a double benefit for the EM stocks someday, I can't tell you when, but I think that value did better than growth in 2022 and if 2023 is a pessimistic year, it might do better in 2023. But you know, the emerging markets, one of these days, places like India are going to have a great growth story and so, you know, I think we can be optimistic, if we have a lot of patience.
Timing is nearly impossible, but Howard Marks If it's difficult for you, it's almost impossible for most people. So, I take that argument very constructively. Thank you so much for talking to us today, and I wish you and Theme a very, very happy and productive 2023!
Howard Marks: Thanks Niraj. It was great speaking with you, your questions are right on the mark, and I look forward to the next time we speak.
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