Conventional Wisdom Conventional Wisdom The most important aspect - - PDF document

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Conventional Wisdom Conventional Wisdom The most important aspect - - PDF document

Feb 25, 2023 142 likes •298 views

It is of the highest importance in the art of detection to be able to recognize, out of a number of facts, which are incidental and which vital. - Sherlock Holmes Basil Rathbone as The Reigate Puzzle Sherlock Holmes Conventional

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 1

“It is of the highest importance in the art of detection to be able to recognize, out of a number

  • f facts, which are

incidental and which vital.”

  • Sherlock Holmes

The Reigate Puzzle

Basil Rathbone as Sherlock Holmes

Conventional Wisdom Conventional Wisdom

“The most important aspect of my personality, as far as determining my success goes, has been my questioning conventional wisdom, doubting experts and questioning authority.”

  • Larry Ellison
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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 2

“I’m a great believer in

  • luck. The harder I work,

the more luck I have.”

  • Benjamin Franklin

Thoughts on Luck Thoughts on Luck

"Progress always involves risk; you can't steal second base and keep your foot on first."

  • Frederick Wilcox
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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 3 “The belief that cyclicality has been ended exemplifies a way of thinking based on the dangerous premise that ‘this time it’s different.’ “These four words should strike fear – and perhaps suggest an opportunity for profit – for anyone who understands the past and knows it repeats.”

  • Howard Marks

The Most Important Thing

“Of the two ways to perform as an investor – racking up exceptional gains and avoiding losses – I believe the latter is the more dependable.”

  • Howard Marks

The Most Important Thing

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 4

Company Company

“It was OK to lend money to build a building, but it wasn’t OK to lend money to any company that would hire a person to work in the building.”

Neutron Legislation - Late 1980s

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 5

1780s Weak state currencies Constitution/Commerce Clause 1830s-1850s Wildcat state banking National currency/Banking acts 1893 Stock market panic Bankruptcy Act 1907 Run on trust companies Federal Reserve Act 1929-1933 Market crash Securities & Exchange Act 1930-1933 Bank failures Glass-Steagall Act, FDIC, New Deal 1970s Commodities speculation CFTC 1970-90s Employment insecurity ERISA, COBRA, HIPAA 1987 S&L Crisis FIRREA 2002 Dot.com/Enron/etc. Sarbanes-Oxley 2008 Great Recession Dodd-Frank

Period

Examples of Regulation Following Volatility

Volatility Regulation

Pages in the Code of Federal Regulations

60,000 80,000 100,000 120,000 140,000 160,000 180,000 1975 1983 1991 1999 2007 2015

Source: Georg Washington University Regulatory Studies Center, 2015.

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 6

More than 2,000 pages… 6 pages … longer than the Torah, Bible and Quran COMBINED!

Regulation Complexity The Nature of Credit

  • 1. Credit is what counts, not leverage.
  • 2. Most loans to real estate are not investment-grade.
  • 3. Interest rates are volatile and unpredictable.
  • 4. Credit research is more than ratings.
  • 5. Sovereign debt is historically risky.
  • 6. Debt values underpin all capital markets
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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 7

Sources: IHS Global Insight, Corelogic, Milken Institute, 3/1/2018.

Home Prices Don’t Go Up Forever

WWI WWII Great Depression 70’s Boom 80’s Boom Last Boom

Change in home prices in 128 years

  • 20%
  • 15%
  • 10%
  • 5%

0% 5% 10% 15% 20% 25% 30%

1890 1906 1922 1938 1954 1970 1986 2002 2018

Source: Thomson Reuters (8/21/2018).

Central Bank Target Interest Rates Begin to Rise

  • 1

1 2 3 4 5 6 7 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Percent

U.S. Federal Reserve Bank of England Bank of Japan European Central Bank

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 8

Central Bank Assets

3 6 9 12 15 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 US$ trillions

European Central Bank U.S. Federal Reserve Bank of Japan Bank of England

Source: Thomson Reuter (6/25/2018).

The most important year in financial history since World War II.

1974 1974

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 9

  • Interest rates double in one year; highest

level in recent recorded U.S. history

  • Regulation restricts lending
  • Energy prices skyrocket
  • U.S. stock market plunges 50%
  • Unemployment almost doubles

1974 1974

Companies with the highest returns

  • n capital, fastest rates of growth in

market share and employment, and greatest innovation were denied access to equity and debt capital.

RESULT #1:

1974 1974

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 10

With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing.

RESULT #2:

1974 1974

The creation of the modern money- management industry (mutual funds and non-trust money managers).

RESULT #3:

1974 1974

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 11

The average P/E ratio of these 16 companies dropped from 66 to 11.

Avon ADP Coca-Cola Disney

  • Dr. Pepper

Kodak H-P J&J Eli Lilly Marriott McDonald’s Merck Polaroid Rite-Aid Wal-Mart Xerox

The $55 Billion Misunderstanding

Investing in the Nifty Fifty 12/31/72 – 12/31/81

90% of the “Nifty Fifty” showed a negative return over nine years. The average inflation-adjusted rate

  • f return was -46%.

The $55 Billion Misunderstanding

Investing in the Nifty Fifty 12/31/72 – 12/31/81

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 12

By 1974, Singer Manufacturing had been paying dividends since 1863.

Source: Chicago Tribune Women’s Corner

Dow Industrials: 1973-76 Dow Industrials: 1973-76

50 60 70 80 90 100 110

Index

December, 6 1974 $578

Source: Thomson Reuters (10/4/2017).

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 13

Dow Industrials: 1973-76 and 2008-11 Dow Industrials: 1973-76 and 2008-11

50 60 70 80 90 100 110

Index

December, 6 1974 $578 February, 18 2009 $6,547

Source: Thomson Reuters (10/4/2017).

200 400 600 800 1,000 1,200

1987 1992 1997 2002 2007 2012 2018

Index, December 1987 = 100

High Yield Treasuries Inflation

High-Yield Bonds vs. Inflation and Treasuries

Note: BofA Merrill Lynch High Yield Master II, BofA Merrill Lynch Treasury Master, CPI. Sources: Thomson Reuters (8/21/2018).

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2018 Milken Institute Hamptons Dialogues A Conversation with Howard Marks and Mike MIlken 14

Commodity Returns 2018 YTD

Source: Bloomberg (8/21/2018). Note: Metals = LME 3mth, Gas and Oil = NYMEX, Heat Oil and Coffee = ICE, Commodities = CBOT and ICE.

  • 28
  • 23
  • 9
  • 8
  • 8

1 3 6 6 9 11 12 20

  • 30
  • 25
  • 20
  • 15
  • 10
  • 5

5 10 15 20 25

Zinc Coffee Aluminum Gold Soybeans Natural Gas Heating Oil Cotton Nickel Brent Crude Crude Oil Gas Oil Cocoa

Percent, 2018 YTD

Currency Returns YTD 2018

  • 17%
  • 15%
  • 10%
  • 7%
  • 7%
  • 6%
  • 5%
  • 5%
  • 4%
  • 2%
  • 2%
  • 1%
  • 1%

0% 2% 3%

  • 18% -17% -16% -15% -14% -13% -12% -11% -10%
  • 9%
  • 8%
  • 7%
  • 6%
  • 5%
  • 4%
  • 3%
  • 2%
  • 1%

0% 1% 2% 3% 4%

Brazilian Real South African Rand Swedish Krona New Zealand Dollar Australian Dollar British Pound Euro South Korean Won Canadian Dollar Singapore Dollar Swiss Franc Egyptian Pound Iraqi Dinar Saudi Riyal Japanese Yen Mexican Peso Source: Thomson Reuters (8/21/2018).

Percent, as appreciation versus U.S. Dollar