Navigating Market Turmoil: Insights on Credit, Equities, and the Changing Global Landscape

Credit vs. Equities: A Month Later

A month ago, Howard Marks of Oaktree Capital released a memo stating that credit offered a better deal than equities, even with current spreads. In light of recent market sell-offs and the implementation of significant tariffs, the question is whether this thesis still holds.

Healthy Credit Yields Amidst Market Volatility

Marks asserts that credit yields remain healthy, and have even improved slightly since the memo's release. High-yield bonds, for instance, were yielding around 7.2% six weeks ago, compared to nearly 8% today. This increase in yield is a direct result of a price decrease in those bonds.

While the stock market is significantly down (estimated at 15-17%), the question remains whether prices have fallen too much, just enough, or not enough. Determining this in the face of current events is challenging.

Gauging the Impact of Trade Restrictions

The Biggest Change in the Environment

Marks considers the current shift away from free trade and globalization as the most significant change he's seen in his career. This new system implies significant trade restrictions and a move towards isolation for the United States.

The Benefits of Globalization

The last 80 years of globalized trade, since World War II, represent the best economic period in human history. A rising tide of trade lifted all boats. He emphasizes that every country excels at some things and struggles with others. The goal of worldwide welfare is maximized when each country focuses on what it produces best and most cheaply, then sells to those who need it.

The Impact of Trade Restrictions

To illustrate, Marks uses the example of Italy and Switzerland. Italians are known for pasta production, and Swiss are known for watch production. If we restrict world trade, Swiss would have to produce pasta, and Italians would have to produce watches. This would, arguably, leave people in both countries worse off, as they aren't able to specialize in the products and services that they are best at producing.

The benefits of globalization, including keeping a lid on inflation, should not be underestimated.

Inflationary Pressures and the Role of Tariffs

Marks anticipates that the move away from globalization could lead to a more persistent inflationary regime. Cheaper goods from abroad have helped keep inflation in check. He asks: If the United States hadn't bought TV sets and appliances from abroad during a 25-year period of declining prices, what would inflation have been? The answer is: Considerably more.

Tariffs, ultimately, are an increased cost. While who ultimately pays them is up for debate, they are still an increased cost, the proceeds of which go to the government.

Assessing Risk and Reward in a Dislocated Market

When measuring the risk and reward of asset classes, considering credit which may return 7-9% vs stocks which have historically returned 10%, you should consider the price to earnings ratio.

• Historical Stock Returns: Stocks have historically delivered an average of 10% annually, but this is not always the case.
• Price to Earnings Ratio: The average return has been 10% when the price to earnings ratio has been 16. The price to earnings ratio is currently 19, historically, investors have seen returns of 1-7%.

In credit, Marks notes, you essentially see what you get. What you see is what you get. Fixed income, credit or bonds, they all show the promised rate. One has to wonder whether the issuer will default. However, issuers have high incentive to pay because they lose the company if they don't keep their promises. Marks has been in non-investment grade credit for 47 years and shares that roughly 99% of issuers have paid as promised.

Navigating Market Dislocation: Fear vs. Greed

The most pressing question is whether now is a time to play or not to. This is a time of dislocation, and everyone has to decide whether the reduction in asset prices has been right, inadequate, or excessive.

• Excessive Reduction: If excessive, you should jump in with both feet.
• Inadequate Reduction: If inadequate, wait until things adjust further.

There's no way to qualitatively determine whether today's asset prices are right for the future environment. All investment decisions are, to some extent, conjecture and guesswork. The future is now more uncertain than ever. The world economy and geopolitics have been shaken up, and nobody knows what the future will hold.

The Importance of Probabilistic Thinking

Marks advises against relying solely on forecasts, advocating instead for incorporating probabilities. Any forecast needs to be paired with an estimate of its likelihood of being correct. The probability of accurately predicting the future is lower than ever.

Seeing Opportunity in Sales

The markets are on sale. The S&P is down 8% in the last two days. People run from the market when the prices go down because they think it connotes risk. The truth is that, it's just stuff going on sale. This discount should encourage people to think about buying.

The United States: A Less Certain Investment Destination

While still likely the best place to invest, the U.S. is "less best" than it used to be. Factors that contributed to its attractiveness are diminishing:

• Rule of Law: May be less of a factor today.
• Predictability of Outcomes: May be less predictable today.
• Fiscal Situation: The US's debt and deficit situation are worrying. The United States has been acting like someone with a golden credit card with no credit limit.

The events of recent days could introduce a credit limit or a bill to be paid. If investors lose confidence in the dollar or U.S. treasuries, the fiscal situation could become very complicated.