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SKARBECK: After 8-year bull market, it's time to get cautious

August 5, 2017

Ken SkarbeckLast week, fellow columnist Mickey Kim referenced the investment “memos” written by the esteemed value investor Howard Marks. Marks’ most recent memo, titled “There They Go Again … Again,” cautions that, after eight years of a bull market, investors should be aware of several yellow flags that have appeared in the markets.

Marks admits he might be too soon with his warnings and isn’t suggesting investors should completely exit the market. However, in his view, risky behavior is commonplace as investors scramble for returns in an investment environment characterized by high asset prices across the board.

A few of the risky conditions he sees creeping into investor psyches include a rejection of valuation norms, a willingness to suspend disbelief, and a fear of missing out. Marks then offers up the following illustrations to make his point.

A measurement used by Warren Buffett to gauge stock market valuation calculates the total U.S. stock market value as a percentage of GDP. That measure hit an all-time high last month of 145 vs. a 1995-2017 median of 100.

Investors are showing a strong attraction to “super stocks” like the FAANGs (Facebook, Amazon, Apple, Netflix, and Google) and have become convinced that no price is too high. A virtuous circle develops as rising tech stocks continue to attract new buyers and index funds must continue their purchases to maintain their proportion in the index.

In last week’s IBJ, Susan Orr’s excellent article discussed private equity funds raising massive sums of money that will be investing in assets priced at all-time highs. Marks notes that few assets can be bought at bargain prices and that buying high means future returns on private equity will almost certainly be lower than in the past.

He also points to the wild speculation taking place in digital currencies, which he dismisses as “nothing but an unfounded fad, or perhaps a pyramid scheme.”

Marks says one thing often heard these days from market pundits is, “We agree, but … .” The common response to the statement that asset prices are high is answered something like, “We agree, but there’s no alternative.” In other words, risk is being tolerated and perhaps ignored.

In a Bloomberg interview, Marks said two glaring points stand out among the many he raised. First, that Neflix can issue bonds with a 3-5/8 percent coupon, in a single-B rated debt issue, while burning through $1.8 billion of free cash flow last year. Should you take such a risk on Netflix to earn less than 4 percent a year? That Netflix can easily get a deal like this done “should tell you something about today’s market climate,” Marks observed.

Second, that Argentina, which is emerging from bankruptcy, can issue a 100-year bond. Argentina has defaulted on its debts five times in the last 100 years. What is the chance this won’t happen again? Yet bids were placed to buy nearly $10 billion worth of the bonds, more than three times the $2.75 billion being issued.

While Marks is careful to say he is not calling a market top, he does say that, for all the things on his list to be simultaneously gaining in popularity, risk aversion has to be low. Therefore, accepting safer, lower returns, versus reaching for returns, is the proper course for investors today.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 317-818-7827 or ken@aldebarancapital.com.

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