With U.S. stocks seemingly hitting a new high almost every week, investors are becoming ever more exuberant. And why not, right? Stocks are impervious to the political dysfunction in Washington, sabre rattling out of North Korea, or the tightening of financial conditions by central banks. Heck, look at the volatility index or VIX. It’s as tranquil as the surface of a lake on windless summer morning. In such an environment, the notion of risk begins to fade from investor memory.
No one wants to be reminded of risk when the party is in full swing. But that is the job of a fiduciary. In his latest memo entitled “There They Go Again…Again,” investing legend Howard Marks does just that, cautioning investors against getting too drunk with recent investment gains and throwing caution to the wind. In his memo, which is a must read for any serious investor, he notes some similarities between today’s financial markets and those of 2000 and 2007. No, he isn’t predicting a crash nor the imminent demise of the bull market. But he is advising caution and reminds investors that risk is real and happens fast. No bull market goes on forever. The following are a few key excerpts for those who don’t have time to read his 22 page memo.
“…it’s essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature. I think it is better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses.”
“Today’s Investment Environment”
- “The uncertainties are unusual in terms of number, scale, and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.
- In the vast majority of asset classes, prospective returns are just about the lowest they’ve been.
- Asset prices are high across the board. Almost nothing can be bought below intrinsic value, and there are few bargains. In general the best we can do is look for things that are less over-priced than others.
- Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.”
“The key strategic decision for anyone shaping investment strategy is whether to apply aggressiveness or defensiveness at a given point in time. In other words, should we worry more today about losing money or about missing opportunity?”
“…Oaktree will continue to follow its 2012 mantra: move forward, but with caution - and, given today’s conditions, with even more caution than in the recent past. If one is going to invest at times like this, investment professionalism - knowing how to bear risk intelligently, striving for return while keeping an eagle-eye on the potential adverse consequences - is the absolute sine qua non.”
PYA Waltman Capital couldn’t agree more. Now is the time to stay sober and alert. As valuations continue to inch higher, the risks are rising, not falling. Indeed, move forward, but with caution.