Howard Marks on the Emerging 25-Year Stock Market Sea Change

The financial landscape is shifting dramatically, and this isn't your typical market ebb and flow. Howard Marks, the renowned investor, believes we’re at the threshold of a transformative economic event, a sea change that defines decades.

A Major Transformation Underway

A sea change denotes a fundamental transformation in the environment and attitudes that govern investment. In a recent memo, Howard Marks describes what he calls a once-in-25-years economic event—something only twice before in his 53-year career. Marks, co-founder of Oaktree Capital Management, has amassed a $2.2 billion net worth and delivered average long-term returns around 20% net of fees. He has guided investors through cycles of credit, distressed debt, and private equity. Today, he warns that post-Global Financial Crisis optimism has given way to a landscape dominated by higher inflation and interest rates, calling for a reevaluation of stock market strategies.

The First Sea Change: The Rise of Risk Analysis

Marks’s first sea change began around 1969, when investors piled into the “Nifty 50” blue-chip stocks like Walmart and Disney at 50 times earnings. By 1974, that bubble burst, wiping out 95% of those gains. Suddenly, no company was infallible. Investors shifted from avoiding risk to measuring risk relative to return, hunting smaller, unprofitable companies with compensating upside. This new focus paved the way for the high-yield bond market, which grew from $2 billion in the 1970s to $1.2 trillion today. Marks himself capitalized by buying non-investment-grade debt with yields that justified the risks.

The Second Sea Change: Inflation and Interest Rates on the Rise

The mid-1970s brought Marks’s second sea change, triggered by an OPEC oil embargo that drove oil from $24 to $65 per barrel and sparked nine years of high inflation. Rates peaked at 13.5% in 1980 before Fed Chairman Paul Volcker hiked interest rates to 20%, finally taming inflation. This laid the foundation for a 40-year bull market, as the Federal Funds rate fell from 20% to zero by 2020. Declining rates acted like an airport’s moving walkway—investors moved forward effortlessly. But as rates rise, that tailwind becomes a headwind.

The Current Economic Environment: The New Paradigm

Over the past 18 months, we’ve departed from the easy-money era. Following the GFC, the Fed kept rates near zero and launched massive quantitative easing, driving stock returns to about 16% annually. Pandemic-driven stimulus and supply-chain constraints then sparked inflation unseen in decades. As consumer demand surged, the Fed raised rates rapidly, shifting investor sentiment from FOMO to fear. Popular assets from crypto to SPACs plunged, reminding us that stability can vanish quickly.

What Lies Ahead: The Narrative of Inflation and Interest Rates

Marks predicts inflation and interest rates will dominate the financial narrative for years. Even though inflation has eased, expectations for further rate hikes persist, given the Fed’s recent underestimates. Globalization’s deflationary boost may be reversing as manufacturing returns to the U.S., adding upward pressure on prices. Meanwhile, the Fed still owns about $9 trillion in assets; reducing its balance sheet could further tighten liquidity. Investors who entered during easy-gain years face a steep learning curve in this bracing new environment.

A Bright Side: Opportunities for Value Investors

Despite challenges, rising interest rates can boost prospective returns on quality stocks. As share prices drop, the yields on high-caliber companies improve, expanding the universe of attractive investments. These conditions favor value investors seeking companies with strong management, durable moats, and resilient cash flows. In this sea change, patient, disciplined investors may uncover hidden gems.

“A sea change is a major transformation of the environment—a complete change in attitudes,” says Howard Marks, capturing the gravity of this economic event.

Conclusion

In this looming sea change, the stock market will no longer be buoyed by declining rates. Investors must adapt to a regime of higher inflation and interest rates by focusing on true value and long-term fundamentals.

• Actionable takeaway: Reassess your portfolio’s exposure to rising rates and inflation, and prioritize high-quality investments that can deliver sustainable returns in this evolving economic event.

How are you reshaping your investment strategy to navigate this pivotal transformation?