In 2007, Oak Tree Capital’s Howard Marks wrote the following warning:
Today’s financial market conditions are easily summed up: There’s a global glut of liquidity, minimal interest in traditional investments, little apparent concern about risk, and skimpy prospective returns everywhere. Thus, as the price for accessing returns that are potentially adequate (but lower than those promised in the past), investors are readily accepting significant risk in the form of heightened leverage, untested derivatives and weak deal structures.
Marks didn’t say when or what exactly would happen. Though the inevitable turn-for-the-worse outcome, he wrote at the time, had “little mystery.” Did Marks “predict” the financial crisis? Not exactly, but dang if he wasn’t close.
In a new note today, Marks argues “we’re seeing another upswing in risky behaviour.”
“It began surprisingly soon after the crisis spurred on by central bank policies that depressed the return on safe investments,” he writes to clients. “It has gathered steam ever since, but not to anywhere near the same degree as in 2006-07.”
How does Marks know? Here’s his “characteristics of 2007” checklist. From the note:
- global glut of liquidity — check
- minimal interest in traditional investments — check (relatively little is expected today from Treasurys, high grade bonds or equities, encouraging investors to shift toward alternatives)
- little apparent concern about risk — check
- skimpy prospective returns everywhere — check
Sure, investors aren’t quite as risk-blind as 2007, but “when risk aversion declines and the pursuit of return gathers steam, issuers can do things in the capital markets that are impossible in more prudent times.”
“In short, it’s my belief that when investors take on added risks — whether because of increased optimism or because they’re coerced to do so (as now) — they often forget to apply the caution they should,” Marks concludes. “That’s bad for them. But if we’re not cognisant of the implications, it can also be bad for the rest of us.”
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