Howard Marks on market cycles, contrarian investing, and why AI is now his mentor

Exchange.

It's that easy.

And we have Howard Marx in the reream waiting room from Oak Tree Capital. Let's bring him into the TV pan. How are you doing?

Welcome.

Thank you so much for joining. Um, I would love to kick it off with the high level on your your theory of the market cycle. Um, and then maybe we can walk into how you're thinking about markets today and over the last few years, but uh the the highle thesis on on the market cycle. Um, how do you explain your overall thesis?

Sure. Well, thanks of all, thanks for having me on today. uh you know I I've watched what you do and it's terrific and I'm glad to be part of it.

Thank you.

Um you know basically a company or a market or an economy

uh makes progress along what we call a trend line.

And uh so uh the value that it creates should progress along that trend line. But the point is that while the progress there is pretty steady and gradual, sometimes people get too excited and they overvalue that progress and and the market goes to an unsustainable high

and then uh something comes along that that makes that correct uh back toward the trend line but given the way human nature works through it to an unsustainable low. uh and then eventually that's corrected back toward the trend line to a high. So the point is that that whereas uh the underlying thing progresses gradually

the price fluctuates wildly around that trend line and the main reason is uh the fluctuation of psychology.

Yeah. Is how far back do you go when you think about market cycles? Does the same theory apply pre-industrial revolution?

Well, I'm you know, I'm old, but I'm not that old. And uh

I didn't mean it like that.

You know, I I wasn't there, but uh yes, I think Well, I think you know you know, one of the one of the most valuable uh operative quotations is from Mark Twain. Yeah.

Who supposedly said that history does not repeat, but it does rhyme.

Yeah.

So, the the things that rhyme

are the elements of human nature. M

that caused these excessive fluctuations around what what what I'll call intrinsic value or reality.

Sure.

So, you know, the desire to get rich quick.

Yeah.

Uh envy

uh of seeing others get rich quick.

Uh the belief that it's possible to get rich quick.

Uh the fear of missing out.

Um uh the fact that people get more excited the higher the price goes, which should be worrisome. So these things I think have always been in place and you read about bubbles that took place uh let's see the tulik bubble I think was 1620 the south sea bubble was 1720 and so

these these excesses these human failings have always been part of what what goes on

but this time is different kidding um uh how do do you think uh a lot of the guests on our show have maybe been through the the COVID kind of brief correction and chaos of ZERP

uh but don't have much else to go off of that can kind of be an advantage because you can just be so optimistic that even if something you know bad you know you do get a big correction maybe you get a a fast rebound. Yeah. Has being through a number of these cycles ever hurt your performance because you just weren't opti like optimistic enough or you know this this idea that you know uh optimists make money uh and you know pessimists sound smart?

Well um you know my firm Oakree Capital Management first of all doesn't invest for the most part in the stock market. We're mostly investors in what's called credit or debt. Yeah.

Uh but I I I think that we are what's called contrarians. I think we're my partner Bruce Kh and I are essentially uh innately contrarian which is to say that we're most comfortable doing the opposite of what the herd is doing at the extreme because we see its error.

And so I think we've always done that naturally. Um and uh so uh we are I I think we're conservative by nature and I always say by the way in 1978 uh City Bank asked me to go to the bond department and start a high yield bond fund in a convertible bond fund and and and and it worked great because uh being a lender requires conservatism. If they would have said, I want you to start a venture capital fund and and predict when Amazon is going to be uh created, I would have been a disaster. Uh I'm not a futurist. I'm not an optimist, etc. Uh but I when I have seen excessive pessimism and excessive gloom causing crashes and I've seen a few uh I it has been it has come kind of naturally to to go against that excess. And so I think one of the ironically one of the things we've done best for conservative people is seize the opportunity at the lows again by being contrarian and uh you know I wrote a memo in October of '08 after the global financial after the bankruptcy of Leman uh with the title the limits to negativism

and there is such a thing as being too negative. Mhm. Do you think contrarianism like you just described uh is purely innate or can it be learned? Is it a muscle that you can build over a career? Is it something that folks in everyday life who maybe aren't professional investors but might benefit from not getting overheated and falling in with the herd can learn? And if so, how?

I think you can learn these things. Uh you know, I wrote a book called Mastering the Market Cycle. I'm not really trying to plug the book, but it wouldn't hurt. Um

but but uh you know uh and it all talks about how to how to uh how to deal with the cycle.

Um and uh

what I think is I get all these questions. Can you learn this? Can can you learn that? Can you learn this? Can you can you learn to be unemotional? Can you learn to be what I call a second level thinker? Can you learn to be a contrarian?

The answer is I can tell you why it's important.

I can explain to you why it's essential. Is it something you can ingest? I don't know.

You know, uh I for some reason or another come by it naturally.

Uh it's easy for me relatively. By the way, I don't want to give the impression that when I make these calls at at the at the highs or the lows that I do it without some trepidation.

I'm never sure.

Anybody who's sure is an idiot. You know, they say there are two kinds of people who lose a lot of money. The people who n know nothing and the people who know everything. So, so I I'm not trying to imply that it's easy.

Yeah.

But it does come fairly naturally to me through the combination of my emotional makeup and and the application of logic.

Yeah.

If somebody else doesn't have my emotional makeup, they could learn the logic. Maybe they could learn to do it.

It might not come so easy. That's all I can say. H how do you think about uh the concept of black swan events or the integration of black swan events into a market cycle? Because going into co I was looking at the health the fundamental health of the American consumer the fundamental health of the economy everything looked very strong and I think that's why the economy rebounded as quickly as it did and then sort of overheated. Um but how do you need to put black swans out of your mind? Are black swans even a real thing? Like, how do you think about that concept?

They're a real thing. I don't think you can do anything about them.

Yeah.

Uh my term, the term I've always used for what TB calls a black swan

is uh an improbable disaster.

Mhm.

And by the way, they're not all disasters. There are improbable bonanzas, too. to the

but but but I mean if you just think about the improbable disaster

it is something where if it happened it would be disastrous

but it's very improbable.

What do you do about it? And in in my in my opinion you can't do anything about it

if you say well I'm concerned that there could be you know an eight hurricane uh earthquake. I'm concerned that there could be four hurricanes in a row. I'm concerned that there could be nuclear war and I'm concerned that there could be uh uh inflation at 20%.

Well, you can protect yourself against that. You can call that guy who lives in in Omaha. He'll write you an insurance policy uh to protect you against all of those things. You just won't like the premium. And if you take out that insurance policy and you pay that high premium and you're protected in the vast vast majority of years, it's not going to happen.

And after a little while, you'll get tired of paying those premiums and it'll stop probably in time for it to happen.

Yeah.

So, so, so you you really can't. And the things that are in the way way distant tales of the probability distribution are just things you have to live with. That's that's real life.

Mhm. How do you think about the education that goes into becoming an investor and how that's changing? It feels like it's easier to learn without mentors because everything's been compacted into AI and open sourced on the internet and you can watch great lectures and podcast interviews. What's changed and what's the same?

Well, my perception is that AI number one, AI has a mentor. Mhm.

It reads everything that ever happened.

Yeah.

And ingests it and remembers it and can find it.

Mhm.

And then AI becomes a mentor.

Mhm.

And and and uh it it it tells you uh you know how to think. It gives you examples of thought processes.

So So I I think it just makes it so much easier to learn, you know. And uh uh I wrote a memo in December. I write memos to my clients. October was the 35th anniversary. And I talked about AI in a memo December 9th.

And then uh I have a son named Andrew. He's in he's in the tech world. He's a he's a terrific venture capitalist. He's co-founder of of a of a a group called TQ Ventures. Mhm.

And uh and and given the recent events, he pushed me to revisit that memo and update it.

Mhm.

And he had this great idea. He said, "Why don't you why don't you ask Claude

to tell you about what's been happening?"

And so, uh, he and I developed a a a request which we input inputed to to, uh, to Claude. his help was invaluable. But of course, he does this all day with all of his brilliant founders and and uh so Claude wrote me a tutorial which enabled me uh to to update the memo

and I I learned an incredible amount uh you know from uh in a field that is not native to me. Yeah. through doing that. And so, uh, it was a mentor to me

and it can be a mentor to others, but as we know, you have to ask it the right questions.

Yeah.

Uh, and Andrew and his his buddies helped me do that.

Yeah. How how has technology changed the credit markets or just investing in in credit over your career? I I can imagine computerization, the internet, there's there's sort of a continuum of advances that just help information flow more freely. AI feels like just an extension of that, but how has like the actual work changed over your career? Right now, AI is helping us marshall data

uh with a with a thoroughess and a speed and a uh and an error-free that we never had before.

Uh I don't think it has changed the process because it what you see it all comes down in the end to uh looking at a company and assessing the probability that it'll pay its debts. Mhm.

And I don't, you know, I don't I think we're still better at doing that than than AI is.

Oh, by the way, I should tell you, uh, that an hour or two ago, we put I put out a new memo updating, uh, the December memo. You probably haven't seen it. I may make reference to it, please.

But,

Pardon me.

No, I was saying we we do have it pulled up, but but for the audience.

Okay, great. So, um, so, uh, you know, it says in there and and I asked Claude, and Claude said, "Look, the truth of the matter is that the thing that AI is the weakest at is doing analyses uh, on brand new things where there aren't established patterns,

and and and so and I think that that's a lot of what we do,

you know, and uh, So uh you know at the present time I think that I I think AI can uh can marshall the data organize the logic out uh frame the question. Uh I don't think it's the top of the heap in answering the question yet. Of course I can always be wrong. Uh but you know and I say in the memo that I think that what AI does is is predicts based on past patterns. It predicts what kind of companies will pay their debts and whether a given company will pay its debts and it puts forth a hypothesis u with with regard to an individual situation. Um and and and it tells you you should or shouldn't invest.

I think as I as I understand the status of things today,

you need people to check the hypothesis.

Yeah. you know, I don't think I would make an investment commitment based on the hypothesis alone. I would want to check it, but I think it gives you a great starting point. And and uh by the way, so I wrote the memo. I said to Andrew, "Do you want to look at it?" He says, "Why why send it to me? Why don't you send it to Claude?"

Ask Claude to take a look at the memo. So I did. And I was I was absolutely And if you read the memo, I was absolutely dumbruck.

Yeah. by what what what I got back because it responded to me

in I said it it it responded to me it felt like a a note from a colleague or friend.

It was personal. It was warm.

It drew analogies to my 35 years of memos. It it talked about some some of my uh some of the people I respect. It uh it it injected humor.

U it was it was complimentary. it, you know, it said it it it talked about a section it thought was really good. So I wrote to Andrew I said it is is uh is AI is clawed an assisser because I thought it was maybe unduly complimentary.

Yeah.

He said well well dad ask it ask it to be hyperritical.

So I wrote back I make a few corrections. I I said now would you please be hyperritical? So it writes me back and it says, "Do you want me to be hyperritical or hypocritical?" It's making a joke,

you know, and and so uh you know, I think that it's going to change our world.

Yeah. Uh I think I think that you know we we have an activity in our investment world called indexation

where rather than pick stocks a lot of people who invest in the stock market now instead just invest in a vehicle that emulates the S&P 500 or some other index

and indexation has put a lot of people out of business

because a lot of people used to a do an inferior job.

Mhm.

Underperform the S&P and then B charge highly for their services. There's something wrong with that.

Yeah.

And a lot of those people uh are out of the business now and and the majority of uh equity mutual fund money is managed through indexation or passive.

Mhm.

I think AI will advance that. It what it does is it it it just raises the bar and weeds out the people who don't add value. Mhm.

I don't think I don't think it'll replace the best.

Mhm.

But it'll replace a lot.

How how are you uh personally comparing the the AI buildout and the advancements uh in the various models and stuff happening at the application layer all the way down to the hardware layer to the internet buildout. There's so many different comps from investor psychology to overall consumer psychology. We were talking earlier this week on the show about the battle of Seattle and the protests around uh the the the internet buildout and the fear that people had around uh jobs getting outsourced uh going overseas as well as just disintermediation. And it feels like so many of the radical predictions that people made about the internet are still being made about AI. Some of them came true with the internet, but they they came true over a decade or two. Uh and in some ways now it feels like AI really is just a continuation of many of the same trends that the internet brought along, but some of the predictions are even wilder this time around. Well, I think that um first of all, I am in that debate. I'm on the side of the warriors visav society. Uh I I by the way, remember I said 10 minutes ago, I'm not that much of an optimist.

Yeah.

Uh so I can imagine the jobs eliminated and I am not imaginative enough to to think of all the jobs that will be that newly created. So I see a net decline in jobs and um and I and I do worry about that. Um AI is uh similar to the technological bubbles that I've seen and and the technological bubbles probably go back all all the way to the railroads, you know, 140 years ago. Um but the power of AI relative to the predecessor technologies I think is vastly higher. The speed of innovation is vastly faster. I think innovation I think if you look at the uh Claude and uh uh all the coding models and the way they've progressed and the way and the way anthropics uh revenues have progressed I think you have to say that this is faster than anything we've ever seen before and I think

well and it's because you have the distribution that was laid

starting over 20 years ago

but but I think I think the I think the the speed at which AI can innovate is faster faster than the speed at which society can adjust.

So you might say it'll catch up, but I think you could I think at minimum you're talking about a a significant period of dislocation. The other thing the other thing that we haven't touched on but is is is the biggest difference between AI and everything else we've ever seen is the autonomy and all the other technologies starting with the railroad up through the internet were I would call laborsaving devices. We had a job to do and the new technology did it better, faster, cheaper. AI it's it's different. It's not just going to do the job we used to do. It's gonna design new jobs.

It's going to assign new jobs. It's going to take on work we haven't asked it to take on. Um it's going to take on work we didn't think it could do. U and it and and it's going to operate at some point in time without instruction. In the memo, I talk about the fact that Chat GPT brought out a new model earlier this month. And in the write up for the for the model, they said basically in English AI the model helped us design the model.

Yeah.

There's never been anything analogous to that before. So uh when I think about the this extreme level of competence, speed, etc. I I think of dislocation.

Mhm. for people and you know there there are people who say and I referenced in the memo there are people who say oh I have great news uh people aren't going to have to work to me that's terrible news uh you know I think we get a great deal from our work other than a paycheck

and and how is are those elements of life going to be replaced

it's a wild time

around how How are you feeling about the United States relative to other countries, the rest of the world? There's a lot of uncertainty generally, politically, at the same time, America seems to have a lead in the AI race. Um, how are you feeling about uh just America broadly?

Well, I don't I don't know enough about the technology to know where we stand in the race or or what it's going to take to win the race or anything like that. Uh but I think you know and and and there was the big news recently was that anthropic is going to uh uh I don't even know the right terminology but u let's say uh be less reticent

uh in certain areas to to apply technology.

Yeah. be because in America and in a lot of developed countries, we have these things called scruples.

Oh, no. You know, I'm not going to do that. You know that. Oh, yeah. Well, yes, you could do that, but I'm not going to do that.

Uh, this is an arms race.

Mhm.

And you know, we're America has never had a serious rival before.

Never had a serious rival. We thought Russia was a serious rival. Uh, we were wrong. uh it it was never really a threat other than militarily or or you know atomically

but we've never had an economic rival before. Now we have an economic we have a rival in many dimensions and of course it's China and and I think that AI will be at the core of that uh of that rivalry and you know if if we slow down because of our scruples

and they carry on pel I think that'll help them win and if they get control of AI if they have highly superior AI. I think that could be one of the things that makes life tough for us.

So, and by the way, I I consider myself as having scruples,

but I I worry about what this implies. And by the way, if you want to think about scruples, think about this. One of the areas in which we we have a problem which is not highly talked about or acknowledged is rare earths.

And rare earths are ubiquitous in many areas of technology. and we're dependent on China for that.

Mhm.

So, here's a question for you two young guys. Before China developed its primacy in rare earths,

who had primacy?

Wasn't it America? I

think we did. And we decided it was dirty and and it was worth shipping overseas before.

Bingo.

Yeah.

A hundred. You get a 100 points for that answer.

Let's go. Thank you.

It was us. And as I understand it, as I understand it, most of the rare earths came out of one mine in California.

And my guess is some ecologists

concluded.

Yeah.

That as you say that it was dirty.

Yep.

And so we maybe we shouldn't do it. Yeah.

And then guess what? And guess what? China said

we'll do it.

We'll do it and we'll do it cheaper.

Oh yeah.

And so they got all the business.

Yeah.

And that's how you create a dependency. Yeah. And there's a big question about how does the dirt over there just come right over here? Like potentially, you know, I think it's possible it's all one atmosphere,

but look at what happened with energy in Europe.

Yeah. Oh, yeah.

Germany had a bunch of nuclear reactors.

Crazy.

And then and then they said, well, we don't really want like having nuclear reactors because of its non-ecological. And Russia said, oh, we'll do it for you.

We'll supply your energy. Yeah. And you dependent you you develop a dependence. Yeah.

So the point is what you had in both cases is you had

decisions made on purely economic terms in areas that probably should have included some strategic decision-m.

Yeah.

Geopolitical strategy.

But but it was all seated to the economists and the ecologists.

Yeah.

Hard decisions. These are hard decisions.

They are. Uh, can I completely switch gears and ask you sort of a personal finance question? Um, I've heard this rule of thumb that uh the allocation between stocks and bonds should be uh tied to your age. If you're 50 years old, you should be 50/50. If you're 25 years old, you should be 25% in bonds. But recently, the bond markets and the stock markets have been more correlated than decorrelated. And I'm wondering how you think the average person should think about the equity markets versus the debt markets.

First of all, there are no numbers that hold true for everybody. Yeah. So any any rules of thumb that have numbers in them, you have to throw out.

The only rule of thumb is no rules of thumb.

Well, like who who was it who somebody once said that every generalization is flawed, including this one.

Yes.

Right. That's great. So, so uh uh the point is that stocks and bonds

have different qualities.

Sure.

Existential qualities and people should understand what the difference is

and it's not the difference is not merely that one is called stocks and one is called bonds. You have to understand the difference

and then you have to figure out for yourself what the right

uh I would say risk posture is

and and each person and each company and each insurance company each sovereign wealth fund each investor should figure out their normal appropriate risk posture based on age wealth income sufficiency of age of wealth and income aspiration number of dependents uh and uh uh intestinal fortitude

the ability to live with fluctuations.

Mhm.

And it's different for everybody. M

so you know that rule of thumb generalization hints at a direction which is to say maybe younger people whose lives lie ahead should take on more uncertain paths which have a higher trajectory but more uncertainty and older people who are approaching uh uh retirement should have a less uncertain path and more dependability

makes per perfect sense the number using something like your age as the answer is silly.

Yeah.

But I think everybody has to think about those things and it and it's not easy to come up with the answers, but you better do it because it's damn important.

Yeah. Last question for me and sorry to jump around a little bit, but I'm curious. Were you ever deeply pessimistic about the internet, about what the internet's impact would be on society in the way that you are around AI and potential labor displacement? Because certainly

a great question

because because you could have pessimism about hey we got a lot of fiber in the ground that's

not actually being used that we're we're headed uh off a cliff here. That's kind of like maybe more like economic pessimism but uh societal pessimism. I'm curious.

You know uh I think the honest answer is that I never was I never knew enough about the internet

uh to reach that point of pessimism

because you didn't have the internet. You didn't have

Well, I also didn't

I didn't have my son kicking me in the butt uh making me uh do the research. I mean, he has really pushed me. He said, "Dad, you have to know this stuff."

Yeah.

And he does it all day.

Uh and and so I I think I know much more about uh AI than I ever did about the internet.

Uh and and so so the answer is I never did uh reach that level of pessimism with regard to the internet. What's the what's the fundraising cycle like for Oak Tree Capital? How do you how often do you raise funds? What's the latest fund?

Well, that's an interesting question. I mean, we have a lot of different kinds of funds. We have some which are very plain vanilla and and produce a uh a steady return fairly dependably

higher. We don't do anything in what's called high-grade bonds or investment grade.

Yeah.

Everything we do is is noninvestment grade. So we don't you know we don't do u uh guilt edge but so nothing we do is 100% dependable but uh but and so we we have some that are mundane and modest return moderate return and then we have some that are highly aspirational and and and often tied to the cycle. Uh I think it's fair to say we're the world's leading investor in distress debt.

Mhm.

And so sometimes when there's a lot of distress, there's a lot for us to do. We have the ability to invest a lot of money and historically have high returns when when everything is placid. There's not much to do in distress land. So we have to kind of uh go into remission

and we don't raise much money in those funds and we we raise small funds with which we can do uh very selective things and and make do with a modest supply.

Uh so it's a lot of our fundraising is tied to that. The other thing is we're worriers. When in good times most people plunge ahead,

we tend to pull back because we get worried because they're too damn optimistic. You know, Buffett says Buffett says the the less prudence with which others conduct their affairs, the greater the prudence with which you must conduct your own affairs. Or he says we we must conduct.

Yeah.

And and and I I believe that. So when everybody is is unafraid, I get terrified

because they do nutty things that put us all in jeopardy. Yeah.

The scariest thing in the world, the riskiest thing in the world is the belief there's no risk.

Yeah.

And when people believe there's no risk, the world gets crazy. There's an old saying in the banking business, which is where I started my career,

that the worst of loans are made in the best of times

for this reason. Mhm.

So that that really defines our cycle when everybody else is having a ball making money hand over fist doesn't see anything to worry about. You know, we kind of go into a cocoon because that's to us that's scary and it hints at very few opportunities

when everybody else is terrified and and wouldn't touch risk with a 10-ft pole. And as a consequence, you get highly paid for taking risk. That's when we turn aggressive. Mhm.

Which uh I don't know how much you you uh if you read or or talked uh with Andrew about Catrini's uh Sunday memo, the 2028 global intelligence crisis, which Citadel responded to by basically saying, "We have an intelligence crisis right now." with everyone's reaction to this piece, but did you ever have a memo that had

wild that that created really wild near-term price action or in the way that that the Catrini piece did or or with the way that information moved historically,

did did that kind of

No, I I look that he he used a device of I mean he he even said this is not a prediction. This is an extreme case to illustrate.

Uh I've never I've never felt that it was attractive to do that.

Uh you know, I try to I try to live in in the in the middle of the probability distribution.

And uh and understand what's going on in the middle of the probability distribution rather than again I I think maybe you would say that Catrini's case was a black swan.

Yeah. Uh and and uh and and uh I don't uh I don't traffic with black swans.

Well,

yeah, it it's interesting. It's uh it kind of needed to come from a substack that gives the kind of appearance of being

if you're just reading it for the first time, it gives these kind of appearance of sophistication.

Sure. but doesn't come with having run, you know, tens of billions of dollars of of of assets.

Well, thank you so much for taking the time to come chat with us. Really enjoyable conversation.

Well, as I said, I think you guys doing a great job and it's really a pleasure to be part of it.

Yes, we've loved having you. Hopefully, we can do it again soon. Uh, congratulations.

Yeah, tell tell Andrew he's welcome.

Let's plug the book. Go buy the book. Uh uh and uh it's it's available where all books are sold. I'm sure that there's a audio version as well.

Exactly.

Thank you so much.

Cheers.

Bye.

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