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welcome back to episode 16 of the 100 to 10 000 series where i invest 100 every month until it goes to 10 000 this week we're up 0.7 and overall we're up 19.48 this week i wanted to cover something that this gentleman here wrote to his shareholders for those of you unfamiliar this is howard marks a famous investor well known for being the co-chairman of oaktree capital management which runs over 120 billion dollars in assets and it is said that howard marks as one of the two asset managers whose investor letters warren buffett reads as soon as they are released and so i'm going to go over his most recent memo to oaktree shareholders to gain insight on his take on the current covid situation the first thing that howard marx does in his letter is to compare the economy as a patient that has gotten very sick and in real life when the patient is in critical condition the doctor has to take extreme measures to help the patient like when a patient loses too much blood doctors have to supply blood from someone else to keep the patient alive in the economy's case the fed and treasury injected trillions of dollars into the economy to keep money circulating and thankfully the fed and treasury have quote unquote unlimited amount of cash that it can supply to the economy and now that the patient was being kept alive the next step was to provide the cure but there was still no vaccine which would have been the best cure so the next best thing that politicians lean to was to provide covet tests and implement social distancing measures and it worked new cases and hospitalizations continued to drop but before the cure could have its full effect many states stop the cure by reopening prematurely and unlike the nations that were hit harder in the beginning of the outbreak like asia and europe which recovered quickly after extensive social distancing and contact tracing measures were used cases in the us went the opposite direction and much of the earlier measures that were used were nullified with things like the absence of uniform national policies on shutdowns social distancing people refusing to wear masks and so this caused gatherings to occur before the virus was under reasonable control so the desired progress of recovery would have been infection coma life support treatment to cure and then finally resuscitation but instead what we had was infection coma life support treatment and then resuscitation so we missed out on the cure and what we have now is a scarred economy with many small and large companies going bankrupt and continued disease that will be difficult to eradicate until we have an effective vaccine much like bridgewater cios ray dalio and bob prince which i covered in episodes 11 and 12 howard marks characterizes the current market situation not as part of the regular boom and bust cycle the times leading up to the march crash was a time period marked by reasonable growth realistic expectations an absence of corporate over-expansion and a lack of investor euphoria but with an unexpected meteor strike the meteor strike that is known as covet 19 wasn't something that investors brought on themselves like in the dot-com bubble when unrealistic investor expectations on a new emerging industry was followed by disappointment and because the time period we are in is not something that is part of this cycle we can't expect the same ways to bring about an economic recovery to be as effective for an economic crisis calls for an economic solution like cutting interest rates but the current crisis is not an economical one it is a medical one that needs to be solved through a medical solution so what shape does howard marx make the recovery going to look like there have been many talks of a v-shaped recovery but marx doesn't think a v correctly represents what we are seeing and what we are going to see because the v pattern implies that the market drops suddenly and recovers back at a rapid pace in the second quarter of 2020 the u.s economy shrunk by almost 33 percent the highest annualized rate in history and it just doesn't see it recovering at such a fast rate especially so because to go back to square one we would need to see a 49 game to make up for the 33 fall howard marx thinks the recovery will take 8 to 14 months and unemployment rates will probably never reach the three and a half percent for a long time if ever the main reasons for his negative outlook of recovery is the renewed spike of cases the unlikelihood that the next rounds of stimulus packages will not be as big as the first ones an overall decrease in productivity per person as workers refused to go back to work in the office scarring effect on travel entertainment restaurants and small businesses and the disappearing of many jobs as brick and mortar retail businesses decline and things move to digital solutions so instead of a v marx thinks the recovery will look much more like a check mark where the rapid decline in the economy is followed by a slower recovery and then marx talks about the markets versus the fed and if the fed and treasury can win against the virus the positives that he points out in our current situation is the reduction of interest rates to near zero which increase the value of investment assets like stocks and by dropping the fed rates to zero bonds that yield anything above this level is going to look attractive to a lot of investors so the price of bonds go up until they yield less than what the fed offers so today 97 of bonds yield less than 5 and 80 of bonds yield less than 1 and the offering of liquidity by the fed and other forms of support for individuals companies and institutions and just the fact that the fed and treasury are willing to provide support and stimulus for the future the negatives are that the virus is still here and that the second spike is preventing many businesses from reopening so from these points the question arises if high asset prices are the result of technical factors like the fed pouring money into the economy and if the fed reduces its support will the prices of assets like stocks fall and how long will the fed be able to keep the support of to answer those questions marx shares the opinion of his colleague randall krosner the deputy dean for executive programs at university of chicago and he says that there is no limit on the ability of a central bank to create reserves as long as there is someone who will take them but there is concern that if the central bank dishes out too much money too quickly and the consequences that we'll have on the money supply and demand but from what we've seen in the past as long as there is a large demand for super liquid safe assets like bank reserves the central banks can raise their balance sheets without leading to crazy inflation rates for example the bank of japan's balance sheet exceeds 100 of gdp and it continues to grow and in the us we're at about 30 percent of gdp and so in comparison we're not in too bad of a shape and so given all this is it risky to be invested in the stock market right now are prices to inflate it traditionally marx is known for being a value-oriented investor but in his memo he seems to be leaning towards the bulls side despite the fact that a majority of value investors today are saying that stock prices are overinflated one of the defenses that marx makes for the bulls case is that low interest rates have an inverse effect on valuations there are many ways to calculate valuations of companies but the one that marx mentions in this memo is the earnings yield the earnings yield is the ratio of earnings over price which is basically the inverse of the p e ratio so he makes the point that when treasuries yield less than one percent and you add in the traditional risk premium at three percent the earnings yield should be four percent and by taking the inverse of this four percent number we get 25.
historically the average pe ratio of the market is about 16 and so from the earnings yield perspective we should expect a higher pu ratio than normal considering the low interest rate economy we are in in addition this target p ratio of 25 does not consider the fact that earnings of companies grow over time so let's try to consider that in our calculations so if we take for example that the growth rate of the market is two percent the earnings yield calculation is going to be a little bit different we still have the one percent yield of the treasuries plus the risk premium of stocks at three percent minus two percent of the growth rate of the market which gives us a target earnings yield of two percent and taking the inverse of this two percent we get a target p ratio of 50.
and right now the p e ratio of the s p 500 companies is at about 29. so if we follow this model we still have about 42 percent of growth left in the market and marx takes things even further on the bulls side and mentions that for companies that have a growth rate above four percent the earnings yield calculation results in a value of zero which then the p ratio becomes 1 over 0 which is equal to infinity obviously no stock is going to grow infinitely and i don't think that is what marx is trying to tell us i think the point here is that we shouldn't be too afraid to invest in the current market because there are companies that will come up better than they were before the pandemic and that there still is a lot of good investments to be made today that's going to do it for this video let me know down in the comments your thoughts and don't forget to hit the subscribe button with the notification bell icon turned on and i will see you guys in the next one
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