Investor Howard Marks in an interview about interest rates, Fed, inflation, stocks and Trump

The US Federal Reserve began a new cycle of interest rate cuts on Wednesday. It reduced the key interest rate in the USA – also known as the Federal Funds Rate – by 0.5 percentage points to 4.75 to 5 percent.

The sharp interest rate cut surprised many market participants, who had only expected a step of 0.25 percentage points. Many investors see this as a signal that another phase of extremely cheap money is imminent.

However, American investor and author Howard Marks, co-founder of the financial company Oaktree Capital Management, takes a different view. “Interest rates are likely to continue to fall, but not as far as in the last cycle,” he said in an interview in Zurich.

“Key interest rates are likely to remain higher than 3 percent on average”

In the period from 2009 to 2021, the Fed kept key interest rates extremely low, mostly close to zero. He expects this average to be higher than 3 percent in the next ten years, says the 78-year-old.

 

According to Marks, one of the reasons for this is that central bankers realized during the period of zero interest rates that they needed ammunition for interest rate cuts in a crisis or recession in order to stimulate the economy. “It’s a bit like a person who has a heart attack,” says Marks. You can give them nitroglycerin tablets to save them and dilate their blood vessels. “But it’s not a good idea for that person to take a nitroglycerin tablet every morning for the rest of their life,” says Marks. You can’t live in emergency mode all the time.

Negative interest rates as an anomaly in the monetary system

According to Marks, it is similar with monetary policy. It does not make sense if it constantly stimulates the economy. In such a case, side effects such as inflation occur, and at some point monetary policy loses its effect.

Reducing interest rates to negative levels has also not proven to be an effective way to combat weak economic growth. Negative interest rates are now increasingly seen as an anomaly that must be prevented. The entire monetary system would then no longer function. “That’s why I’m betting that we won’t see negative interest rates again in the next ten years.”

“Today’s interest rates are not high”

Historically speaking, today’s interest rates are by no means high, says Marks. “When I started my career in the financial markets in 1969, the US key interest rates were 8 to 9 percent,” he says. The average over the past 70 years is around 5 percent, which is the current level.

Many investors do not have this long-term perspective and are guided by short-term developments. These include, for example, reactions to interest rate decisions by central banks, economic data or the American presidential election. In the long term, however, such “micro-developments” have little influence on the financial markets, says Marks. “Neither Donald Trump nor Kamala Harris will mean the end of American democracy or bring about the collapse of the US economy.” Consequently, in the long term, it is less important which of the two candidates becomes American president.

More important are the long-term growth rate of an economy and the financial situation of countries. Demographic development is also an important factor when it comes to deciding which country to invest in. “Although the USA is not doing particularly well in terms of debt and demographics, this does not disqualify it for investment,” says Marks. After all, the money has to be invested somewhere, and the situation in other countries is often no better. When it comes to companies, he looks at their competitive position in the market and their ability to hold their own in a difficult environment.

Falling interest rates drive up yields

However, a very important factor for the success of investors in recent decades is often underestimated: “Forty years of falling interest rates have driven up investors’ returns during this time,” says Marks. The falling interest rates over the years have had a similar effect to walking at a normal pace on one of the treadmills at the airport. The treadmill makes you move forward much faster.

Many investors now assumed that the returns on the financial markets supported by the interest rate cuts were the norm – that they could therefore count on this tailwind in the future. “This is because many of them have never experienced any other environment,” says Marks. He himself experienced having to pay an interest rate of 22.25 percent for a loan in the 1970s. Four decades later, however, he borrowed money at an interest rate of 2.25 percent, and the interest rate was even fixed for ten years. This cannot be repeated – with the result that investors have to adapt to a new environment.

Investing has become more difficult

The second half of the 20th century was the best 50 years in human history, says Marks. The period included the recovery after World War II, technological advances, strong productivity growth, positive demographic development and globalization. Despite the Cold War, there were no really bad wars during this time.

“We have a little less of all of this today,” says Marks. It can be assumed that growth rates in the industrialized countries will be somewhat lower than they were then. “If the second half of the 20th century was the best period ever, it can be assumed that things will get a little worse after that.”

He does not expect a period of very high inflation like in the 1970s. The oil crisis played an important role back then, and the central banks have made great progress in combating inflation in the meantime. However, Marks expects further “accidents” as a result of higher interest rates – in his view, the American commercial real estate market could still produce negative surprises, which could also affect some banks.

Things are getting more complicated for private equity

Some investment strategies may also have had their best days, says Marks. This applies, for example, to those that have particularly benefited from falling interest rates. Significantly, some investment strategies were only invented in an era of falling interest rates – such as private equity. The time was ideal for them. With private equity, an investor’s stake in a company cannot be traded on the stock exchange. Takeovers of companies (buyouts) are often financed with a high proportion of loans. This is easier when interest rates are low.

But that doesn’t mean that the private equity strategy will work in a different environment, says Marks. After all, loans have become more expensive and buyouts are becoming more difficult. In addition, private equity funds are sitting on large cash reserves. At a time when loans are more expensive and harder to obtain, it will be more difficult to invest the money. In addition, competition for potential takeovers will become tougher.

“The definition of insanity is doing the same thing over and over again and expecting different results”: This quote comes from Albert Einstein. “Similarly insanity is doing the same thing in a different environment and expecting the same result,” says Marks.

“Opportunities for bond investors are much greater”

Ultimately, from Marks’ point of view, there are only two major asset classes: property and borrowed money – for example stocks and bonds. After investors have made a lot of money with stocks for a long time, there is now a lot to suggest that bonds are attractive again. “The opportunities for investors with bonds are much greater today than they were three or even ten years ago,” says Marks.

In the period before the outbreak of the financial crisis in 2008, he himself had good experiences with an investment strategy in the bond market in which he invested equal amounts in US government bonds with a remaining term of one to six years. In his view, such a “staggered portfolio” made sense at the time because one sixth of the bond portfolio was always one year away from being repaid. The money released was then reinvested in US government bonds with a remaining term of six years.

Before the financial crisis, he achieved a return of around 6 percent with this strategy, says Marks. Three years ago, however, the same strategy only yielded 1.25 percent. Now it is back to around 4 percent.

Marks’ tip for Swiss investors

Swiss franc investors can of course only dream of such returns. From Marks’ point of view, however, Swiss investors have the opportunity to invest in US bonds and hope that the franc does not appreciate against the dollar. In recent decades, however, this has mostly been the case, especially in the longer term. This is due to the franc’s reputation as a safe haven.

Marks says he would not advise Swiss investors to invest a large portion of their assets in unhedged dollar investments. But one could make such a bet with part of the portfolio.