Oaktree Capital’s Howard Marks is sending a warning to markets.
In his latest investing memo to clients, Marks — one of the most widely-read and respected investing pros out there — strikes an extremely cautious tone and recalls two memos he published in years most investors would like to forget: 2000 and 2007.
Those memos cautioned on the excesses of the tech boom and housing markets, respectively.
“Since I’m convinced ‘they’ are at it again — engaging in willing risk-taking, funding risky deals and creating risky market conditions — it’s time for yet another cautionary memo,” Marks writes.
“Too soon? I hope so; we’d rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains… Since we never know when risky behavior will bring on a market correction, I’m going to issue a warning today rather than wait until one is upon us.”
In his memo, Marks outlines what he calls the seeds for a boom, which include things like more money than ideas (the current bull market is often attributed to a surge in liquidity), willing suspension of disbelief among investors (“this time is different“), and pursuit of the new (think FAANG), among others.
And it is this final idea, and the FAANG stocks, that perhaps sends the clearest warning to investors that they ignore history — and fairly recent history at that — at their own peril.
“Bull markets are often markets by the anointment of a single group of stocks as ‘the greatest,’ and the attractive legend surrounding this group is among the factors that support the bull move,” Marks writes.
And this belief results in investors trusting that a virtuous cycle cannot be interrupted, that the fundamental merit of the “super stocks” justifies buying them at any price, and a suspension of disbelief that “allows investors to extrapolate these positive views to infinity.”
The FAANG stocks, including Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Google parent-company Alphabet (GOOGL) — which have also been modified to FAAMG to add Microsoft (MSFT) by some analysts — have have been powering markets higher through the first half of this year.
None of the FAANG stocks are up less than 20% year-top-date, with Amazon, Facebook, and Netflix each rallying more than 40% through Tuesday’s close.
Together, the FAAMG stocks are market’s five largest members by market cap, and are collectively worth almost $3 trillion. Netflix has a market cap of around $80 billion.
Each of these companies are ever-present in our modern lives and dominate the retail, advertising, mobile phone, media, and social networking spaces. As Marks notes, each of the companies has a great business model and “unchallenged leadership in their markets.”
“Most importantly,” Marks adds, “they’re viewed as having captured the future and thus as sure to be winners in the years to come.” And as we highlighted last week, analysts have made the case that strong earnings growth from this group of tech high-flyers makes this time actually different.
But so many decades of market history have seen a set of hot stocks — the Nifty-Fifty in the ’60s, oil stocks in the ’70s, tech stocks in the ’90s, banks in the ’00s — falter. The inevitability of their long-running dominance eventually came crashing down along with the stock prices.
Marks cites Jeff Bezos’ 1997 letter to Amazon shareholders, which noted the company’s important relationships with partners like America Online, Yahoo!, Excite, Netscape, GeoCities, AltaVista, @Home, and Prodigy.
Twenty years later, the world looks quite different.
So while no one denies that the FAANGs have been the market’s best performers, their current performance appears to on some level justify the fundamental case for these names, with little consideration of what the world would like if other companies came to the fore.
“Many of the most important considerations in investing are counterintuitive,” Marks writes.
“One of those is the ability to understand that no market, niche or group is likely to outperform the others forever. Given human nature, ‘the best’ will always come eventually to be overpriced, even for their stellar fundamentals. Thus even if the fundamentals hold up, the stocks’ performance from those too-high prices will become ordinary. And if they turn out not really to have been the best — or if their business falters — the combination of fundamental decline and multiple contraction can be really painful.
“I’m not saying the FAANGs aren’t great, or that they’ll suffer such a fate. Just that their elevated status today is a sign of the kind of investor optimism for which we must be on the lookout.”
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland
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