That’s what I think happened to investors over the last 40 years. They enjoyed the growth of the economy and the companies they invested in, as well as the resulting increase in the value of their ownership stakes. But in addition, they were on a moving walkway, carried along by declining interest rates. The results have been great, but I doubt many people fully understand where they came from. It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades.
These are the reasons why I believe that the base interest rate over the next several years is more likely to average 2-4% (i.e., not far from where it is now) than 0-2%. Of course, there are counterarguments. But, for me, the bottom line is that highly stimulative rates are likely not in the cards for the next several years, barring a serious recession from which we need rescuing (and that would have ramifications of its own). But I assure you Oaktree isn’t going to bet money on that belief.
What we do know is that inflation and interest rates are higher today than they’ve been for 40 and 13 years, respectively. No one knows how long the items in the right-hand column above will continue to accurately describe the environment. They’ll be influenced by economic growth, inflation, and interest rates, as well as exogenous events, all of which are unpredictable. Regardless, I think things will generally be less rosy in the years immediately ahead:
Howard Marks
Interesting analysis of the macroeconomic environment from an investment perspective. Recently, inflationary pressures have subsided considerably: China has relaxed its zero-COVID policy, easing supply chain bottlenecks in the US in particular, while the warm winter and measures to rationalize energy use have brought natural gas prices in Europe down to 2021 levels without affecting industrial output.
Nevertheless, a number of structural factors remain that will probably induce higher inflation rates in the medium term. The US job market continues to be tight with record low unemployment – a consequence of the workforce lost to the pandemic and the minuscule levels of immigration over the past years (the layoffs in tech may further restrict the supply of human capital, as employees on temporary visas could be forced to leave the US if they can’t find new employment). In Europe, the energy worst case scenario may still materialize over the next winter, if temperatures drop considerably and other countries start competing more aggressively for LNG supplies, especially China, driving availability down and prices back up.
The much-touted, but yet elusive, decoupling from Chinese manufacturing can become a further source of inflationary pressure, just as outsourcing these jobs in the first place kept prices down – and interest rates alongside them – for decades. Even if jobs are shifted out of China to locations with lower wages, companies will need to invest large amounts upfront in building manufacturing facilities, hiring and training a new workforce, and reorganizing supply chains, costs which will inevitably trickle down into higher consumer prices. The same applies to moving away from fossil fuels infrastructure to carbon-neutral energy sources, and to initiatives for ‘near-shoring’ and improving the resilience of supply chains, a pressing topic in the aftermath of the pandemic.
Moderately high interest rates – compared to the past decade at least – could have their silver lining though, if they encourage more prudent investment decisions. Access to cheap capital makes it a little too easy to pour money into poorly formed business ideas and delay profitability by repeatedly borrowing at near-zero interest rates. This new environment has already chilled the IPO market in the US in 2022, so hopefully we’ll see founders with actual business plans instead of cool ideas who wouldn’t succeed in a competitive setting.
Post a Comment