Howard Marx, chairman of Oak Capital, released his latest memo on March 17, entitled "looking back to 2020", but he spent a lot of time on his judgment of 2021. On the whole, Howard believes that positive factors are playing a role, such as the introduction of vaccines and the Fed's loose monetary policy, but there is also a risk that cannot be ignored, that is, the rise in interest rates if inflation rises. Can the Fed keep interest rates low?

But for the market debate about the U. S. stock bubble, Howard believes that it has not reached the crazy stage, and is still within a reasonable range. Maybe we should go back to our pre-epidemic slogan: move on, but be cautious, says Mr Howard.

"although great changes have taken place in 2020, the investment truth has not changed: there is no magical way for investors to safely and reliably get high returns, especially in today's low-return world," Howard said.

The following is an excerpt of the highlights of the memo:

Looking back on 2020

The opening remarks of Charles Dickens'A Tale of two cities (A Tale of Two Cities) are well suited to sum up 2020: this is the best of times and the worst of times. This is the season of light, this is the season of darkness, this is the spring of hope, this is the winter of despair.

We can make a list of rare events that happened in 2020:

• COVID-19 epidemic is the most serious global epidemic in more than a century.

• 340000 people in the United States died from the COVID-19 epidemic, equivalent to 85 percent of the people who died in World War II.

• In the second quarter of 2020, the United States experienced the worst quarterly decline in GDP in 74 years, or an average annual decline of 32.9 percent.

• But in the third quarter, quarterly GDP earnings in the United States hit an all-time high of 33.4%.

• The number of first-time jobless claims climbed from 251000 to nearly 3 million in a week and reached 6.2 million two weeks later.

• Through bond purchases, the Fed's portfolio increased by $2.7 trillion, or about 55 per cent, and the US Treasury provided about $4,000bn in grants and loans.

• After hitting an all-time high of 3386 on Feb. 19, the s & p fell 33.9% in just 32 days to 2237 on march 23.

• But from that low, the s & p 500 has returned to its previous high (up 51.5%) in less than five months. By the end of 2020, the index had risen 67.9% from its low and 18.4% for the whole year.

• Unlike the credit crunch that accompanied many crises in the past, we have seen a huge amount of liquidity release. High-yield bond issuance in 2020 was $450 billion, up 57% from 2019 and well above the record set in 2013. Investment-grade bond issuance totaled $1.9 trillion, up 58% from 2019 and surpassing the record set in 2017.

• After the fed lowered its target for the federal funds rate to 0-0.25%, bond prices began to rise and bond yields began to fall. By the end of 2020, the average yield on class A bonds was only 1.52 per cent, while the average yield on high-yield bonds (such as energy) was slightly less than 4 per cent.

To sum up, in 2020, we encountered a global epidemic crisis, with large amounts of liquidity released by major countries, strong performance in the stock and bond markets, and the upward trend in the stock and bond markets may be explained by aggressive monetary policy.

As the listed events show, the buying opportunity in 2020 is very short, in just a few months:

• Investors are full of confidence in the economic recovery

• People are optimistic about the development of Covid-19 vaccine.

• Interest rates close to zero have lowered the expected rate of return in the entire capital market.

• The risk tolerance of the market has been restored, and people are worried that they will miss a good opportunity and begin to enter the market again.

• The price of capital rose and the market rebounded.

• Therefore, we failed to seize this short-term buying opportunity.

Due to the crisis of the COVID-19 epidemic, the economies of various countries quickly fell into a shutdown, and the capital market also fell sharply. When people considered how to deal with this huge crisis, only a month later, the market began to rise rapidly. I think very few people would do both at the same time.

Judgment on 2021

Recently, the market may be at a critical moment, and there are different views on market trends, so I will focus on my views on 2021. Therefore, you might think that the title of this memo should be "looking forward to 2021" rather than "looking back to 2020".

In fact, most of the macro forecasts turned out to be wrong in the end, because most of them are an induction and inference of the current situation and recent trends. Although the "keep the same" forecast is usually correct (because of the principle of inertia), this judgment contributes little to profits, and high returns can only be achieved by forecasts with significant deviations from trends. However, the probability of major deviation from the macro environment is very small, and it is even more difficult to make correct predictions.

At this point, experts are highly divided about the outlook for the US market, with both bullish and bearish views.

Most importantly, the Fed announced that it would maintain a loose monetary policy, which will keep the US economy sound for some time to come. With the introduction of the vaccine, the United States will emerge from the impact of the epidemic more quickly.

Consumer disposable income is also rising because we will not be able to spend holidays, travel, eat out, listen to concerts and see performances in 2020, and therefore do not buy clothes for special occasions. Harvard economist Jason Furman estimates that about $1.8 trillion in additional disposable personal income has been generated since the outbreak began. Finally, coupled with the rise of the stock market and the appreciation of housing, people's wealth has been greatly accumulated.

This additional disposable income, combined with pent-up demand, is likely to boost the short-term economic recovery. Many economists expect GDP growth in the United States to be well above average this year, and as it is likely to be slow in the first few months, that means significant growth later in the year. Morgan Stanley (Morgan Stanley), for example, predicts that the annualized GDP in the fourth quarter of 2021 will be 7.6 per cent higher than that in the fourth quarter of 2020.

The Fed has promised to keep interest rates low for years to come and continue to buy bonds to boost economic growth. But one factor to consider is that, in general, the market will rise strongly in the years after the economy strengthens. But this time, we saw the full reflection of asset prices in the early stages of the economic recovery, which is a source of risk. But on the other hand, it also confirms that the economy may grow strongly in the coming years.

Finally, there is a positive factor, that is, the uncertainty in American politics has decreased, the probability of extreme events has decreased, and I don't think it is possible to enact a radical bill.

The biggest risk is the rise in interest rates, which have been falling steadily over the past 40 years, which is a major boon for investors, as the environment of falling interest rates reduces the return on demand for assets, leading to higher asset prices. So if interest rates go up, it could lead to a fall in asset prices. (note that the yield on the latest 10-year Treasury note was 1.40%, up from 0.52% in August 2020 and 0.93% in the previous period. )

The Fed says interest rates will remain low for the next few years, but I think it is difficult to achieve that goal. Because the Fed can keep interest rates artificially low forever? How to deal with inflation? Can ten-year treasury bonds maintain a yield of 1.40% if inflation reaches 3%? Will people buy it with negative real returns? Or will prices fall to generate more revenue?

On Feb. 7, Federal Reserve chairwoman Janet Yellen answered questions about the inflation risks posed by the Covid-19 bailout package and discussed the importance of providing relief to suffering Americans. She also made it clear that providing too much relief is better than reducing too much relief. Even so, this does not mean that more relief is better, or that there are no risks.

Some people question this view, economist Larry Summers (Larry Summers) wrote in the February 4 issue of the Washington Post:

…… Despite the great uncertainty, the scale of macroeconomic stimulus is closer to the level of World War II than a normal recession, and could trigger inflationary pressures that our generation has never seen before. which has an impact on the value of the dollar. It will also affect financial stability.

Generally speaking, the influx of liquidity into the economy will raise the rate of inflation, but the Fed says that will not happen. Of course, while central banks may want to see inflation rise (because it makes it cheaper to pay down debt), they have to dissuade such talk for fear of exacerbating inflation expectations. On the other hand, since 2008, we have had a large deficit and loose monetary policy, and have not generated serious inflation. We have seen unemployment at its lowest level in 50 years, but the inflation predicted by the Phillips curve has not yet been reached. Japan and Europe have been trying for years to raise inflation by 2%, but without success. Will inflation soon become a threat? The answer is clear: who knows?

In addition to these major risks, there are other factors that should also be paid attention to (although small, but imminent):

• The effectiveness of the vaccine, if the vaccination speed is not as expected, may delay the time for the economy to return to normal.

• The release of a large amount of liquidity may cause investors to pursue higher returns and replace risk aversion with risk tolerance. There used to be excessive optimism and complacency in the stock and bond markets:

• The strong performance of speculative securities

• Bond trading is hot and bond yields are low.

• Buffett's index (the ratio of total stock market capitalization to GDP) is well above its previous high.

• A large number of IPO shares, including IPO of unprofitable companies, rose dozens or 100 percent on the first day.

• Since many investors have been unable to make good returns on stocks and bonds over the past 20 years, they have flocked to alternative asset investments, which complicates their lives.

• Unemployment may not fall any time soon, and economic growth may not necessarily rise rapidly.

• The relationship between the United States and China is likely to continue to become tricky, and globalization may be weaker than in the past.

• Social and political differences in the United States are unlikely to be resolved in the short term, and the United States may not easily solve the problem of inequality.

• In addition, there are two long-term concerns, which seem to be far away in theory, but I think they are important:

• Can the Fed really add trillions of dollars to its balance sheet without having a negative impact, such as a depreciation of the dollar? If the dollar does not perform well, will it maintain its status as the world's reserve currency and maintain the ability of the United States to borrow unlimited funds to cover its deficit? What happens if the answer to the last question is no?

• For those who have lost their jobs as a result of technological change, how can we provide jobs for them? What will happen to some areas without high-tech enterprises?

Finally, bubbles are thought to be related to valuations, such as the S & P 500 being expensive compared to historical averages. But the judgment based on historical averages is too simple. We also need to consider interest rates, the development of high-tech companies, index composition and economic prospects. With these factors in mind, I don't think most asset valuations today are bubbles.

In many ways, we will return to the investment environment we faced in the years leading up to 2020: an uncertain world that provides the lowest expected returns we have ever seen. Maybe we should adopt Oak's strategy before the outbreak: move on, but be careful.

There have been several times in my career that I have found the logic of calling it the top (or bottom) compelling and highly likely to succeed. But this is not one of them. To draw a conclusion, I would like to briefly summarize the positive and negative factors:

• The economic outlook is optimistic.

• The Fed will keep interest rates low for years. However, due to extremely loose fiscal and monetary policies, interest rates are already rising and are vulnerable to rising inflation.

• Although there are still high unemployment and deficits, inflation remains low, although it is uncertain whether it will remain low.

• As the temperature of the market rises, investors begin to take risks.

• Although valuations are high, low interest rates make high valuations seem reasonable.

• Radicals are less likely to legislate.

• President Biden is seeking broader harmony, but tensions with China and Iran remain noteworthy.

I think the prices of most assets are in a gray area-not low, not unreasonably high, more within the normal range.

The bottom line is: should investors be more active or cautious? Although the income and risk are balanced after risk adjustment, the level of absolute return is still very low. All in all, I think now may not be the time to actively pursue returns. And because interest rates are likely to rise, we should be more cautious.

The main risk is rising inflation and the consequent rise in interest rates, so I think the portfolio must consider several factors: we should be cautious about bonds over 10 years old; bonds that benefit from inflation may be a better choice, such as floating rate bonds. In the real estate and stock markets, the better choice is those companies that have the ability to raise prices or increase their income rapidly.

In this environment to find investment targets, the scope of choice is very small. Because investors had previously focused on "beta", but because of the decline in interest rates, this part of the expected return has fallen. This means that to be as good as before, investors need to take more risks and have enough luck.

Some institutions suffered a lot during the global financial crisis of 2008-2009. Fund managers can not get good returns when there is lack of liquidity. For fund companies, it is necessary to correctly evaluate the viability of fund managers. When liquidity shrinks, some fund managers who are good at choosing alpha returns have better risk resistance, but investors may not be able to get better returns by relying solely on positive alpha.

Although the great changes in economy, market and policy in 2020 have had an impact on our way of life. However, the investment truth remains the same: there is no magic way for investors to get high returns safely and reliably, especially in today's low-return world.

Howard, Max.

Written on March 4, 2021