Howard Marks, one of the world’s most respected investors and founder of global investment management firm Oaktree Capital, believes he is currently witnessing the third “sea-change” in his five-decade career, with higher interest rates and inflation and risk aversion as the new investing theme. 

In his latest memo to clients, Marks wrote, “Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets.”  

Marks recalls two previous “sea changes” in the financial markets. The first was the onset of high-yield bond investing in the 1970s, which allowed the growth of leveraged buyouts and eventually the private equity industry. This led to an important shift in investor mentality which went from risk aversion to risk/return.    

The second change took place during the era of former Federal Reserve Chairman Paul Volcker. In his effort to squash the decade-long double-digit inflation environment, Volcker ushered in the era of lower interest rates that lasted nearly four decades.    

The low interest rate environment gave rise to “the rebirth of optimism among investors, the pursuit of profit through aggressive investment vehicles, and an incredible four decades for the stock market,” noted Marks in his memo.  

Marks now believes the macroeconomic policy response from government and central banks has brought about a new “sea-change.” Marks believes that investors’ hope of the Fed returning to ultra-easy monetary policy witnessed during 2009-2020 is very unlikely as inflation is likely to be more persistent.  

Marks contends that the Fed needs to see inflation revert to its 2% target and extinguish the inflationary psychology, requiring real interest rates (nominal interest rates minus inflation) to be positive.  

“These are the reasons why I believe that the base interest rate over the next several years is more likely to average 2%-4% than 0%-2%,” Marks argued.  

Marks concluded that given the current environment the credit markets should offer a decent return in the years ahead. 

Pictured: Oaktree Capital founder Howard Marks