Stock-market investors may be setting themselves up for disappointment — and losses — by engaging in “Goldilocks thinking” on the economy, legendary investor Howard Marks warned Tuesday in his latest memo.
Marks, the billionaire co-founder of distressed-securities juggernaut Oaktree Capital Management, boiled down his assessment of the current market consensus in five bullet points:
- Inflation is moving in the right direction and will soon reach the Fed’s target of roughly 2%.
- As a consequence, additional rate increases won’t be necessary.
- As a further consequence, we’ll have a soft landing marked by a minor recession or none at all.
- Thus, the Fed will be able to take rates back down.
- This will be good for the economy and the stock market.
“Before going further, I want to note that, to me, these five bullet points smack of ‘Goldilocks thinking’: the economy won’t be hot enough to raise inflation or cold enough to bring on an economic slowdown,” Marks said.
Read the whole memo here.
It’s a fairy tale that Marks, 77, said has played out a few times over the course of his career, and that it rarely prevailed for long.
“Something usually fails to operate as hoped, and the economy moves away from perfection. One important effect of Goldilocks thinking is that it creates high expectations among investors and thus room for potential disappointment (and losses),” he wrote.
In One Chart: Why stock-market bulls should be careful what they wish for on Fed rate cuts
Stocks staged a strong rally into the end of last year, with the Dow Jones Industrial Average
DJIA
scoring a number of record closes, while the S&P 500
SPX
saw a total return of more than 26% and ended the year just 0.5% away from its Jan. 3, 2022, record finish. Stocks have pulled back modestly to begin the new year.
The 2023 rally accelerated as investors priced in a Fed policy pivot to lower interest rates. Rates traders have scaled back expectations for cuts in 2024, but fed-funds futures still reflect a 53.8% probability the fed-funds rate will fall 150 basis points or more by December, according to the CME FedWatch tool.
Benchmark 10-year Treasury yields
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that finance much of the U.S. economy also retreated, edging back to about 4% on Tuesday from a peak of nearly 5% in October.
Marks has previously described a generational “sea change” in financial markets, with rates rising from near-zero levels and investors no longer reliant on stocks and riskier investments to achieve their overall return targets.
Marks, in Tuesday’s memo, said he doesn’t have an opinion as to whether the Goldilocks consensus he described is correct. But even if it is, he’s sticking with his expectation that rates will remain in the 2% to 4% range, as opposed to 0% to 2%, over the next few years.
“My guess — and that’s all it is — is that the fed-funds rate will average between 3% and 3.5% over the next 5-10 years,” he said. “If you think I’m wrong, ask yourself whether you’d put your money on a different half-point range.”
