The longest US expansion on record: when will it end?
The US economy and stock market have delivered record-breaking sustained growth. Veteran investor Howard Marks discusses his theory of cycles and what he believes lies ahead
Known as “Wall Street’s favourite guru”, Howard Marks is one of the world’s most followed investors and market commentators.
He has written several bestselling books and his regular “memos” – informal letters to clients of Oaktree Capital, the firm he co-founded in 1995 – are widely read and discussed. Oaktree’s investment process, which has been highly successful, rests upon an analysis of economic cycles.
Earlier this year Marks, 73, addressed staff and guests at Cazenove Capital’s London offices. He spoke about where he believes we are in the current cycle… and what might be coming next.
“A regulation game of baseball has nine innings. So when I say we’re in the eighth inning, it suggests we’re close to the end.
And when you go to a baseball game, and you get to the eighth inning – you start packing up and maybe even heading to the exit. But investment is not baseball.
There is no regulation number of innings. This game could go to nine innings, or 11, or 14. The eighth inning doesn’t mean it’s about to end.
We are in the second half of the tenth year of an economic recovery. There’s never been an economic recovery in the US that went on for more than ten years.
That doesn’t mean that on the tenth anniversary some gate comes down and economic progress ends – it only means that when you’re here, the probability of continuation declines.
I’ll bet that this is going to end up being the longest economic recovery in history: we will not have a recession this year, and this recovery will go into the 11th and maybe the 12th year.
That’s positive for the short term, but there are some limitations. A year or two from now those limitations on the length of the recovery may come into play. Why do we have cycles?
The US economy, in terms of GDP, grows a little more than 2% per year on average. Why doesn’t it always grow at 2% per year?
Why sometimes 3%, and sometimes 1%? Why is growth sometimes negative? Why not just 2% every year?
The answer is that we have this 2% trend line – but what is an economy, and indeed what is a stock market, other than a bunch of people?
People do not behave like machines. Their behaviour is driven by psychology and emotion.
The great American physicist Richard Feynman once said that physics would be much harder if electrons had feelings. The point is that markets and economies are made up of people, and people have feelings – and they don’t always do what they are supposed to do.
If the economy performs well for a while, the mood becomes positive.
The people who run companies say: “We’re in a boom – let’s build a new company, let’s hire some more workers; let’s produce some more inventory so we’ll be able to meet the demand.”
The problem is that if many of them reach the same conclusion, they all build factories, hire workers and grow inventory – and that becomes a period of divergence from the 2% trend. That’s an above-average growth period.
Then perhaps it turns out that the demand is not there for all of that increased production, and so they shut some factories, lay off workers and sell down inventory rather than produce more – and that results in a correction in GDP. And this is why we have cycles.
In this economic cycle I don’t believe we have had many excesses to the upside – which is why it’s been the slowest recovery since the Second World War. The slow pace of this recovery has a bearing on its continuability.
Other factors, including uncertainties caused by technology and disruption, I think have discouraged excesses on the upside.
And I believe that means we don’t have as much need for an economic correction on the downside.
So we have an economy that’s likely to go on a little longer, to be followed by a recession which I think is not likely to be a very difficult one.
And the markets?
In terms of the market, we are in by some measure the longest bull market in history in terms of US stocks.
That’s not to say it’s not going to go higher – it’s merely to say I think the easy money’s been made – and the big money. And going on from here, when the market is no longer cheap and the economic cycle is old, becomes more challenging.
Record run: US shares over the past three decades
S&P 500, 30 years to June 2019
Source: Thomson Reuters
I want to touch on the psychological cycle. The good news is that this upcycle in the market has not been borne aloft by buoyant psychology. I don’t see euphoria out there – and euphoria is the investor's enemy.
When there is euphoria there is an excess of optimism factored into asset prices, and they’re dangerous. The S&P for example is not priced excessively relative to history.
The issue, however, is that interest rates being so low has forced people away from safe, low-yielding assets into more potentially profitable risk assets, and that has pushed capital up the risk curve and made people engage in what I call “pro-risk behaviour”.
So even though people’s thinking has not been bullish, they have been acting in a bullish way – and that makes the marketplace a riskier environment for us all."