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Howard Marks, co-founder of Oaktree Capital Management, is renowned for his ability to communicate investment concepts with clarity and insightfulness in his periodic memos to clients (see archive at www.oaktreecapital.com).
Marks’ thoughts on investments were published in “The Most Important Thing: Uncommon Sense for the Thoughtful Investor.” It’s a terrific book I refer to often. Though Marks tackles weighty investment topics and concepts, his presentation is one of everyday common sense, not complex or abstract theories.
Marks’ most recent memo, “The Role of Confidence,” is particularly timely.
“I have long been impressed by the role of confidence in an economy,” he wrote. “In fact, I’ve written in the past—exaggerating only slightly—that sometimes I think confidence is all that matters. I consider its impact to be significant, pervasive, self-reinforcing and self-fulfilling.”
The primary impact of confidence on the economy is simple. If people think the economic future will be good, they’ll spend and invest. Thus, things will be good.
• Consumer optimism translates into incremental demand for goods, adding to GDP.
• Consumer buying persuades businesses to invest in facilities and additional workers in order to keep demand growing.
• Businesses’ investment in plants and workers will add to GDP.
• Newly hired workers will have money to spend, and their buying will add further to the cycle.
• The reports of confidence-fueled increases in GDP and other positive mentions of the economy in the media will reinforce this virtuous circle of optimism.
“So, just like the wealth effect, increased confidence makes people and businesses spend more, and this in turn cycles back into the economy,” Marks wrote in his memo. “Confidence leads to spending; spending strengthens the economy; and economic strength buttresses confidence. It’s a circular, self-fulfilling prophecy.”
Marks also noted that confidence tends to swing like a pendulum between optimism and pessimism. At the optimistic extreme, only good outcomes are possible and there is nothing but blue sky ahead. At the negative extreme, only bad outcomes are possible and doom and gloom are pervasive. In addition, both optimism and pessimism can be self-fulfilling as positive and negative feedback loops push the pendulum in one direction or the other.
Five years ago, the pendulum had swung to a pessimistic extreme. Armageddon was at our doorstep.
The pendulum has gradually swung back toward “normal.” Surveys indicate private-sector business leaders’ optimism is increasing. Similarly, consumer confidence is growing. U.S. household net worth has reached an all-time high as stock and housing prices have gained.
At the same time, the U.S. household debt service burden has reached an all-time low as Americans paid down debt and took advantage of historically low borrowing rates. Finally, gasoline prices have dropped sharply. AAA reports the national average for regular is $3.39 per gallon, down 39 cents per gallon from a year ago.
Rebuilding confidence has been a long and difficult journey. Let’s hope the latest Washington budget/debt ceiling follies don’t derail it.•
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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or mickey@kirrmar.com.
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