Chair Powell answers reporters' questions at the FOMC press conference on May 3, 2023. Federal Reserve Photo, Public Domain.
In his memo "Sea Change," Howard Marks argues that the investment world may be experiencing the third major sea change of the last 50 years. Reflecting on his long investment career, he cites the first sea change occurred in the early 1970s when the Bretton Woods system collapsed and the world moved to a floating exchange rate regime. The second sea change occurred in the early 1980s, when the Federal Reserve under Paul Volcker raised interest rates sharply to combat inflation.
Marks argues that the current sea change is being caused by a number of factors, including the spike in inflation, the war in Ukraine, and the Federal Reserve's response to these events. These factors have led to a reversal of the market conditions that prevailed after the Global Financial Crisis and for much of the last four decades.
In the past two decades, investors have enjoyed a period of low inflation, low interest rates, and strong economic growth. This has created an environment in which asset prices have risen sharply and borrowers have been able to access cheap and easy capital. However, Marks argues that this environment is coming to an end.
The Federal Reserve is raising interest rates in an effort to combat inflation. This is likely to lead to slower economic growth and higher borrowing costs for businesses and consumers. As a result, asset prices are likely to fall and borrowers will face more difficulty accessing capital.
Marks believes that this sea change will create opportunities for investors who are willing to take on risk. He argues that lenders and bargain hunters will be well-positioned to profit from the coming market volatility.
In the context of the small business world, these conclusions suggest that the steady and broad-based increase in business valuations is over. Going forward, this privilege will be reserved for those businesses with superior operations.
Sea Change, by Howard Marks (December 13, 2022)