[Music] this is the memo by Howard Marx Nobody knows Yet [Music] again on Friday September 15th 2008 shortly after the close of the New York Stock Exchange Lehman Brothers surprised the world by filing for bankruptcy This came on the heels of rescues/bankruptcies of Bear Sterns and Meil Lynch and was followed quite soon by more of the same at Wakovia Washington Mutual and AIG Market participants quickly concluded that the US financial sector was on the verge of melting down It had become patently obvious unlike a few days earlier that financial institutions might fall like dominoes due to the combination of A financial deregulation B a manic housing boom C unwise mortgage lending D the structuring of mortgages into thousands of tranched securities that were rated too high e investment in these securities on the part of highly levered banks and F counterparty risk resulting from the banks interconnectedness Reflecting this fear the markets embarked on what felt like a downward spiral without end I thought I should comment on these developments and the outlook and the result was a memo called Nobody Knows published 4 days later I affirmed my ignorance of the future as usual but to an even greater degree given that all prior expectations had been upended Nobody knew especially me whether the spiral could be arrested Nevertheless I concluded that we had to assume it would and thus that we should plow money into financial assets at their highly discounted prices There was nothing anyone could say they knew and that included me I was limited to gaming out my conclusions which were as follows We can't confidently predict the end of the world We'd have no idea what to do if we knew the world would end The things we'd do to gird for the end of the world would be disastrous if it didn't end And most of the time the world doesn't end Clearly I didn't base these conclusions on knowledge of the future But I saw no logical choice other than to start putting money to work including the 10 billion that was sitting uninvested in opportunities fund 7B We had formed that fund to prepare for an elevated opportunity in distressed debt How could we not follow through when one arrived especially given the bargains and the extraordinary yields available on some of the highest quality debt we'd ever been able to buy in distress And yet we admittedly had no idea what the future would bring I can't claim to have analyzed the future In fact I consider the phrase analyze the future one of the great oxymorons The future has not yet been created and it's subject to millions of complex unquantifiable and unknowable factors that will always be in flux You can ponder the future and speculate about it but there's nothing to analyze and certainly there wasn't in the early days of the global financial crisis In March 2020 I reused the title of the 2008 memo for nobody knows two my first memo during the CO 19 pandemic In it I cited Harvard epidemiologist Mark Lipuch who said "We usually make decisions on the basis of a facts b informed extrapolations from analogous experiences and c opinion or speculation." But since there were no applicable facts regarding a COVID pandemic and no analogous experiences we were left with only speculation I want to say right here about 2008 and the other crises I've invested through as well as today that I don't reach my conclusions with confidence or act without trepidation There's absolutely no place for certainty in the world of investing and that's particularly true at turning points and during upheavalss I'm never sure my answers are right But if I can reason out what's most logical I feel I have to move in that direction The uncertain outlook [Music] In my February memo 2024 in review which went only to clients I said the word to describe the Trump administration was uncertainty President Trump's thinking seems less predictable than that of most presidents largely because it doesn't necessarily hue to a consistent ideology and it's very much subject to being applied and revised tactically It should be noted however that Trump has complained about how the US is treated in world trade and argued in support of tariffs since at least 1987 Having said that and even though we knew he was going to hike tariffs no one anticipated the magnitude of the increases Clearly the markets hadn't Last week's events remind us of the events of 2008 and the global financial crisis they produced All norms have been overthrown The way world trade has operated for the last 80 years may be of little relevance to the future The impact on economies and the world at large is entirely unpredictable We're faced with largecale decisions Yet again there are no facts or prior experiences on which to base those decisions Truly nobody knows And a lot of this memo will be about things we can't know for sure But I hope it'll help you organize and evaluate the issues I want to point out that there are no experts on the subject at hand Economists have analytical tools and theories to apply but no economist and no tool will produce a conclusion in this instance that we can follow with confidence There have been no largecale trade wars in the modern era Thus the theories are untested Investors business people academics and government leaders will all give advice but none of them is much more likely to be right than the average intelligent observer The things on which everyone will agree are obvious such as the likelihood of higher prices The less obvious truths will be harder to discern One of the things I insist on is that even for someone who deals with the future via forecasts a forecast isn't enough In addition to a forecast you also need a good sense for the probability your forecast is correct Since not all forecasts are created equal in this case under these circumstances it must be accepted that forecasts are even less likely to prove correct than usual Why primarily because of the vast number of unprecedented unknowns involved in the current matter which has the potential to turn into the biggest economic development in our lifetimes There's no such thing as fornowledge here just complexity and uncertainty And we must accept that as true This means that if we insist on achieving certainty or even confidence as a precondition for action we'll be frozen into inaction Or I dare say if we conclude we've reached decisions with certainty or confidence we'll probably be mistaken We must make our decisions in the absence of those things But we also have to bear in mind that deciding not to act isn't the opposite of acting It's an act in itself The decision to not act to leave a portfolio unchanged should be scrutinized as critically as a decision to make changes the old saws that are the refuge of terrified investors We're not going to try to catch a falling knife and we should wait for the dust to settle and the uncertainty to be resolved cannot in themselves be allowed to determine our behavior I love the title of a book by a market analyst named Walter Demer When the time comes to buy you won't want to The negative developments that make for the greatest price declines are terrifying and they discourage buying But when unfavorable developments are raining down that's often the best time to step up Lastly given Trump's tactical focus it's important to bear in mind that absolutely everything is subject to change It shouldn't surprise anyone if he extracts concessions and declares victory or if he responds to other count's retaliation by escalating further Thus I told a Wharton conference on Friday that if anyone thinks they know what a given tariff rate will be 3 months from now I'll bet good money they're wrong even without knowing what they think the answer is Tariffs [Music] What are President Trump's reasons for enacting his tariffs and are they valid on the day of the announcement I heard a commentator on television credit Trump's impulses as having some justification What are his goals they include some or all of the following Support US manufacturing Encourage exports Discourage imports Shrink or eliminate our trade deficit Make supply chains more secure through onshoring deter unfair trade practices aimed at the US Force other countries to the negotiating table generate revenue for the US Treasury It must be acknowledged that every one of these things is desirable in itself and a logical result of tariffs If only it were that easy The problem is that in the real world and especially in economics there are second and third order consequences that must be considered If there weren't economics would be dependable like the physical sciences As in if you do A then B happens As theoretical physicist Richard Fineman said imagine how much harder physics would be if electrons had feelings Well economies and markets are made up almost entirely of people and people do have feelings rendering reactions unpredictable In economics others will react to action A as well as to result B that action A produces And we have to think about the effect of those reactions Not only are repercussions often significant but they're also unpredictable Further politics plays a particularly important and unpredictable role in the matter at hand with a calculus all its own What are some of the likely consequences of Trump's tariffs the list is long and many are particularly serious Retaliation by other countries price increases and rising inflation destruction of demand due to price increases and declining consumer confidence recession and lost jobs both in the US and around the world Supply shortages a massive change in the world order There are many threads to follow and if I try to do them all justice we'll be here forever I'll just touch on a few Some countries will negotiate After all in most cases to borrow Trump's terminology the US is holding the best cards but others won't Perhaps because their leaders will insist on looking strong leading to escalation Higher reciprocal tariffs are unlikely to accomplish anything positive on balance and will probably make life worse for both parties It will be of scant satisfaction if the incremental problems we encounter are less bad than those befalling other nations There is little doubt that the tariffs will raise prices Tariffs are taxes on imports and someone has to pay them This is true in the case of goods brought in from abroad as well as goods made in the US that incorporate imported materials or components This means the effect will be widespread While it's the importer who pays the tariff at the border the cost is usually passed on to the ultimate purchaser of the goods the consumer In theory the manufacturer exporter exporting country or importer can choose to absorb the tax to preserve their business but they won't be eager to cut into their profits to do so And in many cases their profit margins aren't high enough to allow them to do so Note that in my March 2022 memo the pendulum in international affairs I observed that between 1995 and 2020 US consumer durable prices declined by 40% in real terms and total inflation averaged only 1.8% per year Consumer durables consist mostly of vehicles appliances and electronics And a big percentage of these have been imported What would inflation have been if lowcost imports were discouraged or precluded but let's assume the first three goals just listed are actually achieved causing more of the goods purchased in the US to be made in the US First in most cases there isn't sufficient manufacturing capacity that can be switched on For example I doubt there's a factory in the US capable of producing flat screens for TVs or computers It would take years to build enough capacity to satisfy a meaningful percentage of US demand Meaning in the interim there would be shortages and/or selling prices would likely be at the old levels plus the tariffs Second the new factories designed to bring back manufacturing jobs would take years to permit and build and the cost of construction would have to be justified by an expectation of profits many years out in the future This adds further complexity to decisions that had already been made challenging by uncertainty regarding future developments in automation and AI Are CEOs likely to commit to those investments based on tariffs that might be subject to renegotiation or discontinuation when a new administration takes office bear in mind that Trump's 25% tariff on Mexican and Canadian goods replaced the United States Mexico Canada agreement he negotiated during his first term and that went into effect in 2020 which in turn replaced NAFTA which was enacted in 1994 Third there probably aren't enough skilled workers available in the US to take the place of all those in China and the developing world who presently make goods for us Fourth why have Americans been buying imports in the first place because they're cheaper Why did the US lose the jobs it lost because American workers were paid more than workers elsewhere for the same job but US products weren't good enough to justify higher selling prices That's why the US went from importing 330 Volkswagens in 1950 to more than 400,000 in 2012 It wasn't that US tariffs were too low The simple truth is that foreign goods often cost less than comparable goods made in the US Even if tariffs are set high enough in the future to render US-made goods cheaper than imports come tariffs the prices will be higher in the absolute than Americans are used to paying This morning for example it was mentioned on TV that a smartphone made in the US might cost $3,500 Since most Americans have little income left over after paying for necessities the result of higher prices is likely to be declining standards of living That's true unless wages rise as fast as prices But in that unlikely case we're talking about a dangerous inflationary spiral Higher prices are likely to result in lower unit sales and thus in declining profit margins My favorite economist there's an oxymoron for you Conrad Deu Cuadros of Breen Capital considers corporate profit margins to be the best leading indicator of recessions When margins come under pressure corporations stop making new investments and engage in layoffs and other forms of cost cutting often bringing on economic downturns Economics is the science of choices and is fraught with trade-offs That's certainly true in the area of trade and tariffs For example it's widely reported these days I have no idea how reliably that when tariffs were imposed on imported steel in 2018 1,000 jobs were saved in the US steel industry But 75,000 jobs were lost or potential new employees weren't hired in US steel using industries How will these choices be made similarly as I wrote in the memo Economic Reality in May 2016 how will the interests of the 3.2 million Americans estimated to have lost their manufacturing jobs to China be balanced against the hundreds of millions who would have to pay considerably more for imported goods not an easy question In all spheres of economic activity the more uncertain people feel the more reticent they are to bear risk In the less certain world we may be facing people are likely to be loathed to make decisions and enter into agreements and they'll probably offer to pay less for a unit of profit potential John Maynard Kanes described economic activity as being fed by animal spirits which he described as a spontaneous urge to action rather than inaction and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities Per Wikipedia the usual source of this urge is optimism perhaps as reflected in consumer confidence What will be the source of positive animal spirits in the environment that lies ahead the international picture The impact of the developments on tariffs extends importantly to the international arena and goes well beyond economics Global trade has had an enormous beneficial effect on the entire world since the end of World War II Along with expenditures to rebuild after the war technological and managerial progress improvements in infrastructure and the expansion of capital markets globalization contributed to a rising economic tide that truly lifted all boats Some countries and some people did better than others of course but virtually everyone was better off I believe it was because of this among other things that we've generally enjoyed peace and prosperity for the last 80 years As a result we've been privileged to live in the best period in history The main benefit from globalization is called comparative advantage Every country has some things it produces better andor cheaper and others where the reverse is true If every country makes the former products and sells them to the rest of the world and buys the latter products from other countries collective welfare is maximized thanks to increased overall efficiency As I said on Bloomberg TV on Friday we're all better off because Italy makes the pasta and Switzerland makes the watches But if trade barriers were to require Italy to make its own watches and Switzerland to make its own pasta the citizens in both countries would probably end up paying more for products they used to buy cheaper from abroad or consuming inferior products made locally or both US citizens in particular have benefited massively from the fact that most things can be made more cheaply in other countries and especially developing nations because wages are lower This has cost the US a few million jobs but it has also allowed virtually all Americans to live much better than they would have if they had been limited to buying US-made goods That's the simple reason why most of the non-food merchandise at Walmart is imported To cite one more factor that has made the world a better place I describe the behavior of the US in the postw World War II period as generosity toward the rest of the world stemming from enlightened self-interest Under the Marshall Plan we gave not loaned billions of dollars with which Western Europe rebuilt Likewise between 1945 and 1952 General Douglas MacArthur oversaw the reconstruction of Japan and the strengthening of its economy Since then the US has a distributed extensive foreign aid b invested heavily in health care in developing nations created programs that bring foreign students to the US and vice versa and d beamed positive messages to people throughout the world These are all instances of generosity In each transaction we gave more than we directly got And a cynic might say we acted like suckers Yes these things can be described as laress But as the national archive puts it the Marshall Plan provided markets for American goods created reliable trading partners and supported the development of stable democratic governments in Western Europe That's a pretty good payoff People in other countries received lots of freebies But certainly these programs helped the US by restraining communism bringing nations into defensive alignment with the US and contributing to the US's position as the world's most prosperous nation I have no interest in seeing the US turn isolationist But it's very possible we could throw this process into reverse We can antagonize our trading partners and cause our allies to feel like they're being bullied and extorted We can force countries that have depended on us for capital and other forms of assistance to look to China and Russia for these things instead We can convince the rest of the world to invest less in the US and less in US treasuries The first two points could cost us important allies and cause nations to look less favorably on democracy As my friend Michael Smith says you can't antagonize and influence at the same time And the third point would dramatically influence the US's fiscal position To date the world's high opinion of the US economy rule of law and fiscal solidity has allowed us to hold a golden credit card where there's no credit limit and no bill ever comes This enabled the US to run fiscal deficits in each of the last 25 years and all but four of the last 45 including trillion dollar plus deficits in each of the last 5 years In other words we've been able to live beyond our means with the federal government spending more than it takes in via taxes and fees This has led to one of the worst things about the US the $ 36 trillion national debt and the grossly irresponsible behavior in Washington that caused it Since I don't expect Washington to suddenly begin to behave responsibly and live with balanced budgets I'm left to wonder how much longer we can count on that golden credit card Might other countries become less willing to buy US treasuries might they conclude that our fiscal management is unreliable even if we remain the world's strongest credit might they cut back on purchases out of worry spite or political motivation what would happen if a Treasury auction failed i imagine the Fed would buy the unsold securities but I'm uncomfortable about it creating the money to do so by crediting banks with deposits with which to buy In the end where does the money come from will we remain the world's strongest credit if the dollar comes to be less accepted as the world's reserve currency what would happen to the deficit and thus the national debt if buyers demand higher interest rates on treasuries to date some of our trade deficits have probably been recycled into purchases of US treasuries What happens to rates on treasuries if that ceases going all the way back to World War II and longer the US has been holding the cards Trump believes in the strength of the US and in cashing in on it That's what his moves on tariffs amount to No longer throwing the party for the rest of the world No longer generosity in the hope of long-term benefits but rather transactions in which we extract fair value I've received a lot of kind responses to Friday's appearance on Bloomberg TV and I'm going to use a comment from a viewer to bring us to a conclusion on this subject In the 1980s people like Trump's current counselor for trade and manufacturing Peter Navaro decided that Japan pulling ahead of the US in autos threatened the future of the US Japan did indeed pull ahead and never looked back The US economy has more than doubled in size relative to Japan since then It has doubled even after allowing for population changes and currency strength It doubled in spite of losing the lead in autos Or is it that it doubled partly because of it the margins on computer software and jet engines are probably a good deal higher than on mass market automobiles Japan exploited its advantages in producing autos and the US moved on to things in which it could achieve an advantage of its own Isn't that exactly the way things should work in a dynamic global economy as I asked in a memo in September is it a good idea for governments to try to override the laws of economics in an effort to cause their economies which if left alone would follow their own natural course to satisfy policy preferences a tariff is an externality or artificiality designed to a discourage exports that would otherwise take place and thus b help domestic businesses make sales that wouldn't take place if they were left to function on their own What will be the cost and who will bear it the bottom [Music] line I consider the tariff developments thus far to be what soccer fans call an own goal A goal scored for the other side when a player accidentally puts the ball into his own team's net In this way they're highly analogous to Brexit And we know how that turned out Brexit caused the British mightily in terms of GDP morale and alliances and it harmed their reputation for governance and stability All of this damage was self-inflicted I like the way things have gone during my lifetime which conveniently spans 99% of the post-war period I've been discussing Some of our government expenditures have certainly been misspent both at home and abroad and our national debt is nothing to celebrate But I've enjoyed living in a peaceful prosperous and increasingly healthy world And I'm not eager to see that change Just a couple of months ago the US economy was performing well The outlook was positive The stock market was at an all-time high and there was much talk about American exceptionalism Now if Trump's tariffs are put into effect the US economy is likely to experience a recession sooner than otherwise would have been the case Higher inflation and extensive dislocation Even if the tariffs are reversed entirely it's unlikely the other nations will dismiss this incident and conclude that they have nothing to worry about in terms of relations with the US No one should rule out the achievement of some of the goals of tariffs listed previously US manufacturing could increase bringing new jobs and more dependable supply chains Our treatment in world trade could become fairer and the treasury's take could increase On the other hand some of the hoped for benefits are probably beyond reach In particular as for reducing our trade deficit the US is unlikely to ever buy less from other countries than they buy from us as long as the US is bigger and more prosperous and thus has greater buying power This will be especially true as long as our workers are better paid meaning most US-made goods cost more than goods produced elsewhere the hoped for results might materialize or the negative consequences might be felt or some combination of the two It must be borne in mind however that whereas the negative ramifications from tariffs will probably be felt almost immediately any gains are likely to come only in the long run following a multi-year period of adjustment And what about the financial markets in the last few days there's been a massive shift in the economic outlook and a huge stock market decline in reaction As always the key question surrounds the appropriateness of the response to date Has it been just right inadequate or excessive it's even harder to answer that question than usual since there can be little confidence that the economic world of the future won't be significantly different from and probably worse than the one we've lived in up to now On the one hand if the tariffs remain as announced and retaliation leads to an all-out trade war the economic consequences could be truly dire But on the other hand cooler heads and highly negative political and stock market reactions could prevail causing the tariffs to be rolled back to less harmful levels perhaps even leading to gains for free trade How is the Fed likely to respond the threat of recession might call for accelerated rate cuts to bolster economic activity or the threat of inflation might cause rates to stay higher with cuts postponed Note however that inflation fighting measures such as higher rates are probably less likely to succeed against inflation caused by the addition of tariffs to selling prices than they would be against the more typical demanddriven inflation Today's title is particularly applicable to the Fed's actions Certainly nobody knows In oak trees markets fear of defaults not unfounded has caused risk compensation in the form of yield spreads to increase substantially leading to a meaningful increase in the available yields on credit At the same time we anticipate a higher incidence of distress and increased demand for bespoke capital solutions meaning we're likely to invest our latest opportunistic debt fund faster than otherwise would have been the case This is a good time for all of us to connect with our friends around the world Rhyme throughout history For that reason just as I recycled the title of my post Leman bankruptcy memo for this one I'll also borrow its closing paragraph Everyone was happy to buy 18 24 36 months ago when the horizon was cloudless and asset prices were skyhigh Now with here to for unimaginable risks on the table and priced in it's appropriate to sniff around for bargains The babies that are being thrown out with the bathwater We're on the case On a personal note I was fortunate to visit investors in Montreal on the day of the tariff announcement and in Toronto the day after What a time for a trip to Canada I started each meeting by saying "I'm one of the hundreds of millions of Americans who respect Canada and consider it a friend and ally." The reception was stirring This is a good time for all of us to connect with our friends around the world April 9th 2025 Thank you for listening to The Memo by Howard Marx To hear more episodes be sure to subscribe wherever you listen to [Music] podcasts This podcast expresses the views of the author as of the date indicated and such views are subject to change without notice Oak tree has no duty or obligation to update the information contained herein Further Oak Tree makes no representation and it should not be assumed that past investment performance is an indication of future results Moreover wherever there is a potential for profit there is also the possibility of loss This podcast is being made available for educational purposes only and should not be used for any other purpose The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction Certain information contained herein concerning economic trends and performances based on or derived from information provided by independent third-party sources Oakree Capital Management LP Oakeree believes that the sources from which such information has been obtained are reliable However it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based This podcast including the information contained herein may not be copied reproduced republished or posted in whole or in part in any form without the prior written consent of Oak Tree Audiation