Howard Marks, FT, Wednesday, January 8, 2025:
In this article, Howard Marks, co-founder and co-chair of Oaktree Capital Management, argues that “US stocks are frothy, but there seems to be no outlandish bubble.”
The methodology used to make this assessment is particularly insightful. Howard Marks suggests that, when identifying a bubble, a psychological diagnosis is often more effective than relying solely on valuation parameters.
This may appear as a provocative claim, but we, too, have often argued that “fundamentalists” frequently overlook structural changes in risk premia, leading to highly biased estimates of “fair values.” Consequently, when fundamentalists dominate the market and adopt a bearish stance (2022, perhaps?), this often serves as a strong “buy” signal (see Asset Pricing as a Flawed Learning Process).
The right time to sell is when “fundamentalists” remain slightly bearish, yet all other investors are overwhelmingly bullish. This highlights the importance of the “psychological diagnosis” advocated by Howard Marks.
To establish such a “psychological diagnosis”, one must rely on investor sentiment surveys and positioning data. Here, the current landscape might be less favorable than Howard Marks assumes. Perhaps we are not yet at the stage where markets are “nutty” and people claim, “there’s no price too high.” However, many indicators suggest that investor optimism is at a historically high level. As emphasized in a recent Financial Times article (“The world will not revolve around Trump,” Monday, January 6, 2025), “American consumers have not been more bullish on US stocks since surveys began tracking this sentiment.”
In short, the “psychological diagnosis” at the beginning of 2025 appears far less reassuring than it did at the beginning of 2023…