Howard Marks on bubbles - thoughtful advice

It is good to get some perspective on the current bubble discussion across assets. The following comments from Howard Marks provide useful insights that are evenhanded yet focus thinking on the problem. These excerpts are from a longer letter with sage advice on how to think through the AI bubble and associated thinking on financing data centers.

I’ve concluded there are two different but interrelated bubble possibilities to think about: one in the behavior of companies within the industry, and the other in how investors are behaving with regard to the industry.

Newness plays a huge part in this. Because there’s no history to restrain the imagination, the future can appear limitless for the new thing. And futures that are perceived to be limitless can justify valuations that go well beyond past norms – leading to asset prices that aren’t justified on the basis of predictable earning power.

The key thing to note here is that the new thing understandably inspires great enthusiasm, but bubbles are what happen when the enthusiasm reaches irrational proportions.

Struggling with whether to apply the “bubble” label can bog you down and interfere with proper judgment; we can accomplish a great deal by merely assessing what’s going on around us and drawing inferences with regard to proper behavior. 

The key realization seems to be that if people remained patient, prudent, analytical, and value-insistent, novel technologies would take many years and perhaps decades to be built out. Instead, the hysteria of the bubble causes the process to be compressed into a very short period – with some of the money going into life-changing investment in the winners but a lot of it being incinerated.

Debt is neither a good thing nor a bad thing per se. Likewise, the use of leverage in the AI industry shouldn’t be applauded or feared. It all comes down to the proportion of debt in the capital structure; the quality of the assets or cash flows you’re lending against; the borrowers’ alternative sources of liquidity for repayment; and the adequacy of the safety margin obtained by lenders. We’ll see which lenders maintain discipline in today’s heady environment.

I know I don’t know enough to opine on AI. But I do know something about debt, and it’s this:

• It’s okay to supply debt financing for a venture where the outcome is uncertain.

• It’s not okay where the outcome is purely a matter of conjecture.

• Those who understand the difference still have to make the distinction correctly.

from Howard Marks Is It a Bubble? Oaktree Client Letter