In an article published on the latest edition of Barron's Mr Howard Marks said:
"Of all the cycles I write about, I feel the capital market cycle is among the most volatile, prone to some of the greatest extremes. It is also one of the most impactful for investors. In short, sometimes the credit window is open to anyone in search of capital (meaning dumb deals get done), and sometimes it slams shut (meaning even deserving companies can't raise money). This memo is about the cycle's first half: the manic swing toward accommodativeness.
An aside: I recently engaged in an exchange with a reader who took issue with my use of the word "cycle." In his view, something is a cycle only if it's so regular that the timing and extent of its ups and downs can be predicted with certainty. The cycles I describe aren't predictable as to timing or extent. However, their fluctuations absolutely can be counted on to recur, and that's what matters to me. I think it's also what Mark Twain had in mind when he said "History doesn't repeat itself, but it does rhyme." The details don't repeat, but the rhyming patterns are extremely reliable".
Toward the end, my 2007 memo included the following paragraph:
Today's financial market conditions are easily summed up: There's a global glut of liquidity, minimal interest in traditional investments, little apparent concern about risk, and skimpy prospective returns everywhere. Thus, as the price for accessing returns that are potentially adequate (but lower than those promised in the past), investors are readily accepting significant risk in the form of heightened leverage, untested derivatives and weak deal structures. The current cycle isn't unusual in its form, only its extent. There's little mystery about the ultimate outcome, in my opinion, but at this point in the cycle it's the optimists who look best. (emphasis in the original)
Now we're seeing another upswing in risky behavior. It began surprisingly soon after the crisis (see Warning Flags, May 2010), spurred on by central bank policies that depressed the return on safe investments. It has gathered steam ever since, but not to anywhere near the same degree as in 2006-07.
•Wall Street has, thus far, been less creative in terms of financial engineering innovations. I can't think of a single new "modern miracle" that's been popularized since the crisis.
•Likewise, derivatives are off the front page and seem to be created at a much slower pace. A full resumption of derivatives creation and other forms of financial innovation appears to be on hold pending clarification of the regulatory uncertainty surrounding acceptable activity for banks.
•Buyout activity seems relatively subdued. In 2006-07, it seemed a buyout in the tens of billions was being announced every week; now they're quite scarce. Many smaller deals are taking place, however, including a large number of "flips" from one buyout fund to another, and leverage ratios have moved back up toward the highs of the last cycle.
•"Cov-lite" and PIK-toggle debt issuance is in full flower, as are triple-Cs, dividend recaps and stock buybacks.
It's highly informative to assess how the other characteristics of 2007 enumerated above compare with conditions today:
•global glut of liquidity – check
•minimal interest in traditional investments – check (relatively little is expected today from Treasurys, high grade bonds or equities, encouraging investors to shift toward alternatives)
•little apparent concern about risk – check
•skimpy prospective returns everywhere – check
Risk tolerance and leverage haven't returned to their precrisis highs in quantitative terms, but there's no doubt in my mind that risk bearing is back in vogue.
