The Insight: Conversations – Walking into the Unknown with Howard Marks, David Rosenberg, and Aman Kumar

Episode Summary

Executive Summary: Oaktree’s year-end discussion argues that investors should stop treating ultra-low rates and easy credit as “normal.” Howard Marks says the 2024 backdrop is a middle zone for markets and the economy, while liquid credit looks compelling because it can deliver equity-like returns with less risk. David Rosenberg expects recession effects to be milder in credit due to pre-positioning and prior defaults. Aman Kumar sees life sciences lending as attractive amid weak biotech valuations and growing demand for non-dilutive capital.

Main Topics: Rethinking what is “normal” in markets (Priority: 5/5): Howard Marks argues that decades of declining rates created a false sense of normalcy; investors should re-anchor expectations to a new rate regime and avoid assuming past winning strategies will keep working. Market and macro outlook for 2024 (Priority: 5/5): Marks describes equities, the economy, and the Fed as being in a “zone of reasonableness,” with no obvious fat pitch and limited need for macro-driven action. Why credit may be more resilient in a recession (Priority: 5/5): David Rosenberg explains that a widely anticipated recession is likely to be less disorderly than prior downturns because investors and issuers are already stress-testing and preparing. Lower recoveries in loan markets (Priority: 4/5): Rosenberg warns that covenant-lite and loan-only capital structures may reduce recovery rates versus history, because first-lien lenders no longer have the same structural cushion or early intervention tools. Credit as a high-return, lower-risk substitute for equities (Priority: 5/5): Both Marks and Rosenberg emphasize that current credit yields may be competitive with equities, making debt especially attractive on a risk-adjusted basis. Life sciences lending opportunity (Priority: 5/5): Aman Kumar describes a major shift in biotech financing: public market weakness, high capital needs, and expensive equity have boosted demand for direct, non-dilutive lending. Risk management in biotech credit (Priority: 4/5): Kumar outlines the key risks—regulation, reimbursement, and competition—and says disciplined structure plus careful selection of post-approval assets can mitigate them.

Key Arguments: Normal market behavior is history-dependent; investors who assume declining rates and near-zero policy rates are permanent risk making poor decisions when the regime changes. Human psychology and cognitive dissonance make it hard to abandon strategies that worked for 40+ years, even when the environment has shifted. The market and economy are neither extremely cheap nor expensive, strong nor weak; that makes 2024 more of a selective, not macro-driven, investing year. A recession that is broadly anticipated should trigger less panic selling and fewer surprise defaults than recessions in which the shock is sudden. COVID pulled forward defaults, reducing the amount of hidden distress that would otherwise have surfaced in a later recession. Covenant-lite and loan-only structures weaken lender protections and should lead to lower recoveries in the next cycle. Despite this, credit remains attractive because current yields can offer equity-like returns with less risk, especially in better-quality borrowers. Biotech public markets have fallen sharply, creating a favorable entry point for private lenders able to provide non-dilutive capital. Life sciences demand is supported by secular growth drivers and is less tied to the broader economic cycle than many other sectors. For investors, the most compelling move may be to shift from equities into debt to reduce risk without sacrificing expected return.

Data Points: Years of market experience referenced by Howard Marks: 43+ years - Marks says one must have worked more than 43 years before 1980 to have seen anything other than declining interest rates. Fed funds rate average (2009-2021): 0.5% - Marks cites the average federal funds rate during the ultra-low-rate period. Number of memos written in 2023: 4 - Marks reviews his year’s memos: Silicon Valley Bank, taking the temperature, fewer losers or more winners, and further thoughts on sea change. Stock market valuation gap example: 10% over value - Marks says being 10% over fair value does not justify immediate selling because markets can still rise or fall from there. Expected Fed funds rate in two years: 3 to 3.5% - Marks predicts inflation victory will be declared and policy rates will settle around this range. Liquid credit return potential: Approaching 10% - Marks says liquid credit can potentially deliver equity-type returns. Private credit return potential: Above 10% - Marks contrasts private credit returns with liquid credit and equities. Biotech index decline from peak: Almost 60% below peak - Kumar notes the XBI index remained almost 60% below its February 2021 high through end-September 2023. Biotech index peak date: February 2021 - Kumar identifies the all-time peak for the S&P Biotechnology Index (XBI). Direct lending pipeline growth: Approximately 50% increase - Kumar says Oaktree saw roughly a 50% increase in life sciences direct lending opportunities over the prior 18 months. Historical default rate in COVID shock: ~6% high-yield, ~4% loans - Rosenberg references 2020 default rates as defaults pulled forward by the pandemic. Current default rate in credit market: ~2% - Rosenberg says the present market default rate is around 2%. Potential recession default rate (bonds): ~4% - Rosenberg says a recession might push bond defaults to around 4%, near the long-term average. 30-year average default rate for bonds: 4% - Rosenberg cites this as a historical benchmark. Market-wide credit opportunity coverage: 96% of market may perform - Rosenberg estimates that most of the market remains performing even in a recession scenario. Negative enterprise values in biotech: Over 200 companies - Kumar says there are still more than 200 biotech companies with negative enterprise values. FDA approvals from smaller firms: About 70% - Kumar says roughly 70% of new U.S. FDA approvals now come from small to mid-sized companies.

Pivotal Quotes: "Another version of insanity is doing something in a new environment and expecting the same result." — Howard Marks: Marks explains why investors must stop assuming the low-rate era will repeat. "The market is not crazy high and it's not crazy low. It seems a little high, not enough to make you take action." — Howard Marks: Marks describes his view of 2024 market conditions as neither an obvious buy nor sell signal. "The ability to bring your risk down without having to meaningfully impact your expected return is very valuable." — David Rosenberg: Rosenberg explains why debt looks attractive relative to equities heading into 2024.

Implications: Investors should expect a more normalizing rate environment, selective credit opportunities, and less reliance on macro calls. Higher-quality credit and life sciences lending may offer attractive risk-adjusted returns as equity volatility and refinancing needs persist.