Further Thoughts on Sea Change

Summary

• A follow-up memo to the December 2022 "Sea Change" report was sent to Oaktree clients on May 30, 2023, arguing that investment trends represent a sweeping alteration of the environment requiring significant capital reallocation.
• Sir John Templeton warned in 1987 that claims of "this time it's different" often rationalize high valuations, though he acknowledged fundamental changes occur 20% of the time.
• The Federal Reserve lowered the fed funds rate to zero in late 2008 to address the Global Financial Crisis, maintaining accommodative policies including quantitative easing for 13 years.
• This period of low interest rates facilitated the longest economic recovery on record, allowed money-losing businesses to secure financing, and made asset ownership highly profitable.
• Massive pandemic relief measures combined with supply-chain issues caused inflation to rise in 2021, forcing the Fed to end quantitative easing & raise interest rates at its fastest pace in four decades.
• Ultra-low or declining interest rates are unlikely to be the norm in the coming decade, leading to tougher conditions for corporate profits, asset appreciation, borrowing, & default avoidance.
• A 2,000-basis-point decline in interest rates between 1980 & 2020 was likely responsible for the majority of investment profits during that period.
• Gradual interest rate declines went unnoticed due to the "boiling frog" effect, the "moving walkway" analogy, & the extreme brevity of financial memory among investors.
• Most investors today have only experienced declining or ultra-low rates, as few are old enough to remember the higher & stable rates of the 1960s & 1970s.
• The Fed kept interest rates near zero for nearly seven years after the 2008 crisis, a move the author considers an emergency measure that should not be repeated.
• By 2017-2018, the Fed faced pushback when attempting to raise rates to create room for future stimulus, limiting its policy toolkit.
• Fed activism over the last two decades has distorted market behavior, encouraging investments & risks that would not have been accepted in a free market.
• Problems at Silicon Valley Bank & First Republic Bank resulted from errors made during the easy-money period, including rapid growth, unwise inducements, & lax financial management.
• Future consequences of ending the easy-money period may include slower economic growth, eroding profit margins, higher default rates, & less reliable asset appreciation.
• Strategies involving asset ownership & leverage thrived during the 40-year period of declining rates but may yield reduced returns if interest rates do not continue to fall.
• Bargain hunting was difficult during the easy period because complacent asset owners & eager buyers created no urgency to exit.
• Investors may have mistaken the benefits of a bull market & low rates for inherent skill, violating the rule to never confuse brains with a bull market.
• Exceptional returns in the new environment will likely require skill in making bargain purchases rather than merely riding positive trends.