Transcription
The S&P 500 has returned 10% a year on average for the last century. That's enough to turn a dollar into roughly $15,000. Not too bad. So, people got into the habit of buying stocks regardless of valuation and ignoring bonds because of the low yields.
Things today are very different. Today, the Fed funds rate is 4 and a half. Um, the the 10-year Treasury yields 4 and a half. The 30-year Treasury yields close to five. Uh, I wouldn't recommend it because it it it's too subject to shocks, including inflation. But, you know, these are much higher yields and and the things we do like high yield bonds yield in the sevens and so forth. That's pretty good.
Um, now for the individual not in a retirement account, no, but for an individual, uh, bond income is is taxed at ordinary rates, not capital gain rates. So you have to take that into account, but still, seven from what we call credit, uh, non-government bonds is pretty damn good.
Um, the other thing is the stocks are expensive and, uh, at the end of, uh, '24, JP Morgan had published a chart showing that if you bought the S&P 500 at a time when the PE ratio, the main, uh, metric of value, was 23, which it was at the time, the return over the next 10 years on average was between 2% a year and minus 2% a year. So, let's say zero. So stocks are more expensive and and destined to yield less.
>> Did you catch that? Howard Marx is warning of a lost decade for the US stock market. That's one of the most successful investors of our generation. The man who built Oak Tree Capital into a $200 billion powerhouse, essentially saying the golden age of easy stock returns might be over.
Here's what makes this even more alarming. The S&P 500's PE ratio today isn't 23 anymore. It's 30. We're in territory that's historically led to disappointing returns or worse. Think about it. You could put your money in stocks today, wait 10 years, and have roughly the same amount you started with, maybe less after inflation eats away at it.
But here's what most people miss about Marx's warning. He spent 50 years navigating exactly these kinds of markets, and he has a playbook. Today, we're breaking down not just why Marx thinks we're heading for a lost decade, but more importantly, his defensive strategy for protecting and even growing wealth when everyone else is running in place. By the end of this video, you'll understand why optimism is dangerous right now, what Marx's Invest Con 2 means for your portfolio, and the specific moves you can make to avoid becoming a casualty of the next market reset. Let's dive in.
But before we jump to solutions, we have to ask, why are investors still buying if future returns look so bleak?
>> Investors are by nature, uh, optimistic. You have to be by nature an optimistic. What what investors do is they give up their money, uh, for a while in the hope of getting more back later. So that is by definition optimistic. I think that optimism dies hard. I think that optimism introduces cognitive dissonance. That is to say, investors are good at ignoring negatives for a long time and and if there are ambiguous events, in interpreting them positively.
There are also some actual positives, uh, at work. Uh, one of which, uh, might be AI, and AI, you know, some people hold out great hopes for what that will do for our economy. The companies of today, the so-called magnificent seven that account for 30 odd percent of the S&P 500, uh, are some of the greatest companies we've ever seen. They have, uh, incredible technological leads, moats, uh, market shares, incremental profitability.
Um, so I mean, when the market is strong, it's never without, uh, a seed of reason. The only question is whether it's sufficient and, uh, and more importantly, when the market is, uh, incorporating unusual optimism, one thing that introduces is room for disappointment, and if if the reasons for the optimism tend not to be realized, then you can have, uh, some real damage done. So it it's a balancing act. I never want to give the impression that the arguments are all on one side or the other. Uh, but there's no doubt about the fact that the market today incorporates optimism, and that has certain, uh, implications.
>> Marx is basically saying the stock market strength today is propped up by optimism. Some of it justified. Think AI breakthroughs and superstar tech companies, but a lot of it wishful. Investors are wired to stay optimistic, even bending reality to fit a positive narrative. That's the cognitive dissonance he mentions. They tune out bad news and latch on to anything that sounds like good news.
For example, he points out the Magnificent 7: Apple, Microsoft, Google/Alphabet, Amazon, Meta, Nvidia, Tesla. Amazing companies that now make up roughly one-third of the S&P 500's value. These giants have driven a huge chunk of the market's gains. In fact, over 2023 to '24, the S&P 500's jaw-dropping 58% total return was largely thanks to those seven stocks. And yes, technologies like AI truly are exciting. They could boost productivity and profits. So, it's not pure fantasy. There are real reasons to be hopeful.
But here's the catch. When prices already reflect unusual optimism, the bar for reality is set sky high. There's a lot of room for disappointment. Think back to the dot-com bubble of 2000. Investors were euphoric about the internet, and they weren't wrong that the internet would change the world. Look around today. But stock prices in 2000 had priced in perfection. When some of those lofty expectations didn't materialize fast enough, the NASDAQ index plummeted nearly 77% over two brutal years. Many can't-miss tech darlings went bust.
Could something similar happen with today's AI-driven boom? It's not a prediction, but it is a risk. If the Magnificent 7's results or AI's timeline fall short of the market's rosy assumptions, we could see a sharp correction. As Marx warns, you don't need everyone to suddenly turn pessimistic. Even ambiguous events can get interpreted negatively once the spell of optimism breaks.
Now, as investors, what should we do with this understanding? We have stocks priced for perfection, and investors inclined to look on the bright side. It's a dangerous combo if you're fully on offense. Consider this alarming signal that most investors are missing. The S&P 500's dividend yield, the cash companies pay you just for holding their shares, is now around 1.2%. Meanwhile, a 10-year Treasury bond pays you over 4.5% with virtually no risk.
Now, you might think, "So what? Stocks give me capital gains on top of dividends?" And normally, you'd be right. Historically, that 1.2% dividend plus stock price appreciation has crushed bonds over time. But here's the thing. When dividend yields are this low compared to bond yields, it's often because stock prices have been bid up so high that future returns get compressed. Think of it this way. The market is essentially saying you need stocks to deliver at least 3 to 4% in price gains every year just to match what you'd get from a risk-free government bond. And as Howard Marx just warned us, when valuations are this stretched, those price gains might not materialize. In fact, they could go negative.
Historically, when this gap becomes this extreme, when safe bonds significantly outyield stock dividends, it's been a reliable warning sign. Not because dividends alone should beat bonds, but because it signals that investors have become so optimistic, they've pushed prices to unsustainable levels. The last few times we saw this disconnect, stocks delivered disappointing returns for years afterward. It's the market's way of flashing a yellow light that says, "Caution, expensive road ahead."
Speaking of warning signs, if you want to see exactly how Marx navigates these risky markets, the same frameworks he's used to build Oak Tree into a $200 billion powerhouse, I've put together something special for you. It's a free guide breaking down Marx's most important risk management principles, including his offense-defense framework we're about to discuss. These are the exact lessons from his memos and speeches that most investors never take the time to study. Just click the link in the description to grab the ultimate Howard Marks risk management guide. It's completely free and you can reference it while watching the rest of this video.
Now, back to what you should actually do when markets flash these warning signs. If you're an ordinary investor with your nest egg in an index fund, these are flashing warning lights. So again, what do you do? Sell everything? Hiding cash? Marx isn't saying that. In fact, he emphasizes that the world isn't binary. It's not either or, all in or all out. Instead of a panic button, he offers a dial.
Marx has rolled out a framework for adjusting your portfolio's balance between offense, riskier growth assets like stocks, and defense, safer assets like bonds or cash. He jokingly calls it Invest Con, a play on the military's Defcon alert system. Instead of trying to predict exactly when a crash might hit, this approach lets you tilt your strategy based on current conditions.
Now, listen to how he explains this approach.
>> The world is not black or white. It's gray. It's always gray. And anybody who understands how the world works understands that it's always gray. And it's never risk on or risk off. But I think that we should manage our portfolios conscious of our balance between offense and defense, and we can change that balance, uh, given what's going on in the environment. So, uh, I said in the memo that I recommend, uh, possibly going to Invest 2. Uh, now, if you decide you want to be a little more defensive than usual for whatever your usual is, uh, you can go to Defcon one, which is stop buying. Defcon 2, which is tilt your portfolio more toward defense, sell some of your aggressive holdings and buy some more defensive holdings. Number three, which is get out of all your aggressive holdings. Invest 4 is, uh, uh, sell some of your defensive holdings. Uh, number Defcon 5, which is sell all your holdings, and number six, Defcon 6, which is go short the market. And I'm never confident enough. It's not my nature to be confident enough to go to five or six. But I think it's reasonable at this point in time to just be a Defcon 2, which is to say, just to start biasing your portfolio more towards defense and less towards offense.
>> There it is. Marx isn't yelling "sell everything." He's saying dial down your risk a notch in his scale of 1 to six, with six being extreme bearishness like shorting the market. Invest 2 is just a cautious tilt. In practice, what does that look like? It could mean, for example, shifting a chunk of your portfolio from aggressive growth stocks into more stable value stocks or bonds. Maybe you normally keep 70% in stocks. At Invest 2, you might drop that to 50 to 60% and put the rest in treasuries or cash. That way, if the market rockets higher, you still participate. You haven't completely jump ship. But if the market rolls over, you've got a defensive cushion to soften the blow or even take advantage of bargains.
Let's make it concrete. Say you had $100K all in an S&P 500 index. A 20% market drop would hit you with a $20K loss. Ouch. But if you had moved, say 30% into bonds beforehand, that drop might only dent your portfolio by $14K because your bonds hold steady or even rise if investors flee to safety. You've offloaded a chunk of uncertainty in exchange for slightly lower expected returns. That's the Invest Con 2 mindset: play a bit more defense while times are euphoric and risky.
Importantly, Marx is not confident enough to go to a level five or six, selling out or shorting. That tells you he's not predicting an imminent crash with certainty. He's just skewing cautious because the odds look unfriendly. It's like carrying an umbrella when the clouds look dark, even if it's not pouring yet. And this is something you can do, too. Gradually tweak your offense-defense mix based on conditions and your own risk tolerance.
So, how exactly do you tilt defensive in today's market? There are two main paths, and both can work depending on your situation. The first path is what Marx himself is advocating: moving some money into bonds. Now, I know bonds sound boring, but hear me out. Marx believes they're actually quite attractive right now, and for good reason. When you buy a bond, you're essentially giving a company a loan with a promise they'll pay you back on a specific date with interest. As long as the company doesn't go bankrupt, you get your money back. And here's the kicker: if things do go south and the company fails, bondholders get paid before stockholders see a penny. You're basically first in line at the buffet, while equity investors hope there's something left. With yields over 5% on quality corporate bonds, you're getting paid well to take less risk.
But if you're like us at Investor Center and want to stay in stocks, there's a second path: finding the pockets of value in an expensive market. Even when the overall market is priced for perfection, there are always overlooked corners where great businesses trade at reasonable prices. The perfect example during the dot-com bubble in 2000, while the NASDAQ was hitting insane all-time highs, Warren Buffett's Berkshire Hathaway was actually hitting multi-year lows. Investors thought Buffett had lost his touch for avoiding tech stocks. But those who cycled some of their tech gains into Berkshire protected their wealth brilliantly. When the bubble burst and the NASDAQ crashed 78%, Berkshire actually went up. That's the approach we prefer: staying in stocks but being incredibly selective. You can still capture the upside potential of equities while dramatically reducing your risk. It just takes more work to find those diamonds in the rough when everyone else is chasing the latest shiny object.
Howard Marks is essentially flashing a yellow light for investors. Stocks aren't cheap. By some measures, buying at these prices has never ended well. And yet, many investors are charging ahead, fueled by optimism, or some might say FOMO. We've seen how that movie can end. The higher the optimism, the harder the fall if reality disappoints. Marx's advice isn't to predict doom by Tuesday or hoard canned goods. It's to prepare by playing solid defense while others throw a Hail Mary.
In practice, that's moving to what he calls Invest 2, a slightly defensive footing. For you, it could mean trimming some speculative positions, raising a bit of cash, locking in some 5% yields in bonds, or just not piling new money into an overheated market. It's about discipline over emotion. Remember, he explicitly says this is not a time for a carefree attitude. But also, don't panic. Just be conscious of your offense-defense balance because ultimately, you must choose. You can't both maximize growth and perfectly protect what you have. There's no magic asset that gives huge returns with no risk. But by managing that balance, shifting a bit more defensive when risk is high, and vice versa when opportunities abound, you can survive the dry spells and thrive in the long run. As investors, our job is not to predict the future with certainty. It's to navigate uncertainty with a steady hand.
But here's what should really worry you. Even if you follow Marx's advice perfectly, even if you dodge the next market crash by moving into bonds and cash, there's another threat that Marx barely touches on. One that Warren Buffett says could be even more devastating to your wealth. See, Marx is warning you about stock market returns going to zero for a decade. But Buffett's warning about something scarier. In this next video, Buffett exposes the hidden force that's destroyed more wealth than every stock market crash combined. I will see you over there.