HOWARD MARKS: Hi there. I'm Howard Marks, I'm the co-chairman and co-founder of Oaktree Capital Management, which is an alternative management firm dedicated primarily to credit products. I've been in the investment management business since 1969. And I'm pleased to be on this call with Joel Greenblatt.

Joel is one of the world's leading value investors. And we'll talk later about what that means. I've known Joel for about 30 years and have greatly enjoyed working with him. It's a real pleasure to be on with him today.

JOEL GREENBLATT: Well, Howard, thank you very much. I'm one of your biggest fans. I know you have a lot, but I'm one of the biggest. And it's a real pleasure to be here today. I am the co-CIO at Gotham Asset Management, founded Gotham Capital in 1985, started in the business 1981-- so seen a lot, and looking forward to talking to Howard about it. Well, Howard, I guess the first question out of the gate a lot of people would like to know, are we in a bubble of some sort?

HOWARD MARKS: We are definitely in a time of optimism. And I think that that optimism is largely what I call man-made-- stemming primarily from the actions of the Fed and the Treasury to counter the economic weakness of 2020. The economies of the world and the markets of the world were cascading down in March of 2020 when the Fed and Treasury came out with programs in mid-month, and the Fed strengthens its program by March 23.

At that point, the market was down about a third-- its fastest decline in modern era. However, the programs worked and produced a rebound. The S&P ended up the year 18%, and the tech stocks were up much more than that. And the interest rate cut to 0% had a profound effect. And it produced a resurrection of risk-bearing. FOMO, fear of missing out, took over from fear of losing money. And it really led to a very strong demand for securities. So that's worrisome.

The PE ratio on the S&P is high relative to history. And we see risky behavior ranging from the rapid acceptance of financial innovations, such as SPACs, which have taken over the consciousness of many investors, to the ease of doing IPOs, especially for companies that are unprofitable, and the very great performance of those stocks on their first day. And then we have phenomena like GameStop and so forth, and we have the heavy involvement of retail buying, margin buying, and option buying.

So a lot of these taken together could be signs of a bubble. But I think that most asset valuations are reasonable relative to the level of interest rates. The lower interest rates are, the higher the PE is that's warranted. Valuations of all assets are higher when interest rates are lower, which means that the demand in rates of return on all assets are lower. So I think that the PE ratios are justified. And most assets are at equilibrium relative to each other.

They just all are priced to produce below history returns. And so I think bubble connotes unreasonably optimistic psychology and a belief that there's no price too high for the bubble asset. And I don't think that those are going on today, I just think that, as I said, all prices are up, because all demand and returns are down. Prospective returns are low across the board, and that means that the continuation of markets at these levels is contingent on the continuation of low interest rates. That's the primary conclusion I've drawn. What about you, Joel?

JOEL GREENBLATT: Well, I can't disagree with anything you said. I actually agree with it. I would just maybe add a little bit-- the major market averages, I agree with you, they're high but reasonable with expected returns perhaps below normal what we've come to expect. Last 50 years, the S&P has been up over 10% a year, so not sure at these prices that would continue-- I'm not certain it won't.

There are elements of froth. It's, if we're talking about the stock market, a market of stocks, not a stock market. And so we did some work, and there are over 300 companies that lost money in 2019. And so that's pre-pandemic-- not affected by pandemic. And they now have a market cap over $1 billion, those 300 names, that lost money in 2019. And in 2020, they were up over 100% on average. The median stock was up over 70%.

So these are just looking at the batch of companies with market cap over $1 billion that lost money. So that's not usual. While I believe that Amazon, Google, Microsoft, Apple are some of the greatest businesses that we've ever seen, and perhaps are actually priced reasonably given the nature and how great the businesses are, and low interest rates, and all that stuff-- I do not believe there will be hundreds of other Amazons, Googles, Microsofts out there.

Many companies are priced as if they will be. I think that's an element of froth. But if you are in an index which is heavily market cap-weighted for the biggest companies, that may not affect you that much, because these are smaller companies where the froth is. And so some combination of look out in certain areas of the market, and in others, you could be.

HOWARD MARKS: Just two responses. Number one, I certainly agree with your observation. One of the features of a bubble is that people conclude that every member of the subject asset class will be a success. In 1999, everybody said the internet will change the world, so you have to get involved in e-commerce. And the internet did change the world, and all those e-commerce companies-- well, a few of them are household names today, but many, many are gone.

And the other thing is that in my most recent memo, I did mention the fact that never before has it been more acceptable to be unprofitable. When we started, the fact that a company lost money would pretty much put it off limits. And today, it's not a problem for anybody. And people are lined up to invest in companies that are unprofitable.

JOEL GREENBLATT: Well, just because I have to, I've given a lot of thought to that concept of, is losing money always bad? And of course, it's not. But I do think traditional accounting hasn't really kept up with what's going on. Because if you're taking a look at the lifetime value of a customer, and you're going to get a stream of earnings from that customer over a period of years, and let's say your average customer is going to last eight years, and you make $1 a year from that customer-- let's say you're a software program-- but it costs you $2 the first year to get that customer.

So the accounting would say, well, I spent $2, I got $1, I lost $1. But the lifetime value is $8, and that's what, from an economic standpoint, the business is taking a look at. There's no contract that says you have to stay eight years. But in general, if you have a sticky software program or something like that, that's a reasonable guess. And it's a reasonable business decision.

So is that spending, should it be capitalized in some way-- the advertising spending. And when Amazon creates Prime Video and spends a lot of money, or Netflix spends a lot of money producing videos that last a long time, and the customers are signed up from month to month or year to year, it's very hard to understand if that's CapEx-- or in what way should that kind of spending be expensed from an accounting standpoint?

I don't have an answer to that question. As a investor, I just have to make reasonable assumptions about that. I'm not saying we should really change the accounting standards-- but the accounting standards, when you're showing losses. And also, maybe it's good, because you get to deduct those expenses right away, and you don't have to pay taxes, and there's a lot of reasons about that.

So there's an interesting model where it's not really about capital building a plant, or stocking inventory, or something like that that's creating value that traditional accounting metrics have always recorded as capital spending. Now, there's a lot of way to build a business fast without a lot of capital. But you do have to investigate customers, and these are potentially long term, sticky customers.

And so just interesting questions, and saying, they lose money, or even losing cash flow now-- obviously, that's the beginning of the discussion but not the end. And so that's changed, in my mind.

HOWARD MARKS: Well, that leads me to the old saying that this time is different. And Sir John Templeton stated several decades ago that people tend to get into trouble when they start saying, this time is different. What they mean is that the constraints of history don't matter. The normal business cycle and the normal performance of business in the past doesn't matter. And the valuations standards in the past don't matter.

And as I say, when people say those things, they get into trouble. On the other hand, he allowed, back in 1985, I think it was, that 20% of the time, it really is different. And that was then, and the world was a pretty static place then. And I would say right now, it's probably really different 40% of the time or 60% of the time. And the example you gave was one. So one of the things that's different this time is interest rates.

Back 40 years ago in '81, I had a loan outstanding from a bank, and I still have the ticket on my wall. It says the rate on your loan is now 22.75%. Today, I can borrow at 2.25%. So let's talk about the changes that has produced. I mentioned the effect on valuation.

And the world has been flirting with negative interest rates. Do you think we'll have negative interest rates? And what would be the impact of that? And lastly, when the demand and return on something is negative, its value is infinite. So how do you factor the difference in interest rates and the outlook?

JOEL GREENBLATT: Well, that's obviously a question that I don't have a great answer to. I would just say that what I'm trying to do as an investor is normalize interest rates over a long period of time. In other words, buying a equity stake in a business is a long term investment. And I'm going to get a stream of earnings over a long period of time.

So depending on how I finance that, but if it's my equity capital, I have to take into account the prospects of what the world will look like three, five, 10 years from now. So I want to normalize interest rates, not just look at current interest rates. If I'm not borrowing money at 30 years at a low rate and then investing in stocks, that would be different, because I'm locked in.

But for me, I try to normalize rates. And what doesn't change is sort of thinking about Ben Graham, and margin of safety, and saying, well, I pick a really high risk-free rate. And I've written many times, and I mentioned 6% risk-free rate-- and that was a book I wrote in 2005. So things have changed a little bit.

But my standards haven't changed, because if I don't expect to make a risk-adjusted return above 6%, then I'm probably not going to invest in an equity. So I really haven't changed that. I'm not trying to say, well, risk-free rate is 2%, so I can accept a 5% expected return on my equity investment. Businesses go up and down as far as their prospects are concerned. Rates aren't stable over time, and I'm not expecting normalized rates to stay this low.

That doesn't mean I'm right. It means, how do I attack this? I'm picking conservative assumptions. And if I still want to buy it, then that's the way I'm trying to attack this area of low interest rates. I don't know the answer. I don't know, actually, even how to think about interest rates when it's not clear they're fairly representative of what's going on in the world.

Are they being manufactured either on the short end by the Fed or the long end by the purchase of long-dated government bonds to push those rates down by the government? It's really hard to get my bearings on what is the actual price of money, which is a very dangerous thing to be toying with. So what's wonderful about having a grounding in the precepts of value investing along the lines of Benjamin Graham and Warren Buffett is that, well, I'll just throw in a big margin of safety in the I Don't Know category.

And if rates were to move up and this would make it a bad investment, I probably wouldn't want to own it. Of course, it's a world of alternatives. You have to put your money somewhere. But I would say one of your choices, as Seth Klarman and many others have said, is not only what's in front of you today, but what might be in front of you six months from now, two years from now, and you want to keep your powder dry for that.

And so your list of choices is not just what's in front of you today. It's important to keep that in mind. So if rates stay this low, yeah, you can pay high prices for lots of things. My assumption is, they won't. And if I still want to buy it, that gives me some comfort and margin of safety. I don't know what you think of this, Howard, but I'd love to hear.

HOWARD MARKS: Well, one of the reasons you and I have great conversations is because we think a lot alike. And I've been thinking for a long time, since '08, actually, that interest rates have not been naturally occurring. Presumably, all of us as investors are capitalists, and we believe that the capitalist system, the free market system is the best allocator of resources.

But when interest rates are administered, as opposed to naturally occurring, then you can't have great faith that that capital allocation will be optimal. Another question that you rightly give credence to, you talk about normalizing interest rates. But what's normal? Is 22% normal? Is 2% normal? Is 6% normal? When I started managing money when I switched from equity research to high yield bonds in 1978, the short term rate, the T-bills were 9%.

So I would say that your 6% is not high enough. But of course, thinking about 6% or 9% today when they pay a fraction of a percent seems crazy. So we want to normalize, we just don't know what normal is. Well, I think the one thing that you and I would agree on is that the big mistake today would be to make optimistic assumptions for growth and profitability, and then apply today's low discount rate. That would be a disaster.

We don't want to do the opposite either. We don't want to make draconian assumptions and apply 9% or 6%, because that would be nutty. But I think that we can all agree that interest rates can go up, but not down. But the Fed funds rate is 0%, and the Fed says repeatedly that they're not going to go negative. I think we can agree that the 40-year tailwind of declining interest rates that has lifted the price of all assets is at an end.

JOEL GREENBLATT: I appreciate that, Howard. So just a little bit on this topic-- do you have any thoughts on the amount of fiscal and monetary stimulus that we've seen? Do you think it's too much? Do you think it's going to end well or badly? Do you think it's going to end?

HOWARD MARKS: Well, that's the question. Herb Stein, the great economist, once said that if something cannot go on forever, it will stop. And I think we can't argue with that. The question is, can the Fed keep it up forever? Can the Fed, which seems to have adopted the responsibility to preclude recessions and difficult periods-- can they keep it up forever?

Now, last year, I think the Fed increased its balance sheet by $2.7 trillion, and the Treasury spent $4 trillion that it didn't have to fight the pandemic. We worry about the long term consequences-- the effect on inflation, the value of the dollar, the credit worthiness of the dollar, the acceptability of the dollar in the world. You can't run trillion dollar deficits every year if you can't print an unlimited amount of money is the answer.

Now, Modern Monetary Theory says that for a country that is in control of its currency, deficits and debts don't matter. But the question is, will we remain in control of our currency, able to print unlimited amounts? Will we remain the world's reserve currency forever? I wouldn't think so. Keynes-- kind of a synonym for running deficits is the word Keynesian. Keynesians believe in deficits.

Prior to Keynes 100 years ago, deficits were taboo. So 100 years ago before Keynes, deficits were taboo. Keynes said you should run a deficit in a time of weakness to create jobs and buoy the economy. But then in times of prosperity, you should run surpluses and pay it back. And everybody is fine with the first part, and nobody cares about the last part anymore.

And I think that's questionable. And I think that you can't dump $7 trillion into the economy without any impact. And by the way, it looks like the Congressional Budget Office, I believe, is talking about $3 trillion deficits this year and next year also. And the Fed is still buying bonds at $120 billion a month, which is another $1.5 trillion. So can these things go on-- forget forever, can they go on for three years or five years without impact?

And it's hard to believe that there won't be any ramifications. On the other hand-- and the great thing about the investment business is that there's always another hand-- I believe that the world was headed for a global depression if the Fed, and Treasury, and the world's other central banks hadn't done what they did. And so even though I believe there's a likelihood that these things will have negative ramifications, I think they had to do it anyway. And you can't let the possibility of negative ramifications stop you from doing what you must do.

JOEL GREENBLATT: I would agree with that wholeheartedly, especially with the pandemic. If you tell people to stay home, and don't go to work, and close businesses, and everything else, the Keynesian answer would be, of course, we have to help now. And so I think that's really a no-brainer that we have to do it. What are the repercussions of doing it? I think they're less severe than other types of spending.

So in other words, if we're filling a big hole here, maybe we overfill it. But we spend $5 trillion or $10 trillion-- it's like we're in a war, we have to fight it for whatever reason-- maybe it's survival, whatever. The good thing about a war is that, generally, they end-- same thing with the pandemic. If these were entitlement programs that were going to continue forever, that's one thing. But this is a one time $5 or $10 trillion that we have to plug a hole where the economy falls apart, and people aren't eating, and people don't have money.

A, we don't