The Tell: Market valuations look vulnerable if Fed withdraws support, says billionaire investor Howard Marks

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Markets are in a world of trouble when the Federal Reserve eventually rolls back its support to Wall Street.

That’s from Howard Marks, the billionaire investor and co-chairman of Oaktree Capital Management, who worries corporate credit markets will come under pressure once again if the Fed steps back.

“Those of us in markets believe that stocks and bonds are selling at prices they wouldn’t sell at if the Fed were not the dominant force. So if the Fed were to recede, we would all take over as buyers, but I don’t think at these levels,” said Marks, in an interview with Bloomberg TV.

Marks added plenty of companies were outside of the scope of the Fed’s aid.

“There are large, highly levered companies and investment vehicles that the government and Fed rescue program is not likely to reach and take care of,” he said.

Known as a proponent of buying when markets give into fear, Marks added to his holdings of corporate bonds in mid-March when investors panicked over how businesses would make interest payments when cash flows narrowed to a trickle, but stopped once the Fed’s interventions allowed embattled companies like cruise line Royal Caribbean RCL, +17.94% and aircraft manufacturer Boeing Inc. BA, +10.37% to sell bonds.

See: Here’s how billionaire investor Howard Marks is telling clients to ride out coronavirus volatility

To be sure, the central bank has not bought corporate bonds directly from issuers yet. The Fed’s announcement that it would set up emergency facilities to buy IOUs from U.S. businesses was enough to arrest the tumult in corporate credit markets.

“We haven’t actually had to lend anyone any money because now the markets are working because the markets know that we’re there,” said Fed Chairman Jerome Powell, in an interview with CBS on Sunday.

Borrowing costs for U.S. corporations have fallen dramatically, pushing the prices of their bonds higher and narrowing the yield premium those bonds offer over risk-free Treasurys.

This premium, or the credit spread, is down to 2.20 percentage points, after blowing up to a nearly eleven year high of 4.01 percentage points on March 23. Bond prices move in the opposite direction of yields.

The iShares iBoxx $ Investment Grade Bond exchange-traded fund LQD, +0.35% is up 0.8% year-to-date, compared with an 8.6% drop for the S&P 500 SPX, +3.06% and 14.1% decline for the Dow Jones Industrial Average DJIA, +3.55% over the same stretch.

Marks also worried the Fed’s support was encouraging market participants to take more risk than they could bear by themselves as investors count on the Fed to provide a backstop to corporate credit.

At the same time, Marks acknowledged the importance of the Fed’s intervention, even if it did have “unforeseen negative consequences.”

“Thank god it did what it did,” he said.

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