Reminders of the Importance of Caution, Credit, and The Joys of Granddaughters

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It’s going to be a granddaughter week so I will be a bit out of the loop for much of the week but before taking my leave to going in search of waterparks, waterfalls, and wonderment, I wanted to share two pieces I read last week that provide a strong backdrop for the markets in the weeks and months ahead.

Howard Marks has once again given investors a masterclass in clear thinking with his August 14, 2025 memo, The Calculus of Value. In his familiar style, he takes what may seem obvious on the surface, the relationship between value and price and unpacks it into a framework that is both deeply useful and timely given current market conditions. The memo was inspired, as Marks often likes to note, by a rare opportunity to think uninterrupted, this time on a flight to South America. The result is a piece that is as relevant for professional investors as it is instructive for individuals navigating markets dominated by sentiment and speculation.

Marks begins by marking a milestone. This year is the twenty-fifth anniversary of his famous bubble.com memo, in which he warned of the excesses leading into the dot-com collapse. He notes that earlier this year he felt valuations were “lofty but not nutty,” but the subsequent seven months of turbulence and renewed exuberance called for an update. The theme of the memo is simple but powerful: investors must distinguish between value and price, and recognize that the market often confuses the two.

“Value is what you get when you make an investment, and price is what you pay for it,” Marks writes, distilling the distinction to its essence. Value is rooted in fundamentals—earnings, assets, competitive positioning, and intangibles such as brand strength. Price, by contrast, reflects what others are willing to pay, a number swayed by optimism, fear, and shifting sentiment. The gap between the two creates both risk and opportunity. When price climbs far above value, risk is high even if optimism feels justified. When price sinks below value, the opportunity exists, though it may not be realized immediately.

In the short term, prices often move more with psychology than with fundamentals. In the long term, Marks reminds us, value exerts what he calls a magnetic pull. Prices tend to converge toward fair value, but the timing is never guaranteed. He quotes John Maynard Keynes to make the point with characteristic bluntness: “The market can remain irrational longer than you can remain solvent.” An undervalued asset can stay cheap for years, just as an overvalued one can continue to climb before fundamentals reassert themselves.

From these reflections Marks builds what he calls the “calculus of value.” It rests on a few core ideas. Price is what you pay; value is what you get. A good investment requires price to be appropriate relative to value. Psychology causes prices to swing far more than value does. Most short-term price changes are driven by sentiment, not fundamentals. And while valuation strongly influences long-term returns—high valuations lead to low forward returns and vice versa—the impact can take years to play out. To invest wisely, one must assess not only valuation metrics but also the prevailing psychology of the market.

The memo then shifts from theory to practice. Marks reviews the valuation landscape as 2025 has unfolded. At the start of the year, the S&P 500 traded at roughly 23 times forward earnings, well above historical norms. History suggests that buying at such levels leads to poor ten-year returns, in the range of 2% or worse. Early 2025 saw markets falter amid inflation concerns and slowing job growth. In April, tariffs announced by the Trump administration knocked the market down further, with the S&P off 15% and Treasury yields jumping toward 4.5%. Then, in one of those sudden shifts of sentiment Marks has spent a career chronicling, the market rallied nearly 30% from April through August, fueled by expectations that tariffs would be softened, by government stimulus, and by renewed optimism about artificial intelligence. The result is that valuations today, in his view, are even less attractive than they were at the start of the year.

Marks points to several warning signs. The ratio of stock prices to sales has reached historic highs. A Barclays “equity euphoria indicator” that measures derivatives, volatility, and sentiment has surged into bubble territory. Warren Buffett’s favored measure of market capitalization relative to GDP is at a record level, even understating the case given the reduction in the number of listed companies. The spread between Treasury yields and stock dividend yields suggests equities are richly priced relative to fixed income. Meme stocks are back in play despite questionable fundamentals, another indicator of speculative excess. And in credit markets, spreads are near historic lows, a sign of complacency rather than caution. Meanwhile, the so-called Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla) now account for roughly a third of the market’s capitalization. Their valuations may be defensible given their dominance, but their weight makes the entire index vulnerable.

Against this backdrop, Marks introduces his “INVESTCON” framework, a tongue-in-cheek borrowing from the military’s DEFCON levels of alertness. At INVESTCON 6, investors stop buying. At 5, they reduce aggressive holdings and tilt toward defense. At 4, they sell remaining aggressive assets. At 3, they trim even defensive holdings. At 2, they eliminate all holdings, and at 1, they go short. Marks makes clear he is not calling for panic or wholesale liquidation. He notes that overvaluation does not mean imminent decline, and timing such moves is impossible. Instead, he suggests that moving to INVESTCON 5 lightening exposure to expensive assets and adding to safer holdings—is a prudent step. In practice, that means shifting portfolios toward more defensive credit investments, which while offering limited upside, present less risk than today’s richly priced equities.

The lasting lesson of The Calculus of Value is not a call to abandon markets but a reminder to stay disciplined in separating price from value. Investor psychology can swing markets far above or below fair worth, but over time, the two tend to converge. With valuations elevated, spreads compressed, and optimism widespread, Marks counsels caution rather than aggression. His advice is as relevant now as when he first warned about dot-com stocks 25 years ago: anchor decisions in value, remain aware of sentiment, and prepare defensively when the crowd appears overly confident.

Apollo’s Mid-Year Credit Outlook: Navigating the Crosswinds

The first half of 2025 has been nothing short of turbulent for credit markets. Tariffs, geopolitics, and fiscal fireworks all weighed heavily at times, but Apollo’s mid-year report makes clear that the credit cycle has not been derailed. Strong corporate balance sheets, steady economic fundamentals, and relentless institutional demand have carried the market through the storm.

The April “Liberation Day” tariff announcement briefly rattled confidence—equities sold off, credit spreads widened, and the dollar hit a three-year low. Yet the rebound was equally swift. By June, the S&P 500 was setting new highs, high-yield spreads had retraced their widening, and investors were once again leaning into fixed income. As Apollo puts it, “the strength in fixed income markets was also underpinned by solid economic fundamentals and supported by strong technicals.”

That combination of fundamentals and technicals has kept credit on solid footing. Second-quarter GDP bounced back to 3% growth, unemployment hovered near 4%, and earnings broadly beat expectations. At the same time, investment-grade yields near 5.2%—close to the top of their 10-year range—drew a flood of demand from insurers, pensions, and annuity providers. With new issuance running well below average, supply has not kept pace. That imbalance has been the engine behind credit’s resilience.

But Apollo cautions that the landscape is shifting. Their economists still expect a soft landing, but they also put recession odds at 25% over the next 12 months, up sharply from earlier in the year. The One Big Beautiful Bill Act and ongoing tariff resets will remain major sources of uncertainty.

Three big themes stand out from Apollo’s outlook.

First, liquidity inequality is reshaping corporate bond markets. Large, recent issues remain liquid and easy to trade, but older, smaller bonds are increasingly stuck in portfolios. The kicker? Investors are no longer being paid a spread premium to hold these illiquid securities. Apollo’s take is blunt: for the illiquid part of public portfolios, “allocating to private credit can allow for a more efficient and intentional use of less liquid capital.”

Second, capital is beginning to shift away from the United States and toward Europe. Outflows from U.S. ETFs in March and April totaled over $500 billion, while European ETFs saw strong inflows. Direct lending in Europe has already outgrown the region’s high-yield and loan markets, yet non-bank finance still makes up just 12% of corporate borrowing versus 75% in the U.S. With regulatory reforms and fiscal expansion creating tailwinds, Apollo argues Europe is one of the most promising private credit markets in the world.

Third, artificial intelligence has become a credit story. What began as an equity-driven theme is now being financed with debt. Hyperscalers have boosted capital spending guidance by more than $70 billion, OpenAI’s $500 billion “Stargate” supercomputer project is underway, and companies like xAI and Databricks are tapping bond and loan markets. Apollo calls this “an expanding investable universe for credit,” though they warn investors to underwrite carefully given the disruption AI may unleash across industries.

The overarching message is one of resilience tempered with caution. Fundamentals are intact and technicals remain supportive, but liquidity fragmentation, shifting global capital flows, and the rise of AI are rewriting the rules of credit investing. In Apollo’s words, “the trick for investors will be to identify where durable value is being created and at whose expense before the magic becomes obvious.”

Be cautious and focus on credit. I am pretty sure I have heard that somewhere before…