Howard Marks — investor Photo by Hunters Race on Unsplash
I’ve always viewed books as a conversation with the author. The real value in a book, especially non-fiction, isn’t simply in the entertainment value — although no one reads anything without first being entertained. The real value is in the ideas presented. The world of concepts. As someone who deeply appreciates a good idea, the thoughts put forth by an author are really what I’m after. So, when an author presents a few profoundly good ideas, I am thoroughly engaged.
Such is the case for the book, Mastering the Market Cycle, by the preeminent investor Howard Marks. In the book, Marks articulates a few ideas that are worth their weight in gold. These ideas stem from much deeper streams of thought developed through Mark’s own wealth of experience as an investor and his communing with other investors and economists, the likes of whom include John Kenneth Galbraith and Sir John Templeton.
Marks articulates his ideas with the kind of steady confidence of someone throughly steeped in experiential knowledge. The things he writes about are the things he has used to find success in the markets — as his $2.1 billion net worth certainly attests to.
Surprisingly, however, his fundamental ideas aren’t complicated. Instead, throughout the chapters of the book, he crystalizes every idea down to the simplest of principles and supports them with clear rationale and concrete thinking.
By the end, I was convinced of the soundness of his ideas. And, perhaps more importantly, I understood clearly how to apply the ideas to my own investment practices.
The Role of Emotion/Psychology
One of Marks’ first arguments is that the emotion of investors is one of the fundamental causes of the frenetic swings of the market. As he opines:
“One of the most time-honored market adages says that “markets fluctuate between greed and fear.” There’s a fundamental reason for this: it’s because people fluctuate between greed and fear.”
Here, the point Marks’ makes is that investors base their decisions on their emotions, which at their core are fundamentally irrational. Inevitably, all investors, the trained professional and naive lay person alike, are chained to the irrational swells of human emotion, which rock back and forth eternally between greed, optimism, credence, and faith on the upswell and fear, pessimism, and skepticism on the swing back down.
As Marks intimates,
“People have feelings, and as such they aren’t bounded by inviolable laws. They’ll always bring emotions and foibles to their economic and investing decisions. As a result, they’ll become euphoric at the wrong time and despondent at the wrong time — exaggerating the upside potential when things are going well and the downside risk when things are going poorly.”
The Managing of Risk
Marks also points out that one of the central points of confusion among investors is the consideration of risk. He points out that risk is a concept most people, and by virtue most investors, are either unaware of or are unprepared to deal with. In his chapter on risk, Marks defines risk as “uncertainty with regard to future developments, and the possibility of bad outcomes.”
The difficulty here lies in the fact that the future can’t be known with any degree of certainty. You, as the investor, can’t know with certainty that an asset, security, or other investment will indeed produce the projected return. Things inevitably can, and indeed often will, go wrong. When you choose to take on an investment, you agree to bear that uncertainty in exchange for the promise of future profit. That is risk.
Marks’ central point here is that most investors are bad at gauging this risk. Just as with the pendulum of emotion, most investors swing from being too risk-tolerant to being too risk-averse.
Investors’ level of risk tolerance generally follows the swing of emotion, and just like emotions, can be wildly off-base from reality.
The Credit Cycle
After laying the basic foundation of investor psychology and risk tolerance, Marks transitions into a discussion of two other cycles, namely the credit cycle and distressed debt cycle. In his discussion of these cycles, he makes the profoundly important point that not all cycles have the same effect on the overall market. As he explains, some cycles are highly responsive to swings in other cycles; some are not. Likewise, some cycles have an outsized effect on the state of other cycles, and some do not.
Highlighting this, he points out that the credit cycle is the type of cycle that both swings wildly with other cycles and has a profoundly large effect on those other cycles.
As such, the credit cycle is highly volatile and likely to change at any moment. Small changes in other cycles, for instance a slight rise in the price of oil, can scare banks and creditors into tightening their lending criteria, thus reducing the availability of credit. Reduction in credit availability, in turn, can send markets into a frenzy, as well as investors’ moods.
Thus, Marks’ main point is that the credit cycle can change in an instant, and when it changes, you should be ready for a change in all the rest of the markets as well. As he puts it:
“It’s essential to always bear in mind that the widow can go from wide open to slammed shut in just an instant…that’s the bottom line.”
There is much more contained in Marks’ deeply informed book. If you want to think deeper about his central points of view (and you should), you should buy the book and perhaps read it twice. The points he makes are essential for success in any kind of investing, whether in the stock, bonds, real estate markets, or beyond.
At the very least, take away these three points from this article:
- Investors are chained to the swings in their emotions. Inevitably, investor emotion will swing on a never-ending pendulum from greed to fear. Their decisions will be influenced by the swings of the pendulum.
- The swings in emotion affects investors’ ability to calculate and manage risk. When investors are greedy, they underestimate risk. When they are fearful, they overestimate risk.
- Swings in one cycle can affect other cycles. Thus, the credit cycle can fluctuate rapidly and can have an outsized affect on all other cycles affecting the market.
I hope you found this article helpful in some way. More importantly, I hope you see the import of Howard Marks’ few simple ideas and understand just how valuable they are.