Howard Marks is co-chairman and co-founder of Oaktree Capital
Management, an investment manager with more than $120 billion in assets
under management. How smart is Marks and how sound is his judgement?
Charlie Munger once said: “I probably know Howard Marks as well as I
know anybody and he is a very smart man….[For example] you have to
believe in the tooth fairy to believe [Bernie Madoff] was having those
figures by the methods he claimed to be using. You wouldn’t have gotten
that one by Howard Marks for two seconds. I mean you wouldn’t have
finished your sentence before he noticed it couldn’t be true. But people
don’t think like Howard Marks.”
Marks said in a recent Barry Ritholtz podcast that he believes:
“Recognizing and dealing with risk and understanding where we are in the
cycle are really the two keys to success.” In a masterful review of Mastering the Market Cycle, Jason Zweig writes:
Mr. Marks admits his book is a kind of tug of war between his certainty
that “we don’t know what the future holds” and his belief that “we can
identify where the market stands in its cycle.” By studying how the
economy, the markets and the psychology of investors all move in long
cycles of expansion and contraction, Mr. Marks and Oaktree have been
better able to cut back risk near market peaks and ramp it up near
market bottoms, he says. But Mr. Marks doesn’t think you can use that
sort of understanding to go all in or all out of markets again and
again. He likes the book’s subtitle—“Getting the Odds on Your
Side”—better than its title, he quips. “Recent performance doesn’t tell
us anything we can rely on about the short-term future,” he says, “but
it does tell us something about the longer-term probabilities or
tendencies.”
It is worth reading what Zweig wrote above is his review of the book at least twice since it represents the core message of Mastering the Market Cycle.
Marks explains in his new book that by doing things like reading
widely, studying history and paying close attention to the state of the
world right now, an investor or business person can be generally aware
of where the cycle might be even though they can’t predict precisely
when it will shift in the short term. By doing this work an investor or
business person can increase their margin of safety by “getting the odds
on their side.” Marks believes that the right way make this analysis is
to think probabilistically.” Marks suggested in an interview with Zweig
that investors calibrate their exposure to risk using: “a continuum
from 0 to 100, he says, with 0 being completely out of the market and
100 being completely in using aggressive techniques like investing with
borrowed money.” Having said that, Marks is very wary of attempts to
quantify probability given risk, uncertainty and ignorance. He writes in
his latest memo:
“while they may not know what lies ahead, investors can enhance their
likelihood of success if they base their actions on a sense for where
the market stands in its cycle….there is no single reliable gauge that
one can look to for an indication of whether market participants’
behavior at a point in time is prudent or imprudent. All we can do is
assemble anecdotal evidence and try to draw the correct inferences from
it.”
Making this determination requires judgment and there are no recipes
for success. An investor has a lot of information about the past and the
present, but by definition has zero information about the future. Marks
describes this tension by writing in his latest memo: “While the
details of market cycles (such as their timing, amplitude and speed of
fluctuations) differ from one to the next, as do their particular causes
and effects, there are certain themes that prove relevant in cycle
after cycle.” Given this reality, how does an investor or anyone making a
decision in life “get the odds on their side”? One of the most
important themes of Mastering the Market Cycle is
reflected in a quote attributed to Mark Twain: “History doesn’t
repeat itself, but it often rhymes.” Marks believes that if you read
widely and pay attention to what is happening in the world by reading
and doing the right research is it possible to see patterns that can
inform an investor about the current state of the cycle. Charlie Munger
is quoted as saying in a blurb for the new book: “There’s no better
teacher than history in determining the future.’ Howard’s book tells us
how to learn from history . . . and thus get a better idea of what the
future holds.” The words “better idea” are critically important part of
that Munger quote are since the objective is find opportunities that
reflect favorable odds since decision making certainty is simply not
possible to achieve. What Marks is saying is that having the same degree
of conviction about all of opinions is dangerous. In an excellent
podcast interview with Tim Ferriss, Marks pointed out that: “Nobody ever
says, “My opinion is X, and I think I’m wrong.” We all think that our
opinions are correct.” It is one thing to have an opinion, but quite
another to believe that it is necessarily right.” Marks believes in the
value of humility in relation to the markets as he notes here:
There are two things I would never say when referring to the market:
“get out” and “it’s time.” I’m not that smart, and I’m never that sure.
The media like to hear people say “get in” or “get out,” but most of the
time the correct action is somewhere in between. Investing is not black
or white, in or out, risky or safe. The key word is “calibrate.” The
amount you have invested, your allocation of capital among the various
possibilities, and the riskiness of the things you own all should be
calibrated along a continuum that runs from aggressive to defensive.
Tim Ferriss just recently posted a fantastic podcast with Mark on this web site in which Howard Marks gives this answer:
One of those most important things is knowing where we stand in the
cycle. I don’t believe in forecasts. We always say, “We never know where
we’re going, but we sure as hell ought to know where we are.” I can’t
tell you what’s going to happen tomorrow, but I should be able to assess
the current environment, and that’s the kind of thinking that helped us
prepare for the crisis. I think that the two most important things are
where we stand in the cycle and the broad subject of risk, and in fact,
where we stand in the cycle is the primary determinant of risk.
What Getting the Odds on Your Side means
is that we don’t know what’s going to happen – nobody can tell you –
but there are times when the outlook for the future is better and there
are times when it’s worse, and it’s largely determined by where we stand
in the cycle. When we are low in the cycle – that is to say, we’re
coming off a bust – the economy is starting to warm up. Investors are
just barely starting to switch from pessimism to optimism and prices are
starting to rise. Clearly, the odds are in your favor. The outlook is
better. It doesn’t mean you’re going to make money, but the chances are
good.
On the other hand, when the upcycle has gone on for a long time, when
valuations are high, when optimism is rampant, when everybody thinks
everything’s going to get better forever, when the economy has been
moving ahead for 10 years and it looks like it’s never going to stop,
then usually, the enthusiasm has carried the prices to such a high level
that the odds are against you. Just knowing that is a huge advantage in
investing. You should know that when we’re low in the upcycle, that’s a
time to be aggressive, put a lot of money to work, and buy more
aggressive things, and when the cycle has gone on for a long time and
we’re elevated, that’s the time to take some money off the table and
behave more cautiously.”
The link to this Tim Ferriss interview of Howard Marks is in the End
Notes to this blog post as is usual. I highly recommend reading the
podcast transcript or listening to it. I did both. Twice.
Why economies cycle between better and worse performance is something Marks has thought about a lot. In Mastering the Market Cycle he
writes: “The themes that provide warning signals in every boom/bust are
the general ones: that excessive optimism is a dangerous thing; that
risk aversion is an essential ingredient for the market to be safe; and
that overly generous capital markets ultimately lead to unwise
financing, and thus to danger for participants.” Marks quotes a Warren
Buffett on this point: “The less the prudence with which others conduct
their affairs, the greater the prudence with which we must conduct our
own.”
What Marks say about the cause of the great financial crisis is a great
illustration of what he writes about in this new book. Starting in 2005
and 2006 Marks and his partner Bruce Karsh started to see deals get
done on terms that were a “piece of crap.” That investors were buying
the offerings anyway made the two partners conclude that something was
wrong. Marks admits:
… you can prepare; you can’t predict. The thing that caused the bubble
to burst was the insubstantiality of mortgage-backed securities,
especially subprime. If you read the memos, you won’t find a word about
it. We didn’t predict that. We didn’t even know about it. It was
occurring in an odd corner of the securities market. Most of us didn’t
know about it, but it is what brought the house down and we had no idea.
But we were prepared because we simply knew that we were on dangerous
ground, and that required cautious preparation.
This graphic below appears on page 216 of the new book. It is a graphic
representation of why Marks believes that there is value in knowing
roughly where the cycle might be even if you can make short term
forecasts about where it is going. Marks explains:
“Since market cycles vary from one to the next in terms of amplitude,
pace and duration of their fluctuations, they’re not regular enough to
enable us to be sure what’ll happen next on the basis of what has gone
on before. Thus from a given point in the cycle, the market is capable
of moving in any directions, up flat or down. But that does not mean
that all tree are equally likely. Where we stand influences the
tendencies or probabilities, even if it does not determine future
developments with certainty…. Assessing our cycle position doesn’t tell
is what will happen next, just what’s more or less likely. But that’s a
lot. “
Marks is not the only person who thinks in terms of cycles. Ray Dalio,
who writes a very favorable blurb for the new Marks book, believes: “In
the business cycle, [a recession] that happens when capacity is
constrained and inflation is accelerating and tightness of monetary
policy … the long term debt cycle I think is pretty stretched.” One of
the cycle charts Dalio uses is:
In his first book The Most Important Thing (which had sale to date of more than 750,000 copies) Marks wrote:
“Cycles will rise and fall, things will come and go, and our
environment will change in ways beyond our control. Thus we must
recognize, accept, cope and respond. Isn’t that the essence of
investing?” “Processes in fields like history and economics involve
people, and when people are involved, the results are variable and
cyclical. The main reason for this, I think, is that people are
emotional and inconsistent, not steady and clinical. Objective factors
do play a large part in cycles, of course – factors such as quantitative
relationships, world events, environmental changes, technological
developments and corporate decisions. But it’s the application of
psychology to these things that causes investors to overreact or
underreact, and thus determines the amplitude of the cyclical
fluctuations.” “Investor psychology can cause a security to be priced
just about anywhere in the short run, regardless of its fundamentals.”
“In January 2000, Yahoo sold at $237. In April 2001 it was $11. Anyone
who argues that the market was right both times has his or her head in
the clouds; it has to have been wrong on at least one of those
occasions. But that doesn’t mean many investors were able to detect and
act on the market’s error.” “A high-quality asset can constitute a good
or bad buy, and a low-quality asset can constitute a good or bad buy.
The tendency to mistake objective merit for investment opportunity, and
the failure to distinguish between good assets and good buys, gets most
investors into trouble.” “It has been demonstrated time and time again
that no asset is so good that it can’t become a bad investment if bought
at too high a price. And there are few assets so bad that they can’t
be a good investment when bought cheaply enough.”
Marks doesn’t believe anyone should have the same degree of conviction
about all of their opinions. To combat a tendency to think in binary
terms he advocates that people calibrate risk. Marks recommends thinking
about the future as a probability distribution. As an aside, Marks has
said he first encountered probability distributions at a World’s Fair in
Flushing New York just as I did at the Seattle World’s Fair. In each
case there was an exhibit at the fair that dropped balls from the top of
a box with regular spaced pegs pegs in it and the resulting cascade
produced a bell curve distribution as in the picture below.
What the display at the fair did not teach us is that often the
distribution is not a bell curve and that these cases can be
extraordinarily important. People like Mandelbrot and Taleb would arrive
later and help us understand their impact. Charlie Munger describes
what can go wrong:
What they did was, they said, ‘Well, financial outcomes in securities
markets must be plottable on a normal curve,’ – [a] so-called Gaussian
curve, named for probably the greatest mathematician that ever lived.
Gauss must be turning over his grave now with what’s happening. Of
course, the math was very helpful because you could come up with numbers
and results that would make people feel confident with what they were
doing. There was only one trouble with the math: The assumption was
wrong. Financial outcomes in securities markets are not plottable. It is
not a law of God that outcomes in securities prices will fall over time
on a curve and [follow] reality according to Gauss’s curve. Quite the
contrary, the tails are way fatter…. People were actually making
decisions about how much risk to take, based on the application of
correct math, based on an assumption that wasn’t true. And by the way,
people gradually knew it wasn’t true.”
Marks tells a great story about one situation when he and his partner
were worried about buying distressed asset after the great financial
crisis. They eventually decided to keep buying assets and distressed
prices since if the prices did not recover nothing really mattered
financially anyway. This presented a situation with a huge potential
upside and a very small down side from the investments (optionality). On
the subject of today’s markets, Marks believes that the baseball inning
analogy he has used several times is not a good one since there is no
set number of innings when it comes to the cycle. His most current
statement on valuation is:
“equities are priced high but (other than a few specific groups, such
as technology and social media) not extremely high – especially relative
to other asset classes – and are unlikely to be the principal source of
trouble for the financial markets…. Oaktree’s mantra recently has been,
and continues to be, “move forward, but with caution.” The outlook is
not so bad, and asset prices are not so high, that one should be in cash
or near-cash. The penalty in terms of likely opportunity cost is just
too great to justify being out of the markets.”
One of my favorite parts of the Tim Ferriss podcast is when Marks makes
a point that has been a consistent theme of this blog: “there are many
ways to invest; there are many people who engage in activities that I
think can’t be done, and there are many people in each one who do very
well. I don’t say mine is the only way. Venture is an example.” Marks
agrees with Charlie Munger on the importance of “the discipline of
mastering the best that other people have ever figured out. I don’t
believe in just sitting down and trying to dream it all up yourself.
Nobody’s that smart.” During a lunch with Marks Munger once said: “It’s
not supposed to be easy. Anyone who finds it easy is stupid. There are
many layers to this, and you just have to think well.” But it can get
easier if you work hard and stay humble by recognizing what you do not
know. As Michael Mauboussin likes to say: “the best long-term performers
in any probabilistic field — such as investing, sports-team management,
and pari-mutuel betting — all emphasize process over outcome.”
Speaking of probabilistic bets, Marks believes that the best games for
improving decision-making involve uncertainty and ignorance. Annie Duke
explains:
Trouble follows when we treat life decisions as if they were chess
decisions. Chess contains no hidden information and very little luck.
The pieces are all there for both players to see. Pieces can’t randomly
appear or disappear from the board or get moved from one position to
another by chance. No one rolls dice after which, if the roll goes
against you, your bishop is taken off the board. If you lose at a game
of chess, it must be because there were better moves that you didn’t
make or didn’t see. You can theoretically go back and figure out exactly
where you made mistakes.
Marks meets with Munger now and then and I wish he would write a post
about Charlie. Marks describes what makes Munger so interesting and
effective as an investor as follows:
“The main thing is that he has read more broadly. He’s had another 22
years to read further, and he was probably always a broader reader than I
was, and so it’s his ability to call on these references. In a way,
it’s kind of silly to think that we can reinvent all the wisdom in the
world. It’s great to borrow from others, and Charlie does that broadly,
and I try to do it, but he just knows more.”
Marks has over 100 memos on his web site. And he says: “The price is
right, since it is free.” When asked by Barry Ritholtz why he writes,
Marks responded:
“For ten years I never had a response [to my memos]. Not only did
nobody say they thought they were good, nobody even said that they got
it. The interesting question is: What kept me going? I have no idea. The
answer I think is that I was writing for myself. Number one, it is
creative and I enjoy the writing process. Number two, I thought that
the topics were interesting. Number three, writing helps you tighten up
your thinking.”
My motivation in writing over a million words on this 25IQ blog is the same. I would be writing even if no one was reading.
Calvin comments
What Getting the Odds on Your Side means
is that we don’t know what’s going to happen – nobody can tell you –
but there are times when the outlook for the future is better and there
are times when it’s worse, and it’s largely determined by where we stand
in the cycle. When we are low in the cycle –
that is to say, we’re coming off a bust – the economy is starting to
warm up. Investors are just barely starting to switch from pessimism to
optimism and prices are starting to rise. Clearly, the odds are in your
favor. The outlook is better. It doesn’t mean you’re going to make
money, but the chances are good.
THAT IS WHY THE ODDS ARE IN OUR FAVOUR TO BUY OIL AND GAS STOCKS WHEN PETRONAS IS INCREASING CAPEX FOR OIL AND GAS UPSTREAM
AND PH GOVT RECEIVED REVENUE BOOSTER FROM PETRONAS RESTARTS ECRL & OTHER INFRAR PROJECTS TO BUY ECRL RELATED THEME
THE 3RD LINK IS CHINA BUYING MORE PALM OIL FROM MALAYSIA IN THE ECRL PACKAGE GOOD FOR CPO STOCKS
RISING CRUDE OIL PRICE ALSO A BOOSTER FOR BIODIESEL USE - WILL BOOST PLANTATION STOCKS LIKE TDM & JTIASA
BEST REGARDS
Calvin Tan Research
Singapore
https://klse.i3investor.com/blogs/www.eaglevisioninvest.com/201673.jsp
https://klse.i3investor.com/blogs/www.eaglevisioninvest.com/201673.jsp
