«Market conditions make this a time for caution»
Howard Marks, Co-Chairman of the US investment firm Oaktree Capital, speaks about his new book and reveals how investors can master the market cycle.
Few investors get paid such deep respect as Howard Marks. The Co-founder and Co-Chairman of the Los Angeles based investment boutique Oaktree Capital not only stuns Wall Street with his exceptional track record, but he’s also highly regarded for his sober-minded notes on the ever-changing moods of the global financial markets. The essence of his investment philosophy is unveiled in his new book, entitled «Mastering the Market Cycle: Getting the Odds on Your Side». It was released earlier this month, is well written and belongs in the library of every prudent investor. During our conversation, the legendary value investor addresses the recent turmoil in stocks and bonds, explains why conditions demand a defensively calibrated portfolio, and reveals how investors can successfully position themselves in the market cycle.
Mr. Marks, when you speak, investors around the globe listen up. What’s the key to your investment strategy?
I believe that everything an investor can try to do to improve performance falls under one of two headings: Asset selection and cycle positioning. Asset selection consists of owning more of the things that will do better and less of the things that will do worse. Cycle positioning consists of having more investments and more aggressive investments when the market is poised to do well and fewer investments and more protective investments when the market is poised to do poorly.
That sounds quite simple. But how does cycle positioning really work?
Let’s assume your goal is to have defense at the right time and offense at the right time. There are two possibilities to achieve that: Number one, have a forecast of what’s going to happen. You can do this by predicting psychology and guessing at how people are going to feel about things a year from now: How they will feel about the market, the economy, company performance, the administration in Washington and so forth. But I do not think that this can be done successfully.
Why?
Because our world is too uncertain to permit certainty. We don’t know what’s going to happen and we don’t know how the market is going to react to it. Let’s go back two years to October of 2016. There were two things most investors were certain of: Hillary Clinton would win the presidency and, if by some fluke Trump won, the market would crash. But what happened was Trump won, and the market went up. If that’s not enough to convince you that forecasts don’t work I don’t know what will.
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Many investors were also taken by surprise by the recent setback in the stock market. What are your thoughts on the latest financial markets turbulences?
Just a month ago, everything was «cool». Everybody said, «the economy is good, companies are doing well, the tax cuts make everybody rich, and we’re settled with the North Koreans». But then the market had a few very bad days and the main explanation was because long-term interest rates picked up. But how could this have come as a surprise? The Federal Reserve said three or four years ago that interest rates should go up. They have been raising rates on the short end and it shouldn’t be a surprise that the rates on the long end finally woke up and started going up. And yet, if it’s expectable as it should have been, how can it be the source of so much volatility? To me, that just shows you how nutty the market is.
What can investors do to make better investment decisions?
As I make the case in my new book, you have to have a sense for where the market stands in its cycle. That’s what’s determines the odds. When the market is attractively positioned, low in its cycle, then the expected return is above average, and you want to play offense. In contrast to that, when the market is unattractively positioned, high in its cycle, then the expected return is below average, and you want to play defense. When you get this judgment right, then your results will be better than average.
But how exactly do you do that?
The main factors which influence where the market is in its cycle are fundamentals and investor psychology. The market tends to reflect how the economy has been doing and how companies have been doing. But most investors think naively that if good things happen, stocks will go up, and if bad things happen, stocks will go down. But sometimes the opposite is the case. If expectations are too high you can have good things happen, but investors are disappointed, and stocks go down. Or, you can have unpleasant events but if they’re not as bad as expected the market can go up. Every event can be interpreted positively or negatively. For instance, rising interest rates can be a bad thing because it could crush businesses. But it also can be viewed as a good thing because it signals that the economy is strong.
Why is investor psychology so important?
Investors are not good at taking all the factors into account and balancing them. Usually they look only at the positives or only at the negatives. I made this point in my memo from January 2016 entitled «On the Couch»: In real life, things fluctuate between «pretty good» and «not so hot». But in the market, attitudes fluctuate between «all good» and «all bad». That’s what happened a few weeks ago when interest rates on the long end started to rise. So it’s not enough to know what you think is going to happen event-wise. You also have to think about psychology and emotion, because where the market stands and what the market does is the result of the interaction of what events occur and how people react to them. If you can understand what expectations are factored into the market and where emotion and psychology stand, then you have a better chance of getting the odds on your side....
