Howard Marks: Mastering the Market Cycle

all right well Howard thank you so much for spending time with us today your new book is called mastering the market cycle getting the odds on your side you know it contains very few numbers in it there's one of the first things I noticed not too many graphs no Greek symbols that I that I can recall how do you think investors should become better at determining where we are in the market cycle well I think you really have to understand what produces cycles and I go through examples of what led up to the tech bubble and and the subprime bubble and the unwinding of the subprime bubble and so forth and I go through these progressions step by step but to give an appreciation as you say it's not science it's not numbers it's not formula it's understanding developments in the real world and how they occur and and and how the elements combine to produce those cycles and and only by having an appreciation for the workings of these things not by expecting to be given a formula that you can plug and play can investors perfect this essential skill you know when I read this book I saw or thought of one word over and over and you've used this also in your in your memos and that is temperament I once had a really fun conversation with with Daniel Kahneman who won a Nobel Prize for his work in behavioral finance and he spoke about how he actually panicked during the financial collapse and sold everything how how do you think that one becomes more unemotional about investing well that's a great question you know in my first book most important thing I talked about the second level thinking the need to think different from others and better and people ask me well how do you become the second level thinker and I would apply the same answer - how do you become less emotional the first answer is as they say in basketball you can't coach heightened and you know no matter how good the best will coach is his players are not going to get any taller so you know the improvement has to be intentional and the first thing you can learn is why it's important to be on emotion and why emotionality is the enemy of the investor why human emotion conspires to constantly make investors do the wrong thing then the second step is to do it and I I think probably many more people can understand the need for it then can actually apply it but you know you don't have to apply it perfectly you only have to do a better job than you used to do and and I think most people should be able to attain that skill yeah and you know the I think the very interesting thing when you think about market cycles is that they're very real things of course but it's not like these things are they're not naturally occurring they are entirely driven by human behavior maybe a good piece of background would be you know for you to describe what you think actually causes market cycles sure and to reinforce what you just said let me point out that you know starting at the University of Chicago in the 60s people even before the computer age figured out what the return on stocks had been and since 29 to 62 I think they did the work nine point two percent and it's been extended since then and so stocks return nine ten percent a year on average for long periods of time we know that I think they've never actually returned exactly nine twenty two point that's right and the point I was gonna make is that they rarely return between eight and twelve yeah many more observations are outside of the eight to twelve range then inside it so the you know my first observation is the average is not the norm and so why is it if stocks return 12% a year on average why don't they just return 10% III don't know if I said 12 but it stocks return 10% a year on average why don't they just return 10 every year and the answer the biggest answer is emotional excesses to the upside which then require correction to the downside if you think about the value of a company and what it's going to be worth in 50 years that does not change very much from day to day week to week month to month even year to year it's pretty stable you know and the changes in this year's or this quarters earnings are not that important but people react excessively to these things and we want to be on the right side of those reactions and not the wrong so when things are going well the economy is humming and corporations are doing well they're reporting earnings which exceed on the upside the media are issuing only positive reports and interpreting the news positively the prices are going up for every day people feel terrific they love the things they hold they want to go out and buy more the only people who are unhappy are the people who don't hold they want to buy for the first time all of these things together produce rising optimism and rising u4u and greater self satisfaction and consequently higher prices new so the as the prices rise the emotion turns more positive until you reach the top when the price is at its maximum and the emotion is at its maximum now that's when you want to be selling when the price is high and by definition very - people do because they are feeling so positive and of course the reverse is true in the opposite direction and I will not belabor it but at the bottom the price reaches its minimum at the same day that the investors are the most depressed and the most unlikely to buy so so you know we must do the opposite we must stand against the herd we must stand against mass psychology we must sell when fundamentals are at their peak and emotions are the most positive and we must buy when fundamentals are at the trough and people are most depressed it's and I'm sorry please please man and so you know the goal is to buy low and sell high more people buy high than buy low we want to be different from most people we have to understand what's going on we have to understand why people are doing what they're doing you have to understand what's wrong about it and you must be able to stand against it so it's it I think we would maybe best describe the market as being one part psychology and the other part path dependency probably right you know yeah and the psychology part is very important and the people who learn financial analysis in school don't learn much about psychology and this is but this is the thing that's really going to determine whether you have good days or bad days yeah I love that you said that because you know as I've looked through your background and I've read I've read your memos for for four decades now and I and and they were an absolute gift to me but as I was reading this book I remember I'm I'm reminded of the fact that you you have a fairly formal traditional finance education having gone to Wharton and the University of Chicago but when I read this book and when I read your memos I feel like I'm reading the works of a history major in particular in your focus of tendencies over predictions yeah yeah well you know I started 50 years ago the summer and I've seen a lot and I've seen a lot of mistakes made and if you have your eyes open and you are conscious of what's going on you learn from mistakes and you you put together a view of the world which can be helpful and you know I started in 68 at Citibank and Citibank and most of the banks were what we called misty 50 buyers mm-hmm they bought the stocks of the 50 greatest fastest-growing companies in America to which nothing bad could happen well number one a lot of the companies to which nothing bad could happen had bad things happen so much for predicting the future but number two because the companies were so highly rated they were extremely highly priced and if you joined when I did in 68 and you bought those 50 stocks and you held them diligently for five years you lost almost all your money you know not because in every case the companies were troubled but because in every case they had been overrated psychology had been too positive leading to excessive pricing which then the air went out of the balloon so you know it's not what you buy that makes you a successful investor it's what you pay for it and what matters most is not the quality of the asset but the relationship between the price and the intrinsic value and you you get bargains you get easy safe profits by buying things for less than they're worth and if you pay more than they're worth you're going to have a trouble ringing out a profit so relationship betrays in value what determines that emotion no not what's going on but how are people reacting to what's going on how much are they paying for the fundamentals that are present in that situation and so I think it's extremely important to understand the I sum it up with the word of motion but that's an oversimplification you want to some you want to understand what's going on in people's minds and emotions when they price assets and you want to buy the ones they're under pricing and sell the ones they're over pricing you want to buy the market when it is under priced and you want to sell it when it's over priced I love that you've made this point and I do want to challenge something because a lot of people who will be reading and listening to this will think that what you are talking about is market timing but you're not you're not talking about getting in and out of the market at the right time you're not talking about reading the tea leaves and thinking about the trade sanctions in China and pulling out of certain parts of the market you are you are talking about focusing on the areas where there is opportunity based on based on what is out there and where the market sits at any given point in time exactly nothing in the book nothing that we do at oaktree is based on forecasts what I say about an you know I am strongly opposed to facing the investing on forecasting and what I say is we never know where we're going but we sure as hell or to know where we are know where is the market Indian cycle is it depressed or elevated when it's depressed the odds are in the buyers favor and when it's elevated the odds are against him and it's really as simple as that and you know we should your your listeners should distinguish between markets that are high in their cycle and markets that are low they should vary their behavior on that basis they should take more risk when the market is low in its cycle less risk when the market is high in its cycle this is not saying you know who's going to win the election hmm what will the earnings be when we'll rates be increased you know so many people ask me for so many years what month is the interest rate increase going to take place and I would say why do you care that's not what matters what matters is whether interest you're going up or down whether it's going to go up a lot or a little and people don't understand how money is made you know they think that knowing which month the interest rate increase is going to take place is going to make money and that's not what it's about it's it's about investing more and more aggressively when the market is propitious and less and more conservatively when the market is precarious yeah you know I to me there is so much voodoo that that gets thrown about when it comes to them to the market so I'm gonna take a little bit of risk of a risk here and think you know I believe that we are perhaps kindred spirits but it drives me to the point of insanity when pundits who ought to know better either credit or blame for performances of the stock market or the credit markets based on who happens to be sitting in the Oval Office yeah how do you think that people should put either political conditions or macroeconomic events into the context of market cycles themselves well it's it's obvious complex and by the way let's go back two years ago to October of 16 everybody in America or I shouldn't say everybody but most people believe two things number one that Hillary Clinton would win the presidency yeah and number two if Donald Trump did the market would collapse so instead Hillary lost Donald 1 and the market soared so I think that mere fact should be enough to convince most people that they don't know what events are going to happen and they don't know how the market is going to react to the events that happen you would think and and so but having said that how do you factor in politics all things being equal it is more favorable for the market that we have a president who is extremely pro-business and I think clearly Donald Trump is and is a illustration and Hillary would not have been to the same extent and Hillary would have been under pressure from the progressive wing of her party to actually be somewhat possible business and and so this is going to continue with the Trump administration all things being able that'll be a positive now that doesn't mean it's always what's all good among other things or that it's not already in the market correctly yeah I was just gonna say that good you're absolutely right so you know one of the biggest mistakes that most people make and you and I were talking a minute ago about the boo do one of the biggest mistake people make is they sit here and they say I think there will be positive events which means I think the market will go up and that identity is not dependable because maybe there will be positive events but maybe they're already priced into securities in which case they'll be a big yawn or maybe there will be positive events but not as positive as were factored in when stocks were priced which means you'll get a positive event and the stocks will go down so you know as I say predicting these events and predicting the market's reaction to them is is a very thorny yeah so I wanted to talk a little bit about a point in time where you as a practitioner were and and and your group in oaktree were absolutely countered to the market which was in 2008 in which throughout you know throughout the markets the stock market the credit markets there was a great deal of of unrest and uncertainty and and oaktree was aggressively buying what was it that led you to commit capital at that time well number one we had prepared for the global financial crisis ironically we really didn't hang it on subprime mortgages but we had a feeling that the market that the world was becoming a risky place it characterized by risky behavior yeah and I wrote a memo called the race to the bottom in February o7 which cataloged and discussed some of that behavior and proved to be right we sold a lot of assets we wound down large funds and law and raised more funds but then we also raised an 11 billion dollar fund for distressed debt investing that we put on the shelf and we said that's not for now that's for later we think there's going to be an opportunity and that's when we'll put that to work so we were ready with firing power we didn't have to raise money at the bottom we had a lot of money to start spending at the bottom and that's extremely important logistically and then we had the Lehman Brothers bankruptcy on September 15th of OE and I put out a memo a couple days later and I said I think was cold now why man and and that's what I was talking about and I said look there are two states of nature either the world is going to end or it's not and people are assuming that it will and pricing assets as if it will and I you could not prove believe me bill you could not prove that the world was not going to end right it looked like you know there was a movie the China Syndrome with Jane Fonda in which they release a nuclear reaction and it's going to go right through the core of the earth it felt that way in the financial world but I said in the memo you know either the world's going to end it or it's not and if it ends it won't matter whether we bought or sold it but if it doesn't end and we didn't buy then we didn't do our job you know and we were able now that's that's all kind of philosophical but the truth of the matter is we were able to buy the debt of companies the senior debt of companies at prices which implied that those companies were worth a quarter or a fifth or a third of what some very astute buyout funds had paid for them one and two years earlier and they usually don't get it wrong by a factor of four or five so you know we we swung into action we had the money we had the will and we had the bargains and we spent about six hundred million a week over the last 19 weeks of 2015 and that's all you had to do and everybody else the technical term is everybody else was puking and and stuff was coming out every day at ridiculously low prices there were a lot of leveraged entities that were getting margin calls and being sold out on mass and there were a lot of for tonight there was sellers and there were forced sellers and there were no buyers you know and that is Nirvana and we were the buyer with the money and we bought diligently now I want to point one thing out for your listeners which is very important we were terrified this is not easy to have a position and to act in opposition to everybody else in the world you have to have enormous hubris to do that with confidence so some days we said I think we're going too fast and some days I think we're going too slow and and you know we we did it because in our hearts we thought it was right but I never want to give the people the impression that it's easy I love that yeah yeah you're not robots right yeah you you are still humans with the moon you know with human emotions and it was it was it was probably the right thing to do because it was not easy exactly you know Dave Swenson who runs the endowment at Yale and has done the greatest job in the endowment world for 30 years wrote a book 20 years ago called pioneering portfolio models and he in that book he says that in by which he means you know good investment requires the adoption of uncomfortably idiosyncratic positions in other words idiosyncratic you have to do different from what other people are doing or you're not going to perform different and uncomfortable because for you to do something different from what everybody else is doing by definition will be uncomfortable no rich posi knows another great investor once said that he felt like his portfolio was in good was in good stead if if he looked at the positions and felt like he was gonna throw up so so perhaps a harder question and this is something that Warren Buffett said a long time ago and is always stuck with me is that companies get the shareholders that they deserve and that's certainly true for asset managers also so you weren't you are not robots but also your investors the people who put the 11 billion dollars with you waiting for this opportunity they were terrified - like how did you manage these shareholders and their emotions at this time well I mean most of these were long-term investors of ours who had been with us a long time who had seen our ability to perform who understood that we're not the greatest investors for the happy times but we are very good at wringing profits out of bad times that's right and you say you you are you are just stressed investing and distressed current and experts well III think it's safe to say that you said it but but so and the other thing is that our our clients are mostly institutional investors and most of them know that no institution and certainly no investment committee will approve an investment at the depths of the market the market is cascading down the world looks like it's collapsing looks like they'll never be another update very very hard for any bureaucratic institution or committee to approve an investment so the beautiful thing is that they pre committed our fund and we raised that fund between January oh seven and March oh eight so early enough to four four institutions to be able to commit and once they had they were in our hands so the Frog wasn't boiling just yet they traced the money but you know having money and the ability to call we didn't have cash we we called the money as we spent it and having cash we could call during the crisis is really the greatest luxury yeah that's absolutely true you know one of the passages in mastering the market cycle that I gravitated to immediately was this one and it's you know it's pretty brief but in addition to an opinion regarding what's going to happen people should have a view on the likelihood that their opinion will prove correct I love this passage and it also reminds me of something that I think it was Jamie Dimon once said and that is that some people are more confident about everything than I am about anything well it's absolutely the same sentiment I hadn't heard that from Jamie but but it's right you know and I've never seen anything else on that subject but the point is that some people are sure of everything so I'm sure people are sure of nothing the truth is and I'm and Jamie is more sure than he lets on but the truth is that it is obviously a mistake to be equally sure or equally unsure of everything yeah because there are some things that absolutely will happen tomorrow there are some things that have a high probability of being predictable and there are some things that are absolutely unpredictable and if you make predictions about all three with equal certainty then there's something wrong with you know and you can't expect to be a successful risk bearer if if you don't differentiate between the different levels of predictability yeah I think that's exactly right do you think that there are opinions or beliefs in the market that you find to be particularly healthy for investors or maybe in other days or in general and well answered as you wish I just am wondering if there if someone wanted to improve his understanding of market cycles what are some dearly held beliefs that you think ought to be discarded well the what the first thing and I try to make this clear in the book and it's essential if people are going to be able to deal with cycles you know everybody wants an easy answer every wants to say how long does it upswing less and the the first step is you must dispense with any concept of regularity the the whole book is based around Mark Twain's statement that history does not repeat but it does rhyme when he says it doesn't repeat he's saying that the in our case I'm she wasn't talking about the market he was talking about history but the truth of the matter is market cycles vary one to the next in terms of their amplitude their speed their violence their duration it's all different and so people want to know how long is an upswing and the answer is we we absolutely can't tell them so expecting regularity and thus predictability is wrong and then you know you can go from there to the whole concept of predictions and you know what makes the market go up and down to a small extent it is what I call fundamental developments in the economy and the companies but to a large extent it's psychology or let's say popularity you know and it should be clear by now to everyone that the swings in popularity are unpredictable and if they are then most forecasts are not going to work so the next concept is that people say to me okay when will the market turn down and I never answer a question that starts with the word wind in the investment business sometimes we know what's going to happen we never know when no and so I would I would dispense with that immediately you must accept the ambiguity in the situation and and accept the need to live with uncertainty and that's why in the book I say there are certain words that every good investor should drive out of his vocabulary things like never always must Kant has to you know these these words are out you know you know we can talk about likely events we can talk about probabilities more and less likely but we could never say has to or won't so I I do need to ask this question I know that these are sometimes you know somewhat more painful question for you but where is it that you do that you think that we are in presently in the market cycle in in this country and how might you suggests the average investor be positioned today sure well in my book there is a graph which identify Baria stages of a normal up and down cycle bottom rising midpoint rising testament midpoint on the way to a top at the top declining back towards midpoint and so forth and where are we we're not at the bottom that was 10 years ago yeah we're not rising from the bottom to the midpoint we passed that several years ago we are we're not at the midpoint we have exceeded the midpoint and we're rising in the direction of a top and there's no reason to think we're at a top of course we never know when we're at the top we know a few days later when we say hey it reaches an ACME and it went down but the point is we are past the midpoint there are virtually no asset that I'm aware of that are available for less than their intrinsic value you know everything is somewhat overpriced the question is the degree of overpricing and and what that means I I divide the world into cheap fair and rich and I would say today that most assets are on the high side affair or into rich territory and I think that's where we are that now to say that things are highly priced is very different from saying there's going to go down tomorrow yeah things have been highly priced for a good period of time and they have continued to rise I am NOT saying that people shouldn't be in the market I'm not saying there's gonna be a downturn that starts tomorrow I'm merely saying that when you are in the elevated portion of the cycle as I believe we are then the odds are not so much in your favor they're more against you and you know the for me I like the subtitle of the book getting the odds on your side right and knowing where we are in the cycle tells you whether the odds are favorable or unfavorable I think we're in the elevated portion of the cycle which means the odds are not as good as usual and yet the outlook is not so bad and prices are not so high that this is the time to go to cash so at oaktree we've had this manager move forward but with caution and we still do we're investing every day know we're trying to be fully invested but with caution and we're a cautious firm with caution means even more caution than usual so most investors would benefit if they could think of the world the way I do which is to say that investors face every day to twin risks the first is obvious it's the risk of losing money nobody wants to do that the second is more subtle it's the risk of missing opportunities yeah and you if you say I don't want to lose any money then you have to forego all the opportunities if you say I don't want to miss any opportunities then you have to expose yourself to losing money that's right choose one or balance the two yeah and most people say well I don't want to lose a lot of money but on the other hand I don't want to miss all the opportunities and so they balanced it too and that leads to the next question how how should you balance them for yourself given who you are and your financial situation and your age and your emotions and your dependents and your needs what should be your normal manner of balancing the twin risks and then what about today should your balance of the twin risks emphasize risk loss of voidance or opportunity maximization today more offense or more defense and that's really the key question and I think that question has to be based on where the market is in its cycle and I think that that's the key skill that investors should develop and that's what the book aims to do wonderful you know Warren Buffett paid you the compliment that whenever he sees your writing in his inbox it's it's one of the first things that he picks up to read and one of the things that I really appreciate about Buffett is that he articulates so well the fact that those who are at the pinnacle of the industry still have a lot to learn so yeah right I ask you as someone who actually educates Warren Buffett and is also at the pinnacle of our profession what is it that you are reading now or what what are you getting a lot out of and learning from yeah well you know I'm always reading my-my-my publications which I don't and I you know there are some credit market publications that I read on a continuous basis they're very helpful as for books I'm in the middle of two one is called facts Oh wonderful book and it basically it talks about how people misunderstand what's going on in the world because of the biases and filters through which they do it and the other is called thinking in bets by Annie Duke who was the leading woman professional poker player and has a PhD in decision making and tries to teach us how to take day-to-day situations and think about them as you would placing a bet you know in a gambling situation and so you know most of the things I read are not about how to invest but things in the world that have relevance to the world of inventing know the the section in fact fulness on income and wealth it was something that I understood on some levels but just when you when you stop and think that almost everyone in the United States of America is in the top ten percent in terms of of wealth that reframing is really you know is is is is really amazing exactly exactly and you know between our biases of perception and I would say the bias is introduced by media coverage it's very very hard for most people to see things realistically no yeah wonderful so oak tree is a company that I and other analysts at The Motley Fool have recommended to our members I'm not quite sure how to ask this question how do you view your own company's stock given that oak tree stock and trade is is credit and distressed debt do you view of your stock as being a derivative of those segments of the market well I think it clearly is because you know our assets have been flat for about our assets and the management for about five years at a at around the hundred billion this year we changed our counting to bring in our share of the assets of DoubleLine which is a company we own 20% out but but fundamentally speaking of our assets have been essentially flat for five years and you know with the market in the elevated stage that I described we have judged that it was not appropriate to add to assets and imagine and we think we do our clients a favor when we try to dissuade them from piling in more right and so that has kept our a lid on our business and in fact we've been taking profits and and and rotating into assets which are less profitable for oaktree so our assets our income has been a little soft one of these days there will be a time when conditions are more appropriate for a distress investor and a bargain hunter you know I believe will be able to add to our assets at that time I think that our client's credit us with good judgment and integrity and when we tell them you know we're a firm that doesn't say always say our asset class is perfect there are times when we say don't invest and has a consequence they credit us with integrity so that they listen to us when we do when we say do invest I think we'll there will be a time when it's better for our asset classes we will get more money we will make more profits and most people recognize us as a way to profit from bad time yeah not profit in bed times you know people used to say oak trees great because it makes a lot of money in bad times and the answer is when the market goes down we don't make a lot of money you don't have magic beans right exactly we make a lot of we are a prime way to capitalize on bad times and the exit there from yeah and that's the way I looking at it I think that's the way most people look and it you know when on the most bullish days in the market usually our public peers the private equity companies their stocks rocket ahead and and ours kinds of limps ahead no on the bad days maybe they go down and we go up so I you know there was the when I was a kid there was an expression for a for a horse that runs best on bad tracks a mother mu D ger so maybe we're a Mudder maybe we have our best days in in bad science and tests and you know this is what we're good at and and we're going to stick to our last well I certainly appreciate that you have been writing incredibly detailed memos in your role as you know at oak tree capital starting I believe in 1990 is that when you began yes right what made you start writing and and and what have you gotten out of it sure well I can promise you I didn't start writing because I thought it would make me any money because I thought it would change oak trees business of course I was not a taupe taupe we didn't exist when I started in 1990 I started writing for the simple reason that I came across some events the juxtaposition of which I thought it was very interesting and educational and I wanted to share it and we are in those days we only sent them to our clients you know those were the days when you would run them on the Xerox machine fold them up put them in an envelope put a stamp on a dress him and put him in the mailbox and so you know there was no concept of being viral and you know they they went out to a few hundred people and so but it was interesting and the other reason is because I like to write and it's my creative outlet and I'd you know they say it's only work if you'd rather be doing something else I'd rather write they're not right you know and there's usually a memo in January and September which means that I wrote them on Christmas vacation and summer vacation and uh and to me it's great so I started writing in 1990 I wrote one in 91 and 91 maybe two in 92 and maybe I skipped 93 I forget but the point is I did it for 10 years and I never had a response bill I not only did nobody ever say they were good nobody ever said I got it it was as if you were throwing them over the wall into North Korea you don't know message received at all right but then on the first day of 2000 I put one out called bubble calm and you know poking some fun at the tech stocks and the excesses and talking about what I thought was wrong in that market and that had the virtue a number one it was right and number two it was right fast if you're right slow you don't get much credit that's right and so you know I think in the introduction to one of my books I said that after 10 years I became an overnight success but you know now I get plenty of recognition now they go out to 30,000 people and I just heard from somebody I just heard from somebody the other day who said he sent it to 30,000 people so I have no idea how many people see them I get a lot of very positive response which makes my day and keeps me calling and I do not intend to question well they have been a wonderful education for me as I've as I've been on the path of trying to be a better investor every day and and also as a better communicator every day so you know I have I have a debt to you and I really just you appreciate you are taking all of those hours to put to put the pen to paper and put the finger to keyboard and and and and help other people be better investors well it's really my pleasure and then when I when I think I have a big idea I put it into a book and I hope that people will find the book interesting and you know that my main objective in writing my two books now is that I want people to say oh yeah not yeah that's right that that's right I don't want to say that's what I always know I want them to say I never thought of that yeah way yeah yeah something that they may have thought was correct but then it's uh it's it challenges one or two of their closely held beliefs and pushed pushes them down the path a little bit right you know well Howard I I really do appreciate your time today it is it is an honor and a joy to speak with you and your new book is called mastering the market cycle getting the odds on your side and it's it comes out this week is that right yes that's right comes out on on Friday no it actually came out two days ago came out two days ago yep no idea what day of the week it is anymore yeah well I do I I do appreciate your spending this time with with us and with me and and and I wish you all the best thank you and I appreciate your questions let me do it again all right thank you so much hard

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Keywords: Stocks, Investing, Invest, How to Invest, stock picks, stock news, Stock Market, stock market news, investing 101, dividend stocks, stock, investor, Wall Street, investors, investing ideas, finance, business, investment plan, fool.com, The Motley Fool, howard marks, Oak tree capital, howard marks interview, mastering the market cycle

Id: 5kenPOQVelE

Length: 45min 17sec (2717 seconds)

Published: Thu Oct 11 2018