Mastering The Market Cycle by Howard Marks: Review & Quotes
Mastering the Market Cycle Review
Mastering the Market Cycle is Howard Marks 2nd book and follows “The Most Important Thing” (Amazon Link). His initial book should be most investors first read. Many will ask: First, even before The Intelligent Investor? I say yes, because The Most Important Thing will teach you how to think about investing.
Mastering The Market Cycle (Amazon Link) is a continuation of Howard Marks “insightful, direct, homespun, expert and sharply pointed” delivery offered to us in The Most Important Thing. This next book also teaches us how to think about investing.
Marks tells us how, why, and when we can improve our odds of success through mastering the market cycle. How to position ones portfolio given the possible outcomes is the heart of this book.
This is not a get rich quick book but a sound long term investment philosophy that puts the odds heavily in the favor of the investor who studies valuation and investor psychology. Positioning moves and asset selection based on where we are in the cycle reduces risk and increases the probability for successful outcomes.
Mastering the Market Cycle Quotes
I hope the following quotes from the book will tempt you to read the whole book:
Very few investors are known for having outperformed through macro forecasting.
The greatest way to optimize the positioning of a portfolio at a given point in time is through deciding what balance it should strike between aggressiveness and defensiveness.
The outlook for returns will be better when investors are depressed and fearful (and thus allow assets prices to fall) and worse when they’re euphoric and greedy (and drive prices upward).
Cycles have more potential to wreak havoc the further they progress from the midpoint —i.e, the greater the aberrations or excesses.
Advances are followed by mere corrections, and bull markets by bear markets. But booms and bubbles are followed by much more harmful busts, crashes and panics.
Most important deviations from the general trend — and the variation of those deviations’ timing, speed and extent —are largely produced by fluctuations in psychology.
Success carries within itself the seeds of failure, and failure the seeds of success.
Psychology is the essential components in understanding the cycles that matter so much to investors.
The greatest lessons regarding cycles are learned through experience…as in the adage “experience is what you got when you didn’t get what you wanted.”
Most economic forecasts are just extrapolations. Extrapolations are usually correct but not valuable.
Unconventional forecasts of significant deviation from trend would be very valuable if they were correct, but usually they aren’t.
Secular changes in long-term economic cycles are hard to predict, and the correctness of forecasts of such changes is hard to assess.
The ups and downs of short-term economic cycles, too, are hard for any one person to consistently predict better than others.
It’s tempting to act on economic predictions, especially since the payoff for correct ones theoretically could be high. But the difficulty of being able to do so correctly and consistently mustn’t be underestimated.
“Disrupt” is the word of the day, and the ability of new technologies to disrupt traditional industries can create new competition and dismantle the incumbents’ profit margins.
In business, financial and market cycles, most excesses on the upside — and the inevitable reactions to the downside, which also tend to overshoot —are the result of exaggerated swings of the pendulum of psychology.
Underlying the swing between greed and fear is the swing between euphoria and depression.
Euphoria and depression are the foundation emotions that give rise to the swings that follow.
All people feel emotions, but the superior investor keeps these conflicting elements in balance.
The vast majority of highly superior investors I know are unemotional by nature. If fact, I believe their unemotional nature is one of the great contributors to their success
That’s one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not so hot”. But in the world of investing, perception often swings from “flawless” to “hopeless”.
Investor —the smarter, more self-aware ones, I think —understand that the future isn’t knowable with certainty. They may form opinions regarding future events, but they don’t bet heavily that those opinions will prove.
My view that risk is the main moving piece in investing makes me conclude that at any given point in time, the way investors collectively are viewing risk and behaving with regard to it is of overwhelming importance in shaping the investment environment.
Good times cause people to become more optimistic, jettison their caution, and settle for skimpy risk premiums on risky investments.
Risk is high when investors feel risk is low. Risk compensation is at a minimum just when risk is at a maximum (meaning risk compensation is most needed).
Widespread risk tolerance — or a high degree of investor comfort with risk — is the greatest harbinger of subsequent market declines.
When investors in general are too risk-tolerant, security prices can embody more risk that they do return. When investors are too risk adverse, price can offer more return than risk.
This condition is the investor’s greatest enemy: When risk aversion and caution evaporate and risk tolerance and optimism take over.
Warren Buffett: The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.
When others fail to worry about risk and fail to apply caution, as Buffett says, we must turn more cautious. But it must also be said that when other investors are panicked and depressed and can’t imagine conditions under which risk would be worth taking, we should turn aggressive.
Financial innovations promising high returns with low risk rarely keep that promise.
At bottoms, it can be extremely hard to take actions that require conviction and staunchness.
During panics, people spend 100% of their time making sure there can be no losses…at just the time that they should be worrying instead about missing out on great opportunities.
The riskiest thing in the world is the belief there’s no risk. By the same token, the safest (and most rewarding) time to buy usually comes when everyone is convinced there’s no hope.
If I could ask only one question regarding each investment I had under consideration, it would be simple; How much optimism is factored into the price?
Superior investing doesn’t come from buying high quality assets, but from buying when the deal is good, the price is low, the potential return is substantial, and the risk is limited.
Changes in the availability of capital or credit constitute one of the most fundamental influences on economies, companies and markets.
The worst loans are made at the best of times. This leads to capital destruction —that is, to the investment of capital in projects where the cost of capital exceeds the return on capital, and eventually to cases where there is no return of capital.
In making investments, it has become my habit to worry less about the economic future —which I’m sure I can’t know much about —than I do about the supply/demand picture relating to capital.
The behavior of the capital markets is a great indicator of where we stand in terms of psychology and a great contributor to the supply of investment bargains.
Most raging bull markets are abetted by an upsurge in the willingness to provide capital, usually imprudently. Likewise, most collapses are preceded by a wholesale refusal to finance certain companies, industries, or the entire gamut of would-be borrowers.
The bottom line of all of the above is that generous credit markets usually are associated with elevated asset prices and subsequent looses, while credit crunches produce bargain-basement prices and great profit opportunities.
Our job as investors is simple: to deal with the prices of assets, assessing where they stand today and making judgements regarding how they will change in the future.
Prices are affected primarily by development in two areas: fundamentals and psychology.
Security prices generally fluctuate much more than earnings. The reasons, of course, are largely psychological, emotional and non-fundamental. Thus price changes exaggerate and overstate fundamental changes.
Investor rationality is the exception, not the rule; and the market spends little of its time calmly weighing financial data and setting prices free of emotionality.
“What this wise man does in the beginning, the fool does in the end” tells you 80% of what you have to know about market cycles and their impact. Warren Buffett has said much the same thing even more concisely: “First the innovator, then the imitator, then the idiot.”
Capitulation: It’s a highly destructive aspect of investor behavior during cycles, and a great example of psychology-induced error at its worst.
There’s only one form of intelligent investing, and that’s figuring out what something’s worth and buying it for that price or less.
Any investment movement that’s built around a concept other than the relationship between price and value is irrational.
I don’t believe in forecasting. Very few people can know enough about what the future holds for it to add to their returns.
As I wrote in The Most Important Thing, “we may never know where we’re going, but we’d better have a good idea where we are.”
Our understanding of cycle positions can be greatly aided by an awareness of how investors are behaving.
Risk in investing doesn’t come primarily from the economy, the companies, the securities, the stock certificates or the exchange buildings. It comes from the behavior of the market participants. So do most of the opportunities for exceptional returns.
Warren Buffett tells us, “The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”
It’s not what you buy that determines your results, it’s what you pay for it. And what you pay — the security’s price and its relationship to intrinsic value — is determined by investor psychology and the resulting behavior.
When investors are flying high and making money, they find it easy to come up with convenient reasons why assets should be untethered from the constraints of valuation norms.
So the key to understanding where we stand in the cycle depends on two forms of assessment. The first is totally quantitative: gauging valuation. And the second is essentially qualitative: awareness of what’s going on around us, and in particular of investor behavior.
There is no such thing as a market that is separate from —and unaffected by—the people who make it up.
It’s important to note that exiting the market after a decline — and thus failing to participate in a cyclical rebound — is truly the cardinal sin in investing.
Understanding cycles and having the emotional and financial wherewithal needed to live through them is an essential ingredient in investment success.
When the market is high in its cycle, investors should emphasize limiting the potential for losing money, and when the market is low in its cycle, they should emphasize reducing the risk of missing opportunity.
Good timing in investing can come from diligently assessing where we are in the cycle and then doing the right thing as a result.
The study of cycles is really about how to position your portfolio for the possible outcomes that lie ahead. That, in one sentence, is what this book is about.
Positioning and selection are the two main tools in portfolio management.
The choice between aggressiveness and defensiveness is the principal dimension in which investors position portfolios in response to where they think they stand in the cycles and what that implies for future market developments.
When the market cycle is low in its cycle, gains are more likely than usual, and losses are less likely. The reverse is true when the market is high in its cycle.
Positioning moves, based on where you believe the market stands in the cycle, amount to trying to better prepare your portfolio for the events that lie ahead.
Asset selection consists of identifying markets, market sectors and individual assets that will do better or worse than the rest, and over- and underweighting them in portfolios.
The higher an asset’s price is relative to its intrinsic value, the less well it should be expected to do (all things being equal), and vice versa.
We have to safeguard our portfolios against the danger stemming from the fact that the thing that’s most likely to happen — may not happen until long after it first becomes likely.
We have to steel ourselves emotionally so as to be able to live through the potentially long time lag between reaching a well-reasoned conclusion and having it turn out correct.
Detecting and exploiting the extremes is really the best we can hope for. And I believe it can be done dependably — if you’re analytical, insightful, experienced and unemotional. That means, however, that you shouldn’t expect to reach profitable conclusions daily, monthly or even yearly.
By definition, pronounced bargain prices are most likely to be found among things that conventional wisdom dismisses, that make most investors uncomfortable, and whose merits are hard to comprehend. Investing in them requires considerable inner strength.
In investing, success teaches people that making money is easy, and that they don’t have to worry about risk — two particularly dangerous lessons.
I’ll quote Henry Kaufman, formerly Salomon Brother chief economist: “There are two kinds of people who lose a lot of money: those who know nothing and those who know everything”.
The tendency of people to go to excess will never end. And thus, since those excesses eventually have to correct, neither will the occurrence of cycles.
People do have feelings. 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 —and thus they’ll take trends to cyclical extremes.
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