Howard Marks delivers a very consistent message on the importance of understanding where we are in the cycle. He does so because risk changes as we move through the cycle.
So if you’re basing your allocation decisions on risk (you’re controlling for risk, not returns), this is a most important thing to know. In the Investor Series, I linked to last week, Marks came back to explain why a few times:
One thing we’re both very attentive to is cycles. And where you are in the cycle really has a great deal to do with what you should be doing at a point in time. But the interesting thing about cycles is after the things have been going well for six, eight, ten years, everybody says well maybe we won’t ever have another cycle. You know, maybe, you know, this has been fixed and would it be great if we never had a recession again.
But this goes back to cycles. I don’t know if they teach a course here on cycles, Chris? Probably not. But, I mean, one of the greatest lessons you can learn is to observe and learn from cycles. Now that happens to be a plug for my next book, which will be on cycles, but I think it’s very important. And the point is that as you know, in the environment, in the world, as the economy gets better and companies report better results and securities appreciate, what happens is people become more enthusiastic and more bullish and less risk-averse and they buy, buy, buy. Then what happens eventually, things soften. The economy comes down. Corporations report worse results. Markets decline. People get depressed – sell, sell, sell.
So what are we doing if you think that’s an accurate representation? They’re buying up here with the greatest fervor. I mean, obviously they’re buying all along that’s why the markets rise, but they have the greatest fervor here. That’s what makes a top. And then they sell down here and that’s what makes a bottom. And clearly that’s the opposite of what you should do. So it’s extremely important that everybody understand where we are in the cycle and what behavior is called for. You should not act consistently throughout the cycle.
There’s no such thing as an analysis of what’s coming. We don’t know anything about the future and you can’t prove anything about the future. But if you’ve been in business and you’ve seen some cycles and you’ve gained some experience and you’ve gone through those cycles with your eyes open saying, “What are the implications of cycles and for our behavior?”, then I think you can reach a point where you say, “You know what, it just feels like the power is in the hands of the issuers not the buyers. It feels like there are many sellers, just a lot of buyers, and the market is not acting in a disciplined way.”
We want to buy when the market is panicked not when the market is sanguine. So, you know, Buffett says the less prudent with which others conduct their affairs, the greater prudence with which we must conduct our own affairs. When other people are optimistic, we should be worried. When other people are panicked, we should turn aggressive. And that’s what we try to do, but it’s been – when you read my book, there’s a chapter saying that the most important thing is knowing where we stand and it’s almost all intuitive, subjective, qualitative.
One final note from that Q&A, which Marks said and I think it’s worth repeating:
You must have a plan of operation which is sympatico – I don’t know if you use that word anymore – with your personality. If you’re an aggressive guy, you just can’t play it safe. If you’re a chicken, you just can’t play it risky.
If you understand the cycle, you should understand how not to behave. But you should also understand where the riskiest points in the cycle exist and how that fits your personality and thus, your plan.
Howard Marks Investor Series with Bruce Karsh
- Stop Waiting for the ‘All Clear’ From Markets – B. Carlson
- Greatest Hits From Michael Mauboussin & Meir Statman – A Wealth of Common Sense
- A Dozen Thoughts from Charlie Munger from the 2017 BRK Meeting – 25IQ
- Testing Mattresses with Warren Buffett – GatesNotes
- The Unsung Heroes of Investing – BPS and Pieces
- The Power of Failing Well – M. Housel
- A Tale of Two Markets: Politics and Investing – Musings on Markets
- Greatest Hits are Exhausting – S. Godin
- The Crisis of Expertise – Aeon
- Experience Is Overrated – Irrelevant Investor
- The Brains Behind Behavioral Science – Behavioral Scientist
- How to Call B.S. on Big Data: A Practical Guide – New Yorker