Mastering the Market Cycle: Getting the Odds on Your Side

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Alan: Okay, so next question from the audience. This is a reader of your first book, The Most Important Thing, and the question is: do you now know what the most important thing is? The question is based on the conclusion of your book. Cycles have to be understood both analytically and intuitively. Those who possess both abilities will go the furthest. The credit cycle is so important because it is capable of single-handedly driving the economy into a recession. This is what happened in the global financial crisis: there was no underlying economic cause, it was primarily created by a chain reaction inside the financial system. This is a chapter-by-chapter summary of Mastering The Market Cycle, a book written in 2016 by legendary investor Howard Marks. I’m reading this book in May 2022 because, for the first time in my career, the technology industry is entering a serious down cycle. As an entrepreneur there’s not a ton to do other than play it safe and try to remain profitable, but intellectually it’s interesting to me. And as an investor I would love to make the most of this time. An investor needs to question whether they have the skill required to improve on the market’s performance through active decision making, or should give up on doing so and invest passively in index funds, settling for market performance.

The investor’s goal is to position capital so as to benefit from future development. The first step is to decide how you will deal with the future.

7. The Pendulum of Investor Psychology

Alan: Okay. Next question, this actually dovetails on a comment I think you talked a bit about in your first answer about the market cycle. The question is about what you're observing right now in the high-yield bond market and how that impacts your expectations for let's say the next year or two. What I wanted to add to that was I think one of the things you mention in your book is sort of signs that the market might be getting a bit ahead of itself or a bit frothy. One of the things you talk about is the quality of bond issuance and the high-yield markets, and the distress debt arena and that recently we've seen, and I think the Federal Reserve commented on this frankly a few months ago, that the quality of issuance has really slipped. Covenants have gotten weaker. Credit quality's gotten weaker. I'm curious about your perspective on that, as it pertains to the market cycle and, perhaps to answer the question, how that shapes your view of the next year or two? And this is where patience comes in. “Patience and the ability to live through tough periods, until you are eventually proved right, is extremely important,” he said.

The mood swings of the securities markets resemble the swing of a pendulum. They swing between the following:

11. The Real Estate Cycle

Marks said billionaire investor Warren Buffetttold him that for a piece of information to be desirable, it has to satisfy two criteria: It has to be important, and it has to be knowable. Additionally, having a clear and well-defined investment strategy can help investors stay disciplined and avoid impulsive decisions. Conclusion The book is divided into three sections, each of which focuses on a different aspect of market cycles. The first section provides an overview of the concept of cycles, including the different phases and the drivers of each phase. The second section delves into the psychological and emotional factors that influence investor behavior during market cycles, including the role of greed and fear. The third section offers practical advice on how to invest during each phase of the cycle, including strategies for mitigating risk and capitalizing on opportunities. I wish he had more stories here of actual decisions he faced in his career and how he used his sense of cycle timing to make the call. Did he make bad calls in his career that were formative learning experiences? Were there any particular triumphs he’s most proud of? This is all very abstract and impersonal. Howard: Well, I think that I have a bias, and we all have biases, and I think my bias is towards conservatism. It's not the worst thing in the world. It keeps you alive when others get carried out, but it causes you to underperform for long periods of time, especially, for example, the last 10 years, in a couple of months we'll be at the 10th anniversary of the low point of the equity market, March of '09. This has been a challenging time for a cautious investor. Now, most of our clients hire us because we're cautious and retain us, despite the fact that we may trail the indices a little bit.

Investing is basically bearing risk in pursuit of profit. The future is unknowable, but investing is about putting resources at stake based on the prediction that the future will unfold in a specific way. Therefore, how an investor manages risk is the primary determiner of their performance. It’s useful for investors to understand how cycles work and to develop a sense for where we are in the current cycle, because it allows them to position their portfolio for what’s next. So you know, I describe what we do, to finally answer your question, as fixed income investing, where, how the company does matters. It matters a lot, and you know, if you invest in a direct debt or in high yield bonds, or especially in distress debt, you better have the outlook right. So that's what we do. Small swings in the economy lead to big swings in profits, bigger swings in markets, and changes in the credit window. The credit window can go from “wide open” to “slammed shut” in an instant. Small changes in fundamentals can trigger big shifts in markets, with a turn in investor sentiment providing the catalyst. Howard Marks, CFA, a co-founder of Oaktree Capital Management and a pioneer of distressed debt investing, has made his career by stepping in to provide capital when the credit window slams shut.Alan: Okay. A couple, I think, follow-up questions from some of your earlier answers. The first is a question about your statement about being comfortable saying, "I don't know," which I think, honestly, probably a lot of the times, we don't know. I think the question is that a lot of folks aren't comfortable saying they don't know, and would like to be, I suppose, more comfortable doing so sometimes. How have you gotten comfortable with that? How have you gotten over the fear that by saying that, you're going to sound less credible in front of clients? Everyone feels these emotions, but the superior investor does their best to keep these emotions in balance at all times rather than swinging between one and another with the market. Alan: Okay, so I'm gonna start here with some of the questions we've gotten from the audience. Again, I just encourage folks to continue to think of questions and we'll get through as many as we can here. First one here, I think this is interesting, it's a question we probably all ask ourselves from time to time, what investment mistake have you made that comes to mind and what did you learn from it?