Mastering the Market Cycle: Getting the Odds on Your Side - Howard Marks

For the past few months, asset market was overly volatile. The rise of pandemic cycle has attributed to the wide range of fluctuation; sentiments of buying the dip and sell-offs were mixed in the market. The book “Mastering the Market Cycle: Getting the Odds on Your Side” written by Howard Marks, co-founder and co-chairman of Oaktree Capital Management has been helpful to the investors to have more of an insights for the big frame of economic and market cycle. The cycle can be 5 years, 10 years, or more, but pattern of leaps and falls repeats not exact the same but very irregularly. 

The book consists of 18 chapters; the author may repeat his underlying sentences over again, yet each words or phrases are very inspiring. 

Contents

1. Why Study Cycles? 

2. The Nature of Cycles 

3. The Regularity of Cycles 

4. The Economic Cycle 

5. Government Involvement with the Economic Cycle 

6. The Cycle in Profits 

7. The Pendulum of Investor Psychology 

8. The Cycle in Attitudes Toward Risk 

9. The Credit Cycle 

10. The Distressed Debt Cycle

11 The Real Estate Cycle

12 Putting It All Together The Market Cycle

13 How to Cope with Market Cycles

14 Cycle Positioning

15 Limits on Coping

16 The Cycle in Success

17 The Future of Cycles

18 The Essence of Cycles

Cycle

When the position in the cycle changes, so does the probability. If investors do not modify their investment views in response to the change of circumstances, they are vulnerable to so called ‘Mr. Market’. Individual investors might lose their opportunity to make a great profits when reacting passively into so called ‘market efficiency.’ On the other hand, if investors have insight into the cycle, they can invest more aggressively by increasing investment when the odds are in their favor. In addition, when the probability is unfavorable, investors can act defensively by withdrawing cash.

The best way to optimize the positioning of your portfolio at any given point in time is to determine the balance to maintain between investing aggressively and defensively. Rebalancing on their asset is the keyword during the cycle. Investments, asset allocation to various possibilities, and holding risks must be adjusted continuously depending on position of cycle. Investors have to be aggressive when buying the dip, but retreat when the market is irrationally overheated.

In the field of investment, there is no universal answer for how to behave in the certain situation. Investors understand the position of the cycle differently. Suppose the cycle is moving downwards. Some of the investors will think the position of currency cycle is in high risk of losing money, while, others might think it is their great chance to have huge benefits. In consequence, those two parties will act differently based on their own idea and thoughts. However, investors acting passively do not fully understand the nature and importance of the cycle. They don’t invest long enough, do not learn about the finance, do not read the cycle; instead paying attention to the recurring reasons behind a story. Overall they do not understand the importance of cycles.

Smart investors thrive to understand the beginning and end of the cycle, pay attention to the dangerous phase. They are able to make decision independently whether to be greedy or fearfully. Perceiving risk in overheated market is one of the strength of intelligent investors. Making aggressive bets are possible depends on the situation where investors confronts for the intelligent. 

Risk

The core reason of investing is to obtain a profit depends on the how investors act. Investment is a bet of future; risks arise in any situation and the future is unknown. If future is predictable, then the investment will be easy and the profits will be certain. Since risk is a source of important issues in investment, the ability to understand, evaluate, and deal with risk is a hallmark of an outstanding investor and is essential for successful investment.

Real Estate

The real estate cycle can be amplified by specific factors. There is time difference between project plans and the completion. Usually, very high financial leverage is needed in real-estate business. The fact that supply is generally not flexible enough to adjust to fluctuations in demand since it needs time to make a great deal. It is not the development company which benefit from the investment nor a banker which lends construction funds and seizes projects. It is intelligent investors who gain profits by purchasing real estate assets during difficult times when the cycle is at the bottom and has possibility to go upwards. Oak Tree Capital was one of the party who had a great gain on this field.

Three Stages

The book indicates "three stages of a bull market."

Step 1: When only a few usually perceptive people believe things will get better,

Step 2: When most investors realize that improvement is actually taking place

Step 3: When everyone concludes things will get better forever 

The tree does not grow to the end of the sky, but normal investors behave as if the tree will grow to the end. And they pay for the infinite potential they think of. There are no worse investment than paying the most overvalued assets in paying costly price. From this point of view, it is concluded that the investor in the first stage, who hardly finds out the reason for optimism, buys the asset at the low point where a significant price increase is possible. However, the person who buys in the third stage always pays excessively high prices at the peak of the market and suffers losses as a result.

Howards Marks does not believe in predictions. Few people are enough to know what will happen in the future. Even for the investors who sometimes nailed the direction have poor records overall. However he emphasizes that the future direction is unpredictable, nevertheless, investors should know where about where they are located currently."

Sir John Templeton highlighted to buy the assets when others are disappointed, and sell when others are acting in greed; it takes tremendous courage, but the reward is the greatest. When a price rises above its fair value, the following important factors usually emerge: Good news in general, satisfaction of what is happening now, optimistic news media reports, and loss of skepticism, lack of risk aversion, credit market easing, and positive mood. On the other hand, when a price collapses from an appropriate value to an inexpensive level, it generally exhibits some or all of the following characteristics: Generally bad news, dangerous alerts, negative reports from media, bad stories, skepticism over optimism, increase in hedging, credit market crunch, and overall stagnant atmosphere.

Oaktree’s portfolio that was positioned in response to the cycles contributed significantly to its success. It invested aggressively in 1990-93, 2002, and 2008. Also it invessted cautiously and passively in 1994-95 and 2005-06, and recent years. He tried to take advantage of the cycle and add value to it. Positioning its stance in appropriate location never misses a major opportunity.

Human's Psychology

The fundamental reason that cycles exist in the market is that humans are involved. Physical things can move linearly, and time continues to flow forward. The same is true for machines as long as they have adequate power. However, humans are involved in processes in fields such as history and economy. When humans get involved, the outcome becomes variable and it creates a cycle again. The main reason is that humans are emotional, inconsistent, sentimental, and not objective.

The cycle will continue to occur. But if there is something like a perfectly efficient market, and if people really make decisions with computationally excluding emotions, then the cycle will probably be gone and will never happen again.