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.

Pandemic only unleashes inequality between the rich and the poor.

The United States was the lead of the world in financial asset growth last year thanks to tax cuts and a boom in the stock market, but the distribution of wealth was more unequal than any other country. 

According to the annual tally which Allianz, the German insurer which holds world stocks, bonds, cash and other assets, showed that poor countries are no longer able to follow the wealth of advanced countries. For the first time since 2000, the number of people considered middle class worldwide has declined when measured by their financial holdings. 

And the world's super rich are becoming more and more rich. The top 1% own 44% of their financial assets, and their shares are increasing. “The super rich do indeed seem to be moving further and further away from the rest of society,” the Allianz study said. 

The pandemic only exacerbates the gap between the poor and the poor. The decline in global trade will be the biggest obstacle to developing countries, and the poor suffer more from the burden on the health care system and public schools. 

Assets per capita in the United States increased by more than 13% in 2019 to $245,000. The United States was ahead of Switzerland and Singapore in per capita.

Source : NYT

https://www.nytimes.com/2020/09/23/business/united-states-is-the-richest-country-in-the-world-and-it-has-the-biggest-wealth-gap.html

Benjamin Graham, the father of value investor.

Benjamin Graham is considered as most successful investor of all time. Not only he had countless victories on the investment field but also was a father of so many successful investors like Warren Buffet, John Templeton, Irving Kahn and so on. The reason Benjamin Graham is regarded as historically greatest value investor can be found back in days in early 1900s when speculative trading environment was mainstream. Stock market was not kind of what we know now. During the days, investors were anxious of uncertainty since absence of internet provided insufficient information.

As Benjamin Graham was working in NHL, he had his heydays working on security analyst. He was not momentum or day-trader seeking for profit gains in short-term. His investment style is known as the “cigar-butt” which is the “approach that picks up discarded business cigar butts laying on the side of the road, selling them at deep discounts to book value with one good puff left in them.” Warren Buffett was influenced the way Benjamin Graham did in the past to find the firms that were barely out of attention from media.

By reading his book, I was inspired by several investment philosophy which lead present investors to direct themselves in the right path. I will list four principles Benjamin Graham emphasized.

Diversification

Portfolio divergence is the most important for not only for mom-and-pop investors but also the ones who regard themselves as gurus. Benjamin Graham has diversified his portfolio in many different areas. He mentioned finding companies which has significant ‘safety margin’ is the best way to make profit, however, it is not easy to discover such a stock. Some of firms which he regarded as underestimated compared to the present price were invested heavily and concentratively. However, for unknown situation, he invested in various companies to hedge the risk. He invested about 70 different companies to diversify his portfolio because if a company makes a loss, then others will cover it. (Warren Buffett was influenced by Benjamin Graham, though he did not select diversification investment method.)

Intrinsic Value (Cigar-Butts)

Sometimes inexperienced investors tend to follow the trend of stock market. If the market is in upward cycle, then they don’t try to miss out the chances. If opposite, then investors try to sell off their assets. That is what Mr. Market entices innocent investors to join the party. It can give them delusion as they are the successful investors when the market is irrational floated. However, it can lay investors into fury when they think they are deceived by Mr. Market. Sometimes the experts of analysts can allure them to lead market melt-up. Nevertheless, Benjamin Graham puts weight on intrinsic value. If an investor has a clear philosophy based on intrinsic value, there is no need to worry about in attributing his or her mistakes on personified object that does not exist at all. 

Amazon is dominating the retail industry. "Death By Amazon"

Amazon is expanding beyond online and offline to distribute its power through all areas. The company’s widespread expansion in the industry is giving a threat to the offline stores and small and medium-sized shopping malls into bankruptcy. The book “Death by Amazon” introduces “Amazon fear index”, which represents the stock indices of 54 publicly traded companies that are at risk from the Amazon’s business. 

This book explains specifically about how Amazon is increasing its field whether by itself or acquisition. To fight against Amazon’s monopoly, the book reveals the tactics of each company for its survival. Companies such as Walmart, Costco, Wayfair, Nike, Spehora, Warby Parker, Allbirds, Quip, Uniqlo, have mobilized their own strengths to compete against Amazon by their own advanced technology and differentiation strategy.

Internet of Things (IoT) or technology represented as 4th industrial revolution, such as big data, virtual reality, augmented reality, and so on are gradually permeating every aspect of our daily lives. Just only five years ago, many did not imagine a store where customers just need to take things out without any checkout, an artificial intelligence secretary who can request anything with a single word, and a delivery service for drones or unmanned self-driving robots. However, cutting-edge technologies that seemed like a distant future are now beginning to be naturally commercialized. The lead of industrial technology change is dominated by Amazon, the world's largest online e-commerce company. 

Amazon, which is considered as an omnivorous dinosaur, has destroyed the existing industrial ecosystem by making strides in every business from online bookstores to fashion, furniture, drones, robots, and cloud services. In the process, Amazon fears have gripped the market, with a series of offline giants collapsing, including large bookstore chain "Barns & Noble," the world's No. 1 toy company "Toys R Us," and 100 years of traditional department store "Sears." It has come as a huge threat to countless companies to the point. 

On the other hand, there are companies that are steadily increasing their sales by solidifying their territory in the strike of Amazon. From big offline retailers such as Costco, Walmart, Uniqlo, Tiffany to small and medium online shopping malls including Etsy, Wayfair, Casper, what are their strategies that have won the competition against Amazon? Commonly, they have avoided direct challenges against Amazon and tried to differentiate themselves by showing their strengths.

For example, fast fashion brand Uniqlo has launched a customer-centered service that combines cutting-edge technology based on the offline stores world-wide. Also, the world's largest handmade online store, Etsy has survived throughout the pressure of Amazon’s enlargement. Amazon's business strategy is mainly to buy products in large quantities from suppliers and offer them at low prices, which have not worked at all in the handmade market where diversity and uniqueness are important. Soon after, Amazon launched a competitive service called ‘Handmade at Amazon’ to take advantage of the market, nonetheless Etsy still remains the leading player. The book explains fully about the secrets of future strategies of each companies in response of Amazon’s strike. It also revealed Amazon's innermost agony behind its aggressive entry into the market. 

This book consists of a total of seven chapters. First and second chapters are about the steps which Amazon dominated online retail market. Then, Amazon Go was next Amazon’s step to stride in the offline markets: for instance, fashion and furniture industries, which were considered difficult to succeed in online. What's the real story behind Amazon's relentless move across the field? From chapter three to six, the book deals with the events of offline giants such as Walmart, Costco, and Apple. They are fiercely fighting with Amazon to defend their territory with strong brand strategies and smart, high-tech tools. Finally, Chapter 7 reveals the strategies and examples of companies in fighting with Amazon.

The author of the book, Shirota Makoto, is one of the top economist in Nomura Institute. He has been watching the moves of Amazon and the rest of online and offline retail commerce companies. It was clearly witnessed that Amazon was destroying the existing ecosystems. A lot of companies which did not prepare from their competitors later faced bankruptcy. On the other hand, some companies were able to handle themselves from the crisis of so called ‘Amazon Fear’. It is difficult to predict who will be the champion in retail area, however, in order to maintain in survival, overcoming Amazon’s dominance is one of the strategies that companies should bear in mind.

Sony is about to launch PlayStation 5....competing with Microsoft and Nintendo.

The new console competition between Microsoft (MS) and Sony has risen. The two companies began a scuffle for control of the huge console game market as they began pre-booking for new consoles. Microsoft and Sony will release their new consoles Xbox series X and PlayStation 5 on November 10 and 12. It is the first time in seven years that the two companies are releasing new consoles, PlayStation 4 and Xbox One.

The previous models, PlayStation 4 and Xbox One, saw their performance increase fall short of expectations. However, the newly introduced PlayStation 5 and Xbox series X are considered to have improved performance enough to enjoy smooth games even at 4K resolution.

In addition, Sony, which has adopted a strategy of attracting the attention of console users as a traditional way to strengthen its exclusive lineup.  Meanwhile Microsoft is putting strength on console rental service called Xbox All Access, along with subscription game service, GamePass. The competition between two companies are now heating for its market.

Normally, pre-booking serves as a barometer to determine the market's interest in the product before launch. This is also why all companies, regardless of sector, make great efforts to supply and demand pre-bookings, sales outlets and supplies.

Sony began pre-booking PlayStation 5 on the 18th for global primary retailers such as Korea, the U.S., Japan, and Europe. The game industry also commented that Sony, which was slightly behind Microsoft's schedule for price and pre-booking, has started to take the lead by making reservations faster than expected.

The pre-booking of PlayStation 5 was conducted in a hotter atmosphere than expected. In all countries where reservations have been made, supplies have run out while reservations have been made. As soon as pre-booking began in Korea, pre-bookings were sold out, and console users could see how much interest they had in PlayStation 5.

Source WSJ

https://www.wsj.com/articles/sony-to-launch-two-playstation-5-models-this-fall-11600292156?mod=searchresults&page=1&pos=4

https://www.wsj.com/articles/console-makers-now-have-bigger-game-to-play-11600426980?mod=tech_lead_pos13

https://www.wsj.com/articles/sony-earnings-win-boss-battle-with-coronavirus-11596539440?cx_testId=3&cx_testVariant=cx_2&cx_artPos=1#cxrecs_s