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It’s my primary message that we should pay attention to cycles; perhaps I should say “listen to them.”
Warren Buffett once told me about his two criteria for a desirable piece of information: it has to be important, and it has to be knowable.
It’s not that the macro doesn’t matter, but rather that very few people can master it. For most, it’s just not knowable (or not knowable well enough and consistently enough for it to lead to outperformance).
In my view, 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. And I believe the aggressiveness/defensiveness balance should be adjusted over time in response to changes in the state of the investment environment and where a number of elements stand in their cycles.
The events in the life of a cycle shouldn’t be viewed merely as each being followed by the next, but—much more importantly—as each causing the next.
It’s the oscillation of things around the midpoint or secular trend that this book is largely about. The oscillation bedevils people who don’t understand it, are surprised by it or, even worse, partake in and contribute to it. But as I’ve said before, it often presents profit opportunities for those who understand, recognize and take advantage of cyclical phenomena.
The events in the life of a cycle shouldn’t be viewed merely as each being followed by the next, but—much more importantly—as each causing the next.
Cycles are self-correcting, and their reversal is not necessarily dependent on exogenous events. The reason they reverse (rather than going on forever) is that trends create the reasons for their own reversal. Thus I like to say success carries within itself the seeds of failure, and failure the seeds of success.
This effort to explain life through the recognition of patterns—and thus to come up with winning formulas—is complicated, in large part, because we live in a world that is beset by randomness and in which people don’t behave the same from one instance to the next, even when they intend to. The realization that past events were largely affected by these things—and thus that future events aren’t fully predictable—is unpleasant, as it makes life less subject to anticipation, rule-making and rendering safe.
The realization that past events were largely affected by these things—and thus that future events aren’t fully predictable—is unpleasant, as it makes life less subject to anticipation, rule-making and rendering safe.
The superior investor resists psychological excesses and thus refuses to participate in these swings. The vast majority of the highly superior investors I know are unemotional by nature. In fact, I believe their unemotional nature
It’s one of the absolute truths that attitudes toward risk change, and in so doing they alter the investment environment.
Sometimes investors become too risk-averse, and sometimes they relax their risk aversion and become too risk-tolerant.
One of the most important characteristics of psychological cycles is their extremeness. Cycles swing not only in directions and degrees that make sense, but also in wacky ways and to excess.
Just as risk tolerance is unlimited at the top, it is non-existent at the bottom. This negativity causes prices to fall to levels from which losses are highly unlikely and gains could be enormous.
When risk aversion and caution evaporate and risk tolerance and optimism take over. This condition is the investor’s greatest enemy.
Warren Buffett puts it well in the above quote; it’s one I use all the time. I think it aptly sums up this phenomenon, as well as the contrarian response that is required as a result. 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.
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.
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?
And it will always go on, since it seems to be hard-wired into most people’s psyches to become more optimistic and risk-tolerant when things are going well, and then more worried and risk-averse when things turn downward. That means they’re most willing to buy when they should be most cautious, and most reluctant to buy when they should be most aggressive. Superior investors recognize this and strive to behave as contrarians.
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.
Even though the credit cycle is less well-known to the man on the street than most of the other cycles discussed in this book, I consider it to be of paramount importance and profound influence.
The bottom line of all of the above is that generous credit markets usually are associated with elevated asset prices and subsequent losses, while credit crunches produce bargain-basement prices and great profit opportunities. (“Open and Shut”)
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. These conditions are much more the case when the credit markets are in the less-euphoric, more-stringent part of their cycle. The slammed-shut phase of the credit cycle probably does more to make bargains available than any other single factor.
There is no such thing as a market that is separate from—and unaffected by—the people who make it up. The behavior of the people in the market changes the market. When their attitudes and behavior change, the market will change.
At Oaktree, we strongly reject the idea of waiting for the bottom to start buying.
Skill and luck are the prime elements that determine the success of portfolio management decisions. Without skill on an investor’s part, decisions shouldn’t be expected to produce success. In fact, there’s something called negative skill, and for people who are saddled with it, flipping a coin or abstaining from decisions would lead to better results. And luck is the wildcard; it can make good decisions fail and bad ones succeed, but mostly in the short run. In the long run, it’s reasonable to expect skill to win out.
