Mastering The Market Cycle: Getting the Odds on Your Side

by Howard Marks

risk is the possibility of things not going the way we want.

while superior investors—like everyone else—don’t know exactly what the future holds, they do have an above-average understanding of future tendencies.

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.

Mark Twain is reputed to have said (although there’s no evidence he actually said it), “History doesn’t repeat itself, but it does rhyme.”

the themes that provide warning signals in every boom/bust are the general ones: that excessive optimism is a dangerous thing; that risk aversion is an essential ingredient for the market to be safe; and that overly generous capital markets ultimately lead to unwise financing, and thus to danger for participants.

in general, inflation is viewed as a result of a strong upward movement of the economic cycle.

one thing that can be said with total conviction about stock market performance is that the average certainly isn’t the norm.

Greed was the dominant characteristic of that market. Those who weren’t participating were forced to watch everyone else get rich. “Prudent investors” were rewarded with a feeling of stupidity.

Irrational exuberance is replaced by excessive caution.

The superior investor is mature, rational, analytical, objective and unemotional. Thus he performs a thorough analysis of investment fundamentals and the investment environment. He calculates the intrinsic value of each potential investment asset. And he buys when any discount of the price from the current intrinsic value, plus any potential increases in intrinsic value in the future, together suggest that buying at the current price is a good idea.

they tend to become optimistic and eager to buy when good news, positively interpreted, has forced prices up . . . and vice versa.

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 is one of the great contributors to their success.

in the world of investing, perception often swings from “flawless” to “hopeless.” The pendulum careens from one extreme to the other, spending almost no time at “the happy medium” and rather little in the range of reasonableness. First there’s denial, and then there’s capitulation.

it’s not the data or events; it’s the interpretation. And that fluctuates with swings in psychology.

expecting widespread clinical observation during a market mania makes about as much sense as saying “everyone knows the market has gone too far.” If many people recognized that it had gone too far, it wouldn’t be there. (“It’s All Good,” July 2007)