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Most of the great investors I’ve known over the years have had an exceptional sense for how cycles work in general and where we stand in the current one. That sense permits them to do a superior job of positioning portfolios for what lies ahead. Good cycle timing—combined with an effective investment approach and the involvement of exceptional people—has accounted for the vast bulk of the success of my firm,
Because human psychology and behavior play such a big part in creating them, these cycles aren’t as regular as the cycles of clock and calendar, but they still give rise to better and worse times for certain actions.
Investing can be solitary, but I think those who practice it in solitude are missing a lot, both intellectually and interpersonally.
Peter Bernstein, John Kenneth Galbraith, Nassim Nicholas Taleb and Charlie Ellis.
Seth Klarman, Charlie Munger, Warren Buffett, Bruce Newberg, Michael Milken, Jacob Rothschild, Todd Combs, Roger Altman, Joel Greenblatt, Peter Kaufman and Doug Kass.
Oscar Schafer, Jim Tisch and Ajit Jain
The odds change as our position in the cycles changes. If we don’t change our investment stance as these things change, we’re being passive regarding cycles; in other words, we’re ignoring the chance to tilt the odds in our favor.
we can most gainfully spend our time in three general areas: trying to know more than others about what I call “the knowable”: the fundamentals of industries, companies and securities, being disciplined as to the appropriate price to pay for a participation in those fundamentals, and understanding the investment environment we’re in and deciding how to strategically position our portfolios for it.
risk is primarily the likelihood of permanent capital loss. But there’s also such a thing as opportunity risk: the likelihood of missing out on potential gains.
in order to win at this game more often than you lose, you have to have a knowledge advantage. That’s what the superior investor has: he knows more than others about the future tendencies.
The cycle oscillates, as I mentioned, around the midpoint. The midpoint of a cycle is generally thought of as the secular trend, norm, mean, average or “happy medium,” and generally as being in some sense as “right and proper.” The extremes of the cycle, on the other hand, are thought of as aberrations or excesses to be returned from, and generally they are.
the swing back from a high or low almost never halts at the midpoint . . . regardless of how “right” or “appropriate” the midpoint may be. The continuation of the movement past the midpoint and toward the opposite extreme is highly dependable.
Seen through the lens of human perception, cycles are often viewed as less symmetrical than they are. Negative price fluctuations are called “volatility,” while positive price fluctuations are called “profit.” Collapsing markets are called “selling panics,” while surges receive more benign descriptions (but I think they may best be seen as “buying panics”; see tech stocks in 1999, for example). Commentators talk about “investor capitulation” at the bottom of market cycles, while I also see capitulation at the top, when previously prudent investors throw in the towel and buy.
Sheldon Stone says, “The air goes out of the balloon much faster than it went in.”
the details are unimportant and can be irrelevant. But the themes are essential, and they absolutely do tend to recur. Understanding that tendency—and being able to spot the recurrences—is one of the most important elements in dealing with cycles.
Gains in population and productivity have declined in the U.S., as they have in other developed nations. Taken together, these two things suggest GDP will grow more slowly in the U.S. in the coming years than it did in the years following World War II.
Sales of industrial raw materials and components are directly responsive to the economic cycle.
everyday necessities like food, beverages and medicine aren’t highly responsive to the economic cycle.
Demand for low-cost consumer items (like everyday clothing, newspapers and digital downloads) isn’t very volatile,
Purchases of big-ticket “durable goods”—things like cars and homes for individuals and trucks and factory equipment for businesses—are highly responsive to the economic cycle.
Demand for everyday services generally isn’t volatile. If they’re necessary (like transportation to work) and low-priced (like haircuts), demand won’t be highly sensitive to changes in the economy.
increase in operating profits will be considerably greater than the increase in sales: that’s operating leverage.
in the long run, stocks overall should provide returns in line with the sum of their dividends plus the trendline growth in corporate profits, or something in the mid-to-high single digits. When they return much more than that for a while, that return is likely to prove to have been excessive—borrowing from the future and thus rendering stocks risky—meaning a downward correction is now in order.
One of the most time-honored market adages says that “markets fluctuate between greed and fear.” There’s a fundamental reason for this: it’s because people fluctuate between greed and fear.
What is investing? One way to think of it is as bearing risk in pursuit of profit.
the ability to understand, assess and deal with risk is the mark of the superior investor and an essential—I’m tempted to say the essential—requirement for investment success.
we can accept the environment as it is and invest, or we can reject it and stay on the sidelines, but we don’t have a third option of saying, “I don’t like the environment as it is today; I demand a different one.”
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.
Contrarianism—doing the opposite of what others do, or “leaning against the wind”—is essential for investment success.
some activities—like home buying—are highly responsive to movements in the economic cycle, and others—like purchasing food—are not.
It takes only a small fluctuation in the economy to produce a large fluctuation in the availability of credit, with great impact on asset prices and back on the economy itself.
essential difference between positive net worth and liquidity. Even a wealthy company can get into trouble if it doesn’t have cash on hand and can’t obtain enough to meet its debt maturities, bills and other calls on cash
“the worst loans are made at the best of times.”
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.
rationalization for price appreciation that has taken place (and prediction of still more to come) invariably occurs at highs, not lows. For real help I’d look to commentators who issue sober statements in bullish times, or who argue against negativity when markets are down.
There’s only one form of intelligent investing, and that’s figuring out what something’s worth and buying it for that price or less. You can’t have intelligent investing in the absence of quantification of value and insistence on an attractive purchase price. Any investment movement that’s built around a concept other than the relationship between price and value is irrational.
Sir John Templeton put it, “To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.”
Everyone sees what happens each day, as reported in the media. But how many people make an effort to understand what those everyday events say about the psyches of market participants, the investment climate, and thus what should be done in response?
we strongly reject the idea of waiting for the bottom to start buying.
waiting for the bottom to start buying is a great example of folly. So if targeting the bottom is wrong, when should you buy? The answer’s simple: when price is below intrinsic value. What if the price continues downward? Buy more, as now it’s probably an even greater bargain.
exiting the market after a decline—and thus failing to participate in a cyclical rebound—is truly the cardinal sin in investing. Experiencing a mark-to-market loss in the downward phase of a cycle isn’t fatal in and of itself, as long as you hold through the beneficial upward part as well. It’s converting that downward fluctuation into a permanent loss by selling out at the bottom that’s really terrible.
while the errors leading up to the Global Financial Crisis were easily recognizable, the timing of their correcting was absolutely beyond predicting. The best investors can do is act in light of what they see in the environment. But they must bear in mind what John Maynard Keynes is reputed to have said: “The market can remain irrational longer than you can remain solvent.”
investors have to deal daily with two possible sources of error. The first is obvious: the risk of losing money. The second is a bit more subtle: the risk of missing opportunity. Investors can eliminate either one, but doing so will expose them entirely to the other.
The study of cycles is really about how to position your portfolio for the possible outcomes that lie ahead.
We have to safeguard our portfolios (and our investment management businesses) against the danger stemming from the fact that the thing that’s most likely to happen—which our understanding of cycles can tell us—may not happen until long after it first becomes likely. And we have to steel ourselves emotionally so as to be able to live through the potentially long time lag between reaching a well-reasoned conclusion and having it turn out to be correct.
Detecting and exploiting the extremes is really the best we can hope for. And I believe it can be done dependably—if
you shouldn’t expect to reach profitable conclusions daily, monthly or even yearly.
when there’s nothing clever to do, the mistake lies in trying to be clever.
four or five times in 48 years. By making my calls only at the greatest cyclical extremes, I’ve maximized my chances of being right. No one—and certainly not I—can succeed regularly, other than perhaps at extremes.
everything that produces unusual profitability will attract incremental capital until it becomes overcrowded and fully institutionalized, at which point its prospective risk-adjusted return will move toward the mean (or worse). And, correspondingly, things that perform poorly for a while eventually will become so cheap—due to their relative depreciation and the lack of investor interest—that they’ll be primed to outperform. Cycles like these hold the key to success in investing, not trees that everyone is assuming will grow to the sky.
Find those businesses of unusual profitability but also with a moat to keep away incremental capital
