Mastering The Market Cycle: Getting the Odds on Your Side

by Howard Marks

This is true of cycles in finance, and absolutely true of financial crises. As you’ll see later, the Global Financial Crisis of 2007–08 occurred largely because of the issuance of a huge number of unsound sub-prime mortgages, and that took place in turn because of an excess of optimism, a shortage of risk aversion, and an overly generous capital market, which led to unsafe behavior surrounding sub-prime mortgages. Thus the narrow-minded literalist would say, “I’ll definitely turn cautious the next time mortgage financing is made readily available to unqualified home buyers.” But that aspect of the Crisis need never recur for the lessons of the Global Financial Crisis to be valuable. Rather, 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 short, 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.