Mastering The Market Cycle: Getting the odds on your side

by Howard Marks

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.

in my view, 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. Put the two together and we see that risk is the possibility of things not going the way we want.

Superior investors are people who have a better sense for what tickets are in the bowl, and thus for whether it’s worth participating in the lottery. In other words, 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.

In the end, trees don’t grow to the sky, and few things go to zero. Rather, most phenomena turn out to be cyclical.

Simply being right about a coming event isn’t enough to ensure superior relative performance if everyone holds the same view and as a result everyone is equally right. Thus success doesn’t lie in being right, but rather in being more right than others.

So the job of the central banker is to behave appropriately counter-cyclically: that is, to limit the extent of cycles, slowing the economy in times of prosperity in order to keep inflation under control, and stimulating the economy during slowdowns to support employment.

That’s one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not so hot.” But in the world of investing, perception often swings from “flawless” to “hopeless.”

“What the wise man does in the beginning, the fool does in the end.”

When others are recklessly confident and buying aggressively, we should be highly cautious; when others are frightened into inaction or panicked selling, we should become aggressive.

There are three ingredients for success — aggressiveness, timing and skill — and if you have enough aggressiveness at the right time, you don’t need that much skill.