Mastering The Market Cycle: Getting the odds on your side

by Howard Marks

If there were a silver bullet: Why would the purveyor offer it to you rather than buying it up himself? And wouldn’t everyone else buy it and drive up its price to the point where it’s no longer a sure thing?

No investment strategy or tactic will ever deliver a high return without risk,

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.

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. All you need for ultimate success in this regard is (a) an estimate of intrinsic value, (b) the emotional fortitude to persevere, and (c) eventually to have your estimate of value proved correct.

Understanding what things really mean — rather than how they make investors feel — is the first step toward doing the things that are right for the times.

In short, when the market is high in its cycle, they should emphasize limiting the potential for losing money, and when the market is low in its cycle, they should emphasize reducing the risk of missing opportunity.

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.

good timing in investing can come from diligently assessing where we are in a cycle and then doing the right thing as a result. The study of cycles is really about how to position your portfolio for the possible outcomes that lie ahead. That, in one sentence, is what this book is about.

the formula for investment success.

Cycle positioning — the process of deciding on the risk posture of your portfolio in response to your judgments regarding the principal cycles Asset selection — the process of deciding which markets, market niches and specific securities or assets to overweight and underweight

Aggressiveness — the assumption of increased risk: risking more of your capital; holding lower-quality assets; making investments that are more reliant on favorable macro outcomes; and/or employing financial leverage or high-beta (market-sensitive) assets and strategies Defensiveness — the reduction of risk: investing less capital and holding cash instead; emphasizing safer assets; buying things than can do relatively well even in the absence of prosperity; and/or shunning leverage and beta

Skill — the ability to make these decisions correctly on balance (although certainly not in every case) through a repeatable intellectual process and on the basis of reasonable assumptions regarding the future. Nowadays this has come to be known by its academic name: “alpha” Luck — what happens on the many occasions when skill and reasonable assumptions prove to be of no avail — that is, when randomness has more effect on events than do rational processes, whether resulting in “lucky breaks” or “tough luck”

I mentioned above the two main ways in which an investor can add to returns: cycle positioning and asset selection.

“Being too far ahead of your time is indistinguishable from being wrong.”

Remember, when there’s nothing clever to do, the mistake lies in trying to be clever.

The Role of Human Nature

“don’t confuse brains with a bull market.”

The Role of Popularity

nothing will work forever: no approach,

rule or process can outperform all the time. First, most securities and approaches are right for certain environments and parts of the cycle, and wrong for others. And second, past success will in itself render future success less likely.

The important lesson is that — especially in an interconnected, informed world — 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).

“In investing, everything that’s important is counter-intuitive, and everything that’s obvious to everyone is wrong.”

The lesson is simple: investors should be leery of popular assets. Rather, it’s unpopularity that is the buyer’s friend.

The Role of Companies

Companies, like people, have the potential to respond to success with behavior that dooms that very success. Thus companies can: get complacent and become “fat and happy,” become bureaucratic and slow-moving, fail to take action to defend their positions, cease to be innovative and non-conforming, and join the crowd of mediocrity, and/or conclude that they can do pretty much anything, and thus venture into areas beyond their competence.

The Role of Timing

“Reform leads to growth and good times, and good times encourage an arrogance and complacency that leads to a new crisis.”

Likewise, most collapses are preceded by a wholesale refusal to finance certain companies, industries, or the entire gamut of would-be borrowers.

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.