Mastering The Market Cycle: Getting the odds on your side

by Howard Marks

The key to dealing with the credit cycle lies in recognizing that it reaches its apex when things have been going well for a while, news has been good, risk aversion is low, and investors are eager. That makes it easy for borrowers to raise money and causes buyers and investors to compete for the opportunity to provide it. The result is cheap financing, low credit standards, weak deals, and the unwise extension of credit. Borrowers hold the cards when the credit window is wide open — not lenders or investors. The implications of all of this should be obvious: proceed with caution. The exact opposite becomes true at the other extreme of the credit cycle. Its nadir is reached when developments are unpleasant, risk aversion is heightened, and investors are depressed. Under such circumstances, no one wants to provide capital, the credit market freezes up, and proposed offerings go begging. This puts the cards into the hands of providers of capital rather than the borrowers. Because borrowing is difficult and capital is generally unavailable, those who possess it and are willing to part with it can apply rigorous standards, insist on strong loan structures and protective covenants, and demand high prospective returns. It’s things like these that provide the margin of safety required for superior investing. When these boxes can be ticked, investors should swing into an aggressive mode. Superior investing doesn’t come from buying high-quality assets, but from buying when the deal...

credit cycles