Mastering The Market Cycle: Getting the odds on your side

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Extreme economic cyclicality is considered undesirable. Too much strength can kindle inflation and take the economy high that a recession becomes inevitable. Too much weakness on the other hand can cause companies’ profits to fall and can cost jobs. Thus it is part of the central bankers and treasury to manage cycles. Since cycles produce ups and downs that can be excessive, the tools for dealing with them are counter cyclical and applied with a cycle of their own. Ideally inverse to the economic cycle itself. However, like everything else involving cycles managing them is far from easy.

And of course, now we've had something of a correction. Some of the optimism has been trimmed. A year ago, nobody could think of anything that could go wrong. Now they can. These are actually healthy signs for a market, and obviously, by definition, we need a little less caution today than we did for 12 months ago.This obviously informs my agenda in reading this book, and will therefore shape the information I choose to highlight and what I choose to exclude. Specifically, I want to see if this book can help answer the following questions: Alan: Okay. A couple, I think, follow-up questions from some of your earlier answers. The first is a question about your statement about being comfortable saying, "I don't know," which I think, honestly, probably a lot of the times, we don't know. I think the question is that a lot of folks aren't comfortable saying they don't know, and would like to be, I suppose, more comfortable doing so sometimes. How have you gotten comfortable with that? How have you gotten over the fear that by saying that, you're going to sound less credible in front of clients? Trying to know more than others about the “knowable,” the fundamentals of industries, companies, and securities.

I don’t believe in macro forecasts,” he said. “It is one of the views that I hold most strongly.”Why so? So the goal is simple enough: you want to buy assets when they’re cheap and wait for developments in the market to bring their price up. The ability to understand, assess, and deal with risk is the mark of the superior investor and an essential requirement for investment success. Everything else being equal, the bigger the boom – the greater the excesses of the capital markets in the upward direction – the greater the bust. Timing and extent are never predictable, but the occurrence of cycles is the closest thing I know to inevitable. Chapter 10: The Distressed Debt Cycle For instance, imagine the real estate market has crashed, and developers are defaulting on debt and being forced to abandon their building projects. You might be able to snatch up structures whose worth in materials alone exceeds the price at which you’re buying.I get asked a lot, "How do you become unemotional?" In the first book, I had a chapter on what I call second level thinking, which I think is very important, and I said, "I get the question, how do you learn to be a second level thinker?" And I used the example of basketball because they always say in basketball, you can't coach height. No matter how good a basketball coach you are, you're not going to make your players any taller, and so there's no easy answer on how to be unemotional, but if you accept ... It all comes down to logic. Do you accept that the big errors and the big swings in investing come from psychology or emotion, not from changes in fundamentals? Corporate profits are based on the economic cycle, but fluctuate more wildly. Some industries’ average profits follow the economic cycle closely (raw materials like metals and chemicals), others are mostly uncorrelated (haircuts), and others are inversely correlated (Costco memberships). Understanding the investment environment we are in, and deciding how to strategically position our portfolios for it.

During this stage, investors are driven by the fear of missing out and are willing to pay exorbitant prices for assets that are not supported by fundamentals. The next section of this chapter comes from the memo Risk and Return Today, October 27, 2004 which includes several graphs you may want to view. Although the market cycle revolves around a midpoint, it doesn’t spend very much time there. Usually we are either in an upswing, where assets are overpriced, or a downswing, where assets are underpriced. Superior investors have favorably skewed distributions of outcomes, but not batting averages of 1,000. Chapter 15: Limits on Coping As for emotions, Marks said,it starts with the question of whether or not you accept that the big errors and the big swings in investing come from psychology or emotion, not from changes in fundamentals. If you do, then ask whether you accept the importance of being on the right side of that. Finally, do you accept that if you behave like everybody else, you clearly can’t perform better than the others?

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Book Genre: Business, Currency, Economics, Finance, History, Money, Nonfiction, Personal Finance, Psychology Suffice it to say, as moderator Allen Bond, CFA, put it, you need a strong stomach to put up with a lot of pain before a call materializes in your favor. At the very least, you need patience.

The lesson? Skepticism is not the same as pessimism. When everyone is irrationally pessimistic, skeptical investors suspect there may be reason for optimism. 9. The Credit Cycle The macro is certainly important,” Marks said. “The macro drives the markets these days and does so to a much greater extent than ever in the past, and so yes, important. But in my opinion, not knowable.”

Everyone feels these emotions, but the superior investor does their best to keep these emotions in balance at all times rather than swinging between one and another with the market. No one should fear that he is not up to the task just because he is unsure of his conclusions. These are not things about which certainty is attainable. It’s useful for investors to understand how cycles work and to develop a sense for where we are in the current cycle, because it allows them to position their portfolio for what’s next. Alan: Okay. Second of what I would consider the follow-up questions to one of your earlier comments was about really the key, about being emotionless in terms of your investment decisions, and the question is, how do you get there? For those of us that do get emotional and let our emotions impact us, what has worked in your experience that allows you to keep emotion out of the equation? Alan: Okay, so next question from the audience. This is a reader of your first book, The Most Important Thing, and the question is: do you now know what the most important thing is? The question is based on the conclusion of your book.