Mastering the Market Cycle: Getting the Odds on Your Side

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The rational investor is diligent, skeptical, and appropriately risk-averse at all times. But also on the lookout for opportunities for potential return that more than compensates for risk. 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).

Additionally, having a clear and well-defined investment strategy can help investors stay disciplined and avoid impulsive decisions. Conclusion Curious if the idea of emotionally-driven market cycles is compatible with the efficient market hypothesis. However, this optimism can be dangerous as it can lead to overvaluation and a subsequent market crash. 2 – The Bubble Stage – Thrill and EuphoriaMastering the Market Cycle, by Howard Marks will help you understand when is the optimal time to invest given a market’s conditions.

This is evaluated on a company-by-company basis, but market power is probably correlated across similar types of companies over time. For example major US automakers all experienced a decrease in market power as foriegn competitors gained ground in the US. Newspapers all over the world lost their power in the 2000s and 2010s. According to the author, who happens to be just such an investor, the most common questions relate to market cycles. More than anything else, clients want to know how to position themselves within the current market cycle, where they stand within it and how it will play out. Is the market doing well, with prices going up, or is it doing poorly, with prices declining? This chapter contains some of the book’s paragraphs that Howard thinks hold the keys to understanding cycles. This chapter is a recap of the book’s key observations.Small swings in the economy lead to big swings in profits, bigger swings in markets, and changes in the credit window. The credit window can go from “wide open” to “slammed shut” in an instant. Small changes in fundamentals can trigger big shifts in markets, with a turn in investor sentiment providing the catalyst. Howard Marks, CFA, a co-founder of Oaktree Capital Management and a pioneer of distressed debt investing, has made his career by stepping in to provide capital when the credit window slams shut.

Cycles aren’t just a series of events that happen one after another. They are a chain of events linked by causality, where each causes the next, and is caused by what came before. Because the primary driver of ups and downs is overreaction in a positive or negative direction, which is based on human psychology, there will be no beginning or end to cycles. For some reason, that resonates with me, and I find it easier to admit what I don’t know than to persevere as if I did,” he said. It is honestly a luxury to have 50 years of hard won experience condensed in such a graspable format. Marks is a simply superb writer. Much like Warren Buffet the language can be deceptively simple, causing fairly complex issues to sound like child’s play. Make no mistake – this is investment thinking on the highest level. Still, compared to the high standards set by the author’s investment letters some passages of the book are a bit repetitive with their long and recurring chains of cause-and-effects and some newly written chapters that don’t build on previous investment letters, but are required to make an coherent story, are perhaps slightly less inspired than the others. It makes sense because that’s generally what humans do: fixate on whatever information happens to be the most salient, and under-weight information outside our current frame.

1. Why Study Cycles

Investors with the ability to understand cycles will find opportunities for profit. Chapter 18: The Essence of Cycles 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.”

We never know what’s going to happen in the markets,” Marks told the audience at CFA Society Portland’sAnnual Investment Strategy Dinner. “We never can be sure of an outcome, but I think we can get the odds on our side by understanding where we are in the cycle.” The ability to understand, assess, and deal with risk is the mark of the superior investor and an essential requirement for investment success. If valuations aren’t out of line with history, the market cycle is unlikely to be highly extended in either direction.At this point in the book, Marks starts telling real stories from his actual experience investing, and it’s pure gold. There is too much rich detail to adequately summarize here, so if you’re interested you should buy the book and read this chapter. But I will leave you with the one that was most salient to me. If you study past cycles, understand their origins and remain alert for the next one, you will become keenly attuned to the investment environment as it changes. You’ll be aware and prepared while others get blindsided by unexpected events or fall victim to emotions like fear and greed. I think that it would be wonderful to not have the bias toward either optimism or pessimism. I don't know if it's human to not have a bias, but clearly I could've done better over my career if I'd been less cautious. Of course, I might not be sitting here. I might've carried out in the last crisis. Marks’s memoshave a cult following on Wall Street and beyond, and anyone whose read them knows he is fond of adages. And true to form, he pulled out one in response to Bond’s question. So you can forget long-term forecasting. It’s much wiser to pay attention to what the author calls “the knowable” and base your short-term predictions off that knowledge.