03: Mastering the Market Cycle

Mastering the Market Cycle

Howard Marks

The third book in the Investing Book Highlights series is Mastering the Market Cycle by Howard Marks. As the title suggest, the book analyzes the market cycles to help the reader understand how business fundamentals and the investment environment should play a role in investing. As most cycles have tendencies, Marks provides how understanding them can lead to a greater chance of success by informing you when to invest and how to position assets in your portfolio. 

Mastering the Market Cycle via Youtube

TOP TEN JOTS

10. Sales are responsive to the economic cycle in some industries, and in some they aren’t. 

• Raw materials and components, luxury goods, vacation trips and big-ticket durable goods are responsive to the economic cycle.
• Necessities, low-cost consumer items and everyday services aren't as responsive to the economic cycle.
• Investing in certain sectors of the economy based on the market cycle can reduce the risk to your portfolio or increase the likelihood of returns.

9. Skepticism and pessimism aren’t synonymous. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive.

• Doing the opposite of what others do is one of the key trait for successful investors.
• Excessive risk tolerance (or the belief that everything will keep going well) contributes to the creation of danger while excessive risk aversion (or the belief that everything will never get better) that depresses markets, creates some of the greatest buying opportunities, advises Marks.

8. Cycles are self-perpetuating.

• Each event in a cycle causes the one that follows.
• The Economic cycle influences investor's psychology, company profitability and incidence of default.
• The cycle in psychology influences fluctuations in the credit market conditions.
• The cycle in credit market attitudes influence the amount of weak bonds and can even deny refinancing.
• The stringent issuance of debt influences the demand for high quality companies and low default rates.

7. Cycles don’t necessarily progress smoothly; rather, they can be marked by dips, recoveries and feints along the way.

• Cycles move in both directions and sometimes simultaneously.
• Cycle speeds vary by the way the components influence each other.
• "Unlike a normal baseball game, we have no way to know how long a particular cycle will go on. There is no regulation length.", states Marks.

6. In the world investors inhabit, cycles rise and fall.

• Marks remarks, "Cycles vary in terms of reasons and details, and timing and extent, but the ups and downs (and the reasons for them) will occur forever, producing changes in the investment environment."
• Approximating where the market cycle can help investors prepare what to do next.
• Marks masterfully coins, "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."
• The chart shown here from Marks, Mastering the Market Cycle, represents a typical market cycle. Would you rather invest at point "c" or point "f"?
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5. Risk is the likelihood of permanent capital loss

• Losing most or all of your money is the risk that should be highly considered.
• Risk is unknowable so investments could turn out to be in your favor, neutral or not in your favor.
• In life and investing there can be many different outcomes therefore uncertainty and risk, although most times undesirable, are inescapable, Marks implies.

4.  Investor psychology seems to spend much more time at the extremes than it does at a “happy medium.”

• Investors fluctuate between greed and fear.
• Positive events encourage euphoria, which aids greed and lead to optimism. Negative events encourage depression, which aids fear and lead to pessimism.
• Superior investors resist external influences, remain emotionally balanced, act rationally toward both positive and negative events, weigh events objectively and analyze them dispassionately. 

3. Since investing consists of dealing with the future but the future isn’t knowable, that’s where the risk in investing comes from.

• Marks offers this sage wisdom, "Investments that seem riskier have to appear to promise higher returns, or else no one will make them."
• If riskier assets could be counted on to produce higher returns, they by definition wouldn’t be riskier.
• The chart shown here from Marks, Mastering the Market Cycle, shows an example of how risk and return can be related.
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2. Calibrate your portfolio to take advantage of opportunities and reduce risk.

• Marks suggest that finding a balance between being aggressive or defensive largely depends on the investment environment. 
• Since nobody can accurately predict the future, looking at the tendencies of the current investment environment can help increase the probability of your investment success by allowing you to take an aggressive or defensive stance.
• A knowledge advantage regarding the tendencies is enough to create success in the long run.

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

• Here is a nice summary of market cycles from Marks:
• The three stages of a bull market:
• The first stage, when only a few unusually perceptive people believe things will get better,
• The second stage, when most investors realize that improvement is actually taking place,
• The third stage, when everyone concludes things will get better forever.
• The three stages of a bear market
• The first stage, when just a few thoughtful investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
• The second stage, when most investors recognize that things are deteriorating,
• The third stage, when everyone’s convinced things can only get worse.

What do you think of Marks' ideas? Please comment below. If you have already read it, please let me know which were the most important for you.