Books Finance

Mastering the Market Cycle by Howard Marks

Setting the context: Howard Marks is a legendary billionaire investor and has received acclamations for his memos by Warren Buffet himself. He is the Co-Founder and Co-Chairman of Oak Tree Capital Management and has about 50 years of investing experience under his belt. Through his books “Mastering the Market Cycle” and “The Most Important Thing”, Marks delineates important lessons he’s garnered over the course of his journey in the world of Finance. In this week’s post, I’ll be going over the key lessons from the book “Mastering the Market Cycles”.

Important lessons garnered from the Book: Mastering the Market Cycles

Through the book “Mastering the Market Cycles” Howard Marks emphasises on the nuances to be understood in order to get a good “sense” of Market Cycles and to gauge it’s tendencies with some foresight. Understanding what produces cycles are key. Market Cycles like any other cycle tend to fluctuate between periods of booms and busts. Booms – are scenarios wherein optimism fills the air, there’s a lot of money and credit in circulation, there’s a surge of debt with relative to income and there’s too little caution exercised. And well Busts are phases when all of that is reversed.

Ultimately, the key point to understand is that cycles, are not just mechanical but are mainly driven by Psychology and people’s tendencies to react hyperbolically to situations (emotional excessiveness). Hey, we aren’t always “rational” are we?

It’s not what you buy, it’s what you pay for it

Howard Marks

What are Market Cycles?

A market cycle can be characterised by periods of fluctuations between highs and lows in stock prices as a reaction to economic circumstances. For example, the stock market crashed during the Dot-Com burst and boomed during the Housing Bubble only to crash again during the Great Financial Crisis of 2008. This cyclical behaviour is called a market cycle and it tends to fluctuate around a long-term trend called a “Secular-Trend” made up of stock market profits and dividends. The long-term “secular” trend has an upward trajectory as shown in the image below.

Parts of a Market Cycle

  • (A) Tendency to mean revert from an extreme low
  • (B) Continuing above mean
  • (C) Bubble (Top)
  • (D) Tendency to mean revert from an extreme high
  • (E) Continuing below mean
  • (F) Depression (Low)
  • (G) Repeat (reversion to mean)

This cycle tends to be self-reinforcing and keeps repeating itself due to the underlying psychology. When things are good, people are bullish about the markets, they invest more, asset values rise, stocks markets boom, it continues until there are triggers indicating the market is overpriced. And well, the cycle reverses, with people selling off financial assets, stock markets plummeting and the bearish sentiment prevails (ah, the smell of pessimism).

History doesn’t repeat itself, but it sure does rhyme

Mark Twain

No Investor can know anything with certainty however we certainly can have some prescience about market tendencies or what’s more likely to happen by studying the past. In investing, the superior investor is able to tell which investments have a higher probability of performing well given the market conditions.

Factors impacting the Market Cycle

  1. Economic Cycle
  2. Debt Cycle
  3. Psychology Cycle – Attitude towards risk
  4. Corporate Profits Cycle – Business profits

How do we determine where we are in the market cycle?

  • We need to determine how the valuations are currently. Are they overpriced, underpriced or just-right?
  • We need to also observe how the investing community is behaving. Are they highly bullish, bearish or neutral?
MetricMarket UpturnMarket Downturn
Investor SentimentOptimisticPessimistic
MarketsOver-CrowdedLack of liquidity
Investor BehaviourAgressiveDefensive and Cautious
Recent PerformanceStrongWeak
Capital AvailabilityAbundantLow

Depending on where we are in the market cycle we can design portfolios accordingly:

The underlying philosophy that Howard Marks emphasises on is the ability to avoid emotions and herd mentality when viewing our investment portfolios. It’s to be able to sell when something is so dear to the world around and the ability to buy when nobody around wants to. The balancing act of being aggressive and defensive based on the position in the market cycle, would be the first step towards mastering the market cycle.

And that’s a wrap for this week! Stay tuned for new articles every week, simplifying Finance for Gen A to Z.

Happy Learning,

Prarthana Shetty

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