Howard Marks, a seasoned investor and co-founder of Oaktree Capital Management, offers a unique perspective on navigating the volatile waters of financial markets. His strategy is grounded in recognizing market patterns, understanding investor psychology, and seizing opportunities during both high and low market conditions. Importantly, Howard advocates for going against the crowd, when necessary, while avoiding emotional impulses.
He published his memo “Taking the Temperature” and I thought we could extract valuable lessons by analysing his five successful market calls.
January 2000
In 1999, amid the surge in tech, media, and telecom (TMT) stocks, Howard Marks read Edward Chancellor's book "Devil Take the Hindmost." He discerned parallels between the TMT boom and historical financial bubbles. These parallels included the allure of easy profits, people leaving jobs to chase gains, and investments in unprofitable companies with unclear business models. These signs indicated the potential for bubbles and subsequent collapses.
Though not directly involved in equities, Howard observed unrealistic market narratives and penned a memo titled "bubble.com" in early 2000. This memo highlighted how investors were purchasing shares of young companies at soaring prices based on revenue multiples, often without profits or revenues.
Late 2004 to Mid-2007
In the mid-2000s, Howard noticed the Federal Reserve's adoption of accommodative monetary policies following the burst bubble. In his 2004 piece "Risk and Return Today," he noted that low returns were pushing investors toward risky "alternative" investments.
His 2005 memo, "There They Go Again," explored overconfidence in real estate. He spotlighted investor pitfalls such as ignoring past cycles, embracing new developments, and making irrational risk-taking decisions.
During this time, Oaktree responded to concerns about reckless deals saturating the market. These deals offered low returns, high risk, and favourable terms for issuers. Oaktree pivoted defensively, selling assets, liquidating funds, creating small funds or none at all in certain strategies, and elevating investment criteria.
In 2007's "It's All Good," Howard cautioned against the lack of scepticism and fear in the market. Investors were accepting higher risks for modest returns due to unattractive prospects for safer investments. The collapse of Bear Stearns and Lehman Brothers followed, leading to a plunge in the S&P 500.
Oaktree's caution was due to market analysis, not expertise, a testament to Howard's keen market sense.
Late 2008
As the 2008 Global Financial Crisis unfolded, Howard foresaw opportunities in distressed debt. He organized an $11 billion "reserve fund" between 2007 and 2008.
Despite scepticism, Oaktree invested cautiously as the crisis progressed, assuming that the financial world would persist. They believed that if they did not invest and the crisis did not worsen, they would fail to fulfil their role. Amid prevalent pessimism and fear, Howard recognized an overly negative market sentiment, indicating undervalued assets and a buying opportunity.
March 2012
After the 2000 TMT bubble burst, the S&P 500 faced annual declines, leading to disillusionment among investors. A shift toward alternative investments like hedge funds and private equity occurred. By 2012, Howard, inspired by a 1979 article titled "The Death of Equities," noticed parallels between then-current market conditions and the past. He saw that pessimistic sentiment could perpetuate poor performance.
Employing second-level thinking, Howard questioned such pessimism's logic. He observed that emotions, not analysis, often drove investor convictions. He believed that positive scenarios were plausible, and from 2012 to 2021, the S&P 500 returned 16.5% annually.
March 2020
Amid the Covid-19 pandemic's onset, the S&P 500 plummeted by mid-March 2020. In his pandemic-era memo "Nobody Knows II," Howard acknowledged the lack of historical precedence to predict the pandemic's course. Despite this uncertainty, he emphasized that not knowing the future does not necessarily mean taking no action.
This was evident in his 19 March 2020 memo, "Weekly Update." Howard rejected waiting for the market's "bottom" and emphasized investing when value was accessible. He believed favourable conditions existed for bargains despite uncertainty.
Howard's approach demonstrated his ability to logically determine actions even in the absence of historical precedent. He highlighted that when most investors reacted with panic or inaction, contrarian decisions to buy might be warranted. This approach required maintaining a clear head amid market turbulence, as exemplified by Rudyard Kipling's quote, "Keep your head when all about you are losing theirs."
Learning from Howard Marks
Howard's goal in discussing his five successful market calls is not to boast but to establish a foundation for understanding market observations. He underscores the value of learning from experiences and analysing patterns for valuable insights.
He acknowledges that markets occasionally reach extremes, either extremely high or very low, where taking action becomes compelling and the likelihood of being correct is high. However, he cautions against attempting to predict market moves too frequently, as most of the time markets hover around the middle ground, making reliable conclusions difficult. He suggests that successful investing often involves waiting for opportune moments, as advocated by Warren Buffett.
Howard believes that achieving a superior view of market performance during extreme highs or lows requires an understanding of prevailing investor psychology. He outlines key components of his approach, which he describes as "taking the temperature of the market":
Engage in pattern recognition by studying market history to understand the implications of current events.
Recognize that cycles stem from "excesses and corrections," and that strong movements in one direction are likely to be followed by corrections in the opposite direction.
Identify moments of extreme optimism or pessimism, recognizing that such sentiments often lead to unsustainable price levels.
Embrace contrarianism during extreme times, taking actions opposite to prevailing sentiment. But being a contrarian is not just about always disagreeing with what most people think. So, to effectively be a contrarian, you need to know: (a) what most people are doing, (b) why they are doing it, (c) what is problematic about it, and (d) what better alternative there is and why it is better.
Understand that market shifts often result from emotional investor reactions rather than mechanical processes.
Resist succumbing to emotional crowd psychology and stand apart from it.
Be vigilant for illogical propositions and take appropriate action when encountering widely accepted but flawed views.
Howard delves deeper into pattern recognition, noting that recognizing market patterns often requires years of experience and an unemotional, contrarian mindset. He also explains his view of cycles as a series of events causing one another, and how they stem from "excesses and corrections."
Making macro calls
When addressing questions about Oaktree's investment approach about making market calls, Howard explains how macro forecasting fits within their philosophy. He describes their six investment tenets, focusing on two relevant ones:
"We don't base our investment decisions on macro forecasts."
"We're not market timers."
While acknowledging that macro assumptions are necessary for bottom-up investing, Howard clarifies their approach. They assume the future macro environment will resemble past norms and account for the possibility of worse conditions by maintaining a "margin of safety." However, they avoid projecting distinctly better macro environments that would make specific investments winners. Instead, they construct portfolios to withstand surprises on the upside, relying on "neutral" assumptions rather than optimistic ones.
Regarding the idea of market timing, Howard explains Oaktree's stance:
They do not sell attractive long-term holdings to raise cash before a market decline. They sell when an investment reaches the target price, the investment case weakens, or a better opportunity arises.
They do not delay buying when something is cheap in anticipation of further price drops. If it is cheap, they buy it. If it gets cheaper and they conclude the thesis is still intact, they buy more.
Howard emphasizes the importance of being more afraid of missing a bargain opportunity than buying too early.
Bottom line
Howard Marks' insights provide a clear guide for navigating financial markets. His successes, like identifying bubbles and seizing opportunities during crises, show his ability to recognize patterns and think differently. He emphasizes understanding investor psychology, valuing logic over emotion, and recognizing extreme sentiment. This approach encourages careful action in uncertainty, as seen during the pandemic. Marks' principles—contrarianism, pattern recognition, and rational decision-making—guide investments and teach important life skills for understanding human behaviour and market changes. His legacy inspires us to learn from history, stay alert to prevailing narratives, and make informed choices with a clear head in tough times.
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