Legendary investor and Co-Founder of Oaktree Capital, Howard Marks, puts out memos on his website on a regular basis. Many investors, including Warren Buffett, have very high praise for these memos:
“When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something.”
– Warren Buffett
If you want to be a successful investor, it would be a smart move to learn from these memos.
And if you’re intimidated by these memos because of the stature of these investors, or the language they use, don’t worry – Wealth Potion exists to break it down into simple language.
Here are the top takeaways from Howard Marks’ latest memo ‘Taking the Temperature’, posted July 10, 2023.
Be Disciplined with your Market Calls
Howard Marks begins the memo by recounting how over his 50 year career, he made 5 market calls, and in hindsight, they were all correct.
That’s 5 calls in 50 years, or put another way, that’s 1 call every 10 years. Really think about that!
Most investors make the mistake of making calls too frequently. Successful investing requires patience and long-term thinking.
Understand Market Cycles
So how did Howard Marks make those 5 accurate market calls? He made those calls when he felt confident that the market was either “crazily elevated or massively depressed”.
To do this, you must understand Market Cycles, and how they work. We will write more about market cycles (and mean reversion) in the future. But for now, consider this definition from Investopedia.com:
“A cycle refers to trends or patterns that emerge during different business environments. (…) During a cycle, some securities or asset classes outperform others because their business models are aligned with conditions for growth.”
– Investopedia
The title of Marks’ memo is a helpful analogy for thinking about market cycles. When a market cycle is near its peak, think of it as ‘running hot’. When a market cycle is near its bottom, think of it as ‘being cold’.
Understanding market cycles (and profiting off them) is an extremely difficult skill that takes investors years if not decades to learn. It is also more of an art than a science – there is no way to perfectly predict the future. But it can increase your probability for success.
Be Fearful When Others are Greedy, and Greedy When Others are Fearful
Howard Marks describes in detail how his firm Oaktree Capital accurately predicted the 2008 financial crisis in 2007, and pulled money from many risk assets. They then accurately predicted the following correction in 2008, heavily deploying capital when everyone else was not.
“During a cycle, some securities or asset classes outperform others because their business models are aligned with conditions for growth.”
– Howard Marks, Taking the Temperature
This quote from the memo is reminiscent of a famous Warren Buffett quote:
“Our goal is modest: we simply attempt to be fearful when others are greedy, and greedy when others are fearful.”
– Warren Buffett, Berkshire Hathaway 1986 Shareholder’s Letter
Howard Marks describes in detail the parallels between 1979 and 2012, following multiple years of poor stock market performance. In 1979, just as everyone was giving up on the stock market, and BusinessWeek had published an article titled ‘The Death of Equities’, the market proceeded to accelerate into the biggest bull run in history.
If you invested $1 into the stock market when ‘The Death of Equities’ was published, 20 years later you would have had $32. An average annual return of 17.9%.
Howard Marks noticed a similar negative sentiment in 2012, and so placed a contrarian bet on the market. What was the result? 16.5% average annual returns from 2012 to 2021.
The Gap Between Theory and Reality is Psychology
The entire memo is incredibly insightful, but Page 9 is especially important to read.
Howard Marks argues that you cannot beat the market by looking only at the macroeconomic environment, nor from looking only at company reports. These datasets are available to everyone, and are therefore priced in.
The key to investor success is to understand investor psychology. That is what drives markets to extreme highs and lows.
Finding the gap between objective reality and the performance of the stock market is what Marks means when he says he is ‘Taking the Temperature’.
What You Can Do About It
Howard Marks concludes the memo with his process for ‘Taking the Temperature’ of the market. Summarized here:
- Learn how to engage in pattern recognition.
- Know that cycles stem from “excesses and corrections”.
- Watch for moments when most people are too optimistic.
- When these times arise, be a contrarian, not a conformist.
- Realize that markets are a result of investors’ emotions.
- Resist your own emotionality.
- Look out for illogical propositions.
Again, full credit to Howard Marks and Oaktree Capital. Read or listen to the full memo here.
Here are some final questions to ponder:
- What do you feel like the temperature of the market is right now?
- If you’re not sure, what could you learn today to get better at taking the temperature?
- Based on your reading of the temperature, how might that change your investment decisions?
To your prosperity,
Wealth Potion