Book Review: Howard Marks's 'Mastering the Market Cycle'
“No Phil, in truth, I don’t see that for you. You’re lacking the one thing that a musician absolutely has to have. And that’s meter. You don’t feel when one musical phrase ends and another begins. I’m sorry. But I can’t teach you that. I don’t know anybody who can.”
Those were the words heard by wannabe musician Phil Spector as a child. His music teacher uttered them. It turns out the legendary music producer had little musical talent of his own. He could spot in others what he lacked. But no amount of teaching was going to relieve Spector of his lack of “feel” despite his mother’s willingness to purchase for him all manner of musical instruction.
Spector’s struggles as a musician came to mind as I read legendary investor Howard Marks’s (Oaktree Capital) very excellent 2018 book, Mastering the Market Cycle: Getting the Odds on Your Side. Marks’s insights into the investment process are compelling, fascinating, and most frustrating of all, they’re relentlessly logical. The logic is frustrating mainly because as Marks stresses throughout Mastering the Market Cycle (future title references will be MMC) through the words of another investing legend (John Templeton), “To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.” What’s relentlessly logical in theory is extraordinarily difficult to execute in practice.
Marks’s immense wealth reveals him as someone capable of intrepid buying when others are desperate. Marks has “feel” in spades, and aims with MMC to help investors develop a reasonable understanding of how he thinks so that they can avoid being average, or less than average. The latter is important in consideration of Marks’s crucial observation that “Almost anyone can make money when the market rises and lose money when it falls.” His goal with the book is to get investors thinking about market cycles. As he puts it, “The study of cycles is really about how to position your portfolio for the possible outcomes that lie ahead.” Optimism (perhaps the time to sell) and pessimism (perhaps the time to greedily buy) drive these cycles, so Marks stresses the importance of developing a sense for where the market is in terms of despondency versus glee. As he explains it on page 1 of MMC, “I can’t say an understanding of cycles is everything in investing, or the only thing, but for me it’s certainly right near the top of the list.”
About the importance of cycles, few, including this reviewer, would be in the position to question Marks on it. It all makes so much sense, and that’s why this same reviewer will be quoting MMC for many years to come. It’s that good. Marks has an intuitive sense of the human psyche, and what happens to that psyche during boom and bust periods. While the pundit class talks and writes obsessively about the when of “recessions,” and how to avoid them, Marks thinks very differently. He notes that “success carries within itself the seeds of failure, and failure the seeds of success.” This essential view will be referenced throughout this review, but for now it’s important to point out that per Marks, it’s during the booms that we’re developing bad habits, relaxing our aversion to risk, and in a broad sense developing a level of optimism that sets the stage for the correction. In Marks’s own words, “the shakiest financings are completed in the most buoyant economies and financial markets.”
All of the above matters a great deal in consideration of the desire among politicians, pundits and economists to “avert” recession. It’s apparent that Marks at least implicitly rejects such a strategy. Indeed, as his failure unearthing “the seeds of success” line indicates rather prominently, to fight recessions is to fight recovery. As Marks alludes, it’s during recessions that we fix what we’re doing wrong. More on this in a bit, but Marks’s comment about what leads to hard times needs to be taped on the wall of every pundit, politician and economist who strides the earth. The recession is the cure for errors committed during periods defined by a lack of fear.
Thinking about the previously discussed quote in terms of market cycles, boom times lead to a relaxation of investment standards that are corrected during market corrections. Marks’s genius, and indeed that of Oaktree, is that more often than not he and his firm have revealed a preternatural ability to sell to the greedy during periods of optimism and buy during periods of desperation. Getting into specifics that would most interest readers, Marks writes about how he and his partners would look at certain financings leading up to 2008 with a great deal of incredulity. Though Marks doesn’t claim that they saw things with total clarity, he stresses that “You didn’t have to fully understand what was wrong with sub-prime mortgages or deconstruct mortgage backed securities” to know that something was amiss.
And so Oaktree raised its largest fund yet to profit from “distressed opportunities” that the firm expected to happen upon. Better yet, they acted on the Templetonian maxim to “buy when others are despondently selling.” They did so in size fashion. Marks recalls that Oaktree was buying $500 million “a week over the fifteen weeks from September 15 through the end of year.” Readers should think about that for a minute. It’s easy in retrospect to say one should be greedy when others are desperate, but plainly very difficult when others are actually desperate. There was so much pessimism back then.
Which leads to questions that I found myself wanting to ask Marks. And while his views on economic matters will soon be discussed, for now his comment that “Very few investors are known for having outperformed through macro forecasting” rates discussion as it applies to markets. Up front, it’s not surprising what Marks says. To read macro analysis is to routinely read what’s ridiculous, and that’s defined by endless fallacy.
At the same time, it’s not unreasonable to at least suggest that market forecasters must have a similarly bad track record relative to those who presume to divine the macro future. In each instance the forecaster is seeking to make sense of what’s driven by billions of people making infinite decisions every millisecond. Furthermore, how does one define a “market” that his populated by Amazon and Apple on the theoretical high end, but also Sears and Blockbuster on the low end? Marks regularly makes the point in MMC about trying to be ahead of the cycle, but it would be interesting to ask him how he and his partners discern between what’s got upside, and what’s not going to revert to any kind of mean. There's something so "macro" about any discussion of the "market."
Along the lines of the above, late in MMC Marks writes, “things that perform poorly for a while eventually will become so cheap – due to their relative depreciation and the lack of investor interest – that they’ll be primed to outperform.” No doubt that’s true to a degree, but isn’t pessimism or a general lack of investor interest a flashing market signal itself; one transmitting crucial information to investors? Blockbuster was mentioned in the previous paragraph, and it’s instructive mainly because there was no upside in it for investors who purchased its shares in 2010, and it seems investors who bought Sears or Payless in more recent times were similarly burned. That’s a long way of saying that while Marks describes a successful investor as being “unemotional by nature,” the success of Oaktree can’t just be about its employees possessing the nerve to buy when others are selling. How did they and do they know what to buy?
Better yet, how much can being "greedy when others are despondent" exist as an investment strategy in consideration of its broad acceptance among investor greats as the most important ability for a successful investor? For instance, a third of the way through MMC Marks calls into the question the accepted belief that ‘”riskier assets produce higher returns.”’ He rejects the conventional wisdom given his view that “if riskier assets could be counted on to produce higher returns, they by definition wouldn’t be riskier.” But doesn't the previous truth apply just as much to the famous Templeton line? Translated, it would be interesting to know how much the profits that come from buying when there’s blood in the streets have been eroded by investor knowledge that the time to buy is when there’s blood in the streets.
Marks reminds readers throughout MMC to be cautious amid excessive optimism and “this time is different” commentary, but if each emotion is predictive of troubled times ahead, wouldn’t the trouble be somewhat priced? Apparently not, judging by periodic corrections in markets, but it would be interesting to know how Marks’s investing strategy evolves in consideration of how much smarter the market itself becomes with each stretch of pessimism and optimism.
Moving to economics, Marks as previously mentioned doesn’t think much of macro forecasting. With good reason. At the same time, he devotes several chapters to macro concepts. This is where most of the disagreements with the author were found.
Regarding birthrates, Marks writes that the “output of an economy is the product of hours worked and output per hour; thus the long-term growth of an economy is determined primarily by fundamental factors like birth rates and the rate of gain in productivity.” The problem there is that “this time is truly different,” and better yet, it’s always been different.
That’s the case because with each technological advance, the productivity of humans soars. Figure that the discovery of something as prosaic as coal was said to have been the productivity equivalent of a worker gaining over twenty assistants. Coal’s profound impact raises the question of how much more productive we’re made modernly by computers, WiFi access, the supercomputers that sit in our pockets, what 5G will mean for individual productivity if it at least somewhat lives up to the hype, not to mention what rapid automation will mean for growth. With automation alone, what we call the economy is set to benefit from the addition of millions (and presumably billions) of hands that don’t need vacations, don’t call in sick, and don’t quit. This is a long way of saying that birthrate declines are the natural product of economic progress as human productivity surges due to technology that more and more enables the world’s inhabitants to produce alongside one another. It’s not unreasonable to suggest today that Jeff Bezos could start Amazon in a retirement community, so advanced is the technology that brings the world’s workers together.
Importantly, the numbers support the contention that birthrates are highest in the poorest countries, lowest in the richest countries. Fast-rising South Korea has the lowest birthrate of any developed country, and also the highest suicide rate. Yet it prospers.
Marks ultimately seems to come around to the previous truths somewhat. Several pages after his initial birthrate comment he writes that technological advances “are permitting tasks to be accomplished that weren’t dreamed of in the past.” Several pages later he makes the most essential point that “economies are made up of people.” Exactly. And that’s why the birthrate scare is well overdone. Automation doesn’t put people out of work as much as it enhances the work of people. The more work is divided up, the more people specialize. Continued automation promises soaring specialization on a level that’s hard to fathom today, but that will power productivity increases that will surely boggle the mind.
That’s why Marks’s comment that the “few million manufacturing jobs estimated to have been lost to China since 2000 certainly made U.S. economic growth lower than it otherwise would have been” was surprising. Marks has to know that it’s not true. Oaktree began in Los Angeles, and his primary residence is now New York. This is relevant mainly because New York (#1) and Los Angeles (#4) were two of the top U.S. manufacturing locales (Detroit and Flint #2 and #3 respectively) in the 1920s, only for the jobs to vanish. That LA and New York are no longer manufacturing hubs speaks to why each city is so prosperous, and also to why locales that cling to the past (Flint and Detroit) are so poor in a relative sense.
Along the lines of the above, Marks writes of better times for American workers after WWII when they “could remain the best-paid, safe from competition from goods produced more cheaply elsewhere.” The problem there is that rich or poor, workers get up each morning in order to get things. That so much of the world was on its back after the tragic war didn’t redound to American workers as much as it slowed their specialization and the evolution of their living standards, while at the same time limiting the amount of goods they could exchange their work for. Marks would surely agree that competition lifts the boat of Oaktree, that a lack of it “carries within it the seeds of failure,” and it seems he underestimates the typical worker in presuming growth and happiness come from a lack of competition. If true, American workers would studiously avoid the richest American cities where competition is greatest due to the greatest concentrations of talent, yet he surely wouldn’t quibble with the truth that California and New York take in exponentially more Michiganders than does Michigan take in transplants from each. Where there’s no competition there’s often stagnation. The unseen economic shame of WWII is just how much progress was lost for the rest of the world, and by extension the American workers who suffered a lack of competition (and workers competing to meet their needs) after the war.
On page 69 Marks writes that “inflation results from economic strength.” This is an assertion that it would have been great if he’d discussed more simply because Marks has to know that the view expressed, one that’s accepted among economists who write forecasts that he feels don’t “contain information that’s likely to add value and lead to investment success,” is belied by his investment genius. That’s a long or short way of saying that Marks has to know that the true driver of economic growth is the investment that, in his own words, is “permitting tasks to be accomplished that weren’t dreamed of in the past.” Investment drives individual productivity which drives growth. Crucial here is that what’s previously been said is all about falling, not rising prices. As an investor Marks knows better than anyone that the Phillips Curve is bogus, that economic growth is all about enhanced production at costs that plummet, yet he promotes the party line of economists whom he knows to be not very reliable. As a reader I wanted him to address the accepted view about what causes inflation to see if it squares with his experiences as an investor.
Much the same, I wanted him to address the accepted view expressed in MMC that the Fed can reduce “the money supply, raising interest rates and selling securities.” It says here that Marks the investor and credit expert knows the latter to only be true in theory, but not in practice. Marks knows better than anyone that no one borrows “money” as much as they borrow what money can be exchanged for. In that case, isn’t credit abundant in the U.S. not because of the Fed, but because the U.S. is populated by individuals who produce copious amounts of resources, and who by extension rate monetary loans that are exchangeable for copious resources?
What would be really interesting to learn from Marks is whether he thinks the Fed an instigator of credit abundance, or more realistically a follower of economic trends that it can at best confirm. The Fed projects its presumed influence through banks that shrink daily as sources of credit, which raises a question of how influential the Fed’s rate machinations actually are.
Most of all, does Marks think the Fed can truly shrink “money supply”? Or add to it where it’s slight? Considering where he lives, it seems unrealistic in a globalized world that the Fed could ever truly limit the money that always finds its way to Manhattan’s talented. Assuming dollar shortages, other money forms would replace the greenback as evidenced by how much global trade the Swiss franc liquefies. Conversely, it seems unrealistic that the Fed could ever boost the supply of money in neighboring Newark. If he’s planning a future book, it would be very interesting to read how Marks perceives the Fed’s true influence on the economy. Judging by the economy’s dynamism, it seems the Fed’s expressed desire to plan the cost of credit vivifies how little it actually plans. In short, if the Fed were truly powerful, then the U.S. economy would be very 2nd rate.
Which leads to what Marks describes as the GFC, as in the Global Financial Crisis. It was surprising that Marks described it as “financial,” and that the “carefree attitudes” in the markets “were inflamed by demand for high-yielding investments that resulted from the Fed’s lowering of general interest rates.” First the Fed. Can it really make borrowing cheap just by lowering an interest rate? The question isn’t flippant. Marks once again lives in Manhattan, and no doubt knows that any attempt by Mayor de Blasio to decree apartments cheap through rent controls would result in reduced supply of apartments.
Ok, so why would the Fed’s actions be any different? How could it achieve credit abundance through artificially low rates? And if the answer is that the Fed can print, the response to that answer is that markets are wise. People once again borrow money for what it can be exchanged for, and because they do it’s hard to countenance the idea that the Fed, for being the Fed, could somehow create an easy lending environment through its rate mechanism. More realistically, investors wouldn’t be fooled by “easy money” any more than world leaders would be fooled by Kim Jong-Un decreeing himself 10’ tall based on his new definition of the inch. The Fed angle about 2008 also ignores that housing similarly boomed in the 1970s, and did so despite the Fed actively jacking up interest rates. Furthermore, Marks writes that “There is no such thing as a market that is separate from – and unaffected by – the people who make it up.” So true, but since it’s true, is it realistic to assume that the Fed’s actions with an interest-rate lever could so profoundly change a market?
As for the crisis being financial, this didn’t ring true. Please read on. Marks obviously has an intimate sense of what happened since he witnessed it all so very closely. He had billions worth of client funds on the line. He’s writing from his perch in the realest of real worlds, while your reviewer is commenting from the sidelines. Still, it’s Marks himself who as previously mentioned asserts that “success carries within itself the seeds of failure, and failure the seeds of success.” By his own accounting in MMC, some really questionable loans were made in the lead-up to 2008; as in the seeds of failure were being planted.
That they were calls into question how a correction of those errors could cause a crisis. It seems more realistic to say that the crisis was one of intervention by the Bush administration and the Bernanke Fed in what was healthy. If bad things were happening, how could a correction of what’s bad result in a crisis? That’s why it was surprising to this reviewer that Marks would write that one reason Oaktree’s 2008-focused fund at least somewhat succeeded was thanks to the bailouts. Marks writes,
“I’m convinced that if Hank Paulson, Tim Geithner and Ben Bernanke hadn’t acted when they did, or they had acted different, or if their actions hadn’t been as successful as they were, a financial meltdown and replay of the Great Depression absolutely could have occurred. In that case our actions [Oaktree’s size buying after 9/15/08] wouldn’t have been cause for celebration.”
The above passage proved the most disappointing in an excellent book full of amazing insights. To be clear, Marks was in the proverbial arena. But the statement about Paulson, Geithner and Bernanke doesn’t read as true in consideration of his crucial reasoning about boom and bust periods. The seeds of failure are planted during the booms, and because they are, it’s necessary to allow markets to correct them so that economic growth can resume. Applied to ’08, it seems Oaktree would have enjoyed even greater post-’08 returns had Washington done nothing. As for the Great Depression, it was plainly an effect of intervention. Goodness, the U.S. economy contracted much more in 1920-21 than it did in 1929-30. The difference was that the federal government did less than nothing in response to what was healthy in the early ‘20s such that the seeds of success planted during the contraction were allowed to grow. Marks regularly makes a case that “this time is different” thinking is the stuff of failure, so it was so puzzling that he would assert a variation of the latter with his defense of the very interventions that limited the planting of the succeeds of success; those seeds an effect of failure that was necessary.
Still, the critiques and quibbles are just that. Marks’s book is much more than a triumph, and he’s someone I’ll once again be quoting for a long time. Writing about investing early on in MMC, Marks notes that “some people just tend to ‘get it’ (whatever ‘it’ may be) and some don’t.” Marks plainly gets it. As few do. Investors will understand “it” much better for reading Mastering the Market Cycle even if they can’t ultimately mimic the author’s coolheadedness at a time when others are losing theirs.
