With the recent turmoil in the markets, investors can take great benefit from reading something soothing and objective such as Howard Marks' last memo "On the Couch." While I obviously encourage readers to read the whole document, which is about 16 pages long, I found five paragraphs that are worth not only reading but commenting upon.
"Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what's going on and what to do about it. This is one of the biggest mistakes you can make. As Ben Graham pointer out, the day-to-day market isn't a fundamental analyst; it's a barometer of investor sentiment. You just can't take it too seriously."
In times of uncertainty, investors look at the market for validation and for an accurate description of value. For this, it is critical to understand that the market is far from rational, that it feeds upon fear and greed, and those will never leave the equation. So, in times where everything seems to be bad (or good), it is more important to keep our eyes glued to hard data and intrinsic value estimates, instead of prices, unless it is to benefit by selling high or buying low.
"The bottomline is that investor psychology rarely gives equal weight to both favorable and unfavorable developments. Likewise, investors' interpretation of events is usually biased by their emotional reaction to whatever is going on at the moment. Most developments have both helpful and harmful aspects. But investors generally obsess about one or the other rather than consider both."
As an example, with the recent concerns about China, oil and interest rates, we tend to read every subsequent news with a negative connotation. As Marks mentions, it is important to remember that every development could play a part for both a bullish and bearish scenario.
"In the real world, things generally fluctuate between 'pretty good' and 'not so hot.' But in the world of investing, perception often swings from 'flawless' to 'hopeless.'"
This line pretty much sums up how the market reacts to developments, and how the crowd starts perceiving things as perfect or doomed, mostly swinging between those moods.
"The bottom line for me is that, if you aren't an oil company or a net oil-producing country, low oil prices aren't necessarily a bad thing. For net oil importers like the U.S., Europe, Japan and China, the drop we've seen in the price of oil is analogous to a multi-hundred-billion-dollar tax cut, adding to consumers' disposable income. It can also increase an importer nation's cost-competitiveness."
To me, this is one of the reasons Marks has been able to beat the market repeatedly. The ability to read and interpret data objectively in the investing game is of much value. While all the headlines are now focused on the oil crash, we are forgetting the benefits that it may bring, which, as the author mentions, are very similar to a large tax break that could have spillover effects on consumption for net-importer countries such as the U.S., Europe and Mexico.
"There's something wrong if an event that has been widely anticipated for years- and considered a certainty for months- can be thought capable of significantly impacting the market when it becomes a fact. People's expectations should be incorporated into the prices as they assign to assets. So a negative reaction to the imminence of a widely heralded interest-rate increase must imply that either a) investors are too dense to have incorporated it into prices before this, b) the increase will be a bigger deal than people thought or c) the market is irrational."
"Over the years since Bernanke's statement in 2013, the question I've been asked more often than any other has been, "What month will the Fed begin to raise interest rates?" My response has been consistent: "I have no idea, and why do you care?" If someone tells me he'll do one thing if he thinks the Fed's going to raise rates in March and something different if it's going to happen in January, what he's demonstrated is that he doesn't understand how asset prices incorporate expectations."
Talking about the much-anticipated interest rate hike, Marks states that if the market is efficient, then expectations are incorporated into asset prices. Given that the interest rate changes have been expected for quite a long time by now, it shouldn't come either as a surprise or a negative factor to asset prices. What matters is, as Marks mentions, the degree and speed that the hike will take, because that is the uncertain aspect of the equation.
After reading the memo, I got the impression that it was the equivalent of taking a financial yoga class. It centered me and reminded me of the importance of staying strayed of sentiment and emotions (obviously easier said than done). It also was refreshing to read some second-level thinking on several topics that are being currently discussed across the media. Marks' memo was certainly enlightening and a great reminder of the habits that make great investing a reality.
