Howard Marks: Anatomy of a Selloff

An Oct. 25, 2018 Barron’s interview with legendary and perspicacious value investor Howard Marks (Trades, Portfolio) can offer illuminating perspectives on the current coronavirus-induced market panic. The insights Marks shared with Barron’s in that interview about the ebb and flow, or recurring vacillations, in the market cycle are as instructive for intelligent investors today as they were in 2018.

During the interview, Marks discussed some of his investing philosophy gleaned from his then-recently published book, "Mastering the Market Cycle: Getting the Odds on Your Side." Marks noted that an essential aspect of value or intelligent investing is to know where you stand on the axis of risk-aversion. Marks noted that at one end of the line is the investor who seeks to be right all the time, regardless of the market cycle, and who dreads the possibility of being wrong. At the opposite end of the axis lies the investor who fears the prospect of loss and, as such, over the long term can never win.

Marks told Barron’s that “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.’” He also said, “Nobody can say why this happens or why the tipping point was reached. But the psychology of the market is so irrational and excessive in its swings.”

The concept of market cycle irascibility is a common theme that not only pervades much of Marks' writings, but also informs his assessment of risk. For Marks, investor intemperance, is the result of the inherent unpredictability of the market cycle’s excesses on both the down and the upside. The current health and economic crisis makes Mark’s comments to Barron’s in 2018 rather prescient. When asked by Barron’s what the best environments for good investing opportunities were, his response was quite telling:

“When things are undiscovered or intimidating, that’s when you find bargains. But when they are popular, nobody can see a flaw in them, they have been performing well, and the capital is flooding in, that’s not the environment in which you find bargains. In the book, I cite Mark Twain, who is reputed to have said that history doesn’t repeat itself, but that it does rhyme. But what is it that rhymes?”

Marks made the compelling argument that because of market cycles, the unwavering predictability of human nature, ego and greed, an essential, indeed, indispensable aspect of successful value investing, entails adopting a contrarian investment posture. This approach is most auspicious during moments of market tergiversations, prompted by hysteria, ignorance or the panic of the Wall Street herd.

In his 2008 memo to clients, Marks emphasizes the importance of the contrarian element of value investing within the context of the 2008 financial crisis. Marks observed that in terms of risk assessment:

"The key—as usual—was to become skeptical of what “everyone” was saying and doing. One might have said, “Sure, the negative story may turn out to be true, but certainly it’s priced into the market. So there’s little to be gained from betting on it. On the other hand, if it turns out not to be true, the appreciation from today’s depressed levels will be enormous. I buy!” The negative story may have looked compelling, but it’s the positive story—which few believed—that held, and still holds, the greater potential for profit."

Marks told Barron’s that no one can determine with any degree of accuracy where we are in the market cycle. He further buttressed this contention by stating that investing will always have to be conducted in an environment of uncertainty and unpredictability. He said:

“The truth is: Investing is not easy; making money isn’t easy. How can it be easy? Everybody wants to make money. It is a very competitive activity. But if you are disciplined, if you study, and if you can keep your emotions under control, then you can do these things. But one of the real keys is to keep your emotions under control. Everything in the environment conspires to make us do the wrong thing, to buy when things are going well and prices are high—and to sell when things are going poorly and prices are lower, which is the exact opposite of what we should do. But it all comes from emotion. We have to resist.”

The coronavirus panic has not changed Marks' belief in the inevitability of the market cycle and its predictable excesses. With characteristic humility, Marks admits in his latest memo that he cannot say for certain what the future holds in terms of the economic and health ramifications from the coronavirus epidemic, nor when the market bottom will have been reached. However, he astutely notes that:

• “The bottom” is the day before the recovery begins. Thus, it’s absolutely impossible to know when the bottom has been reached. Oaktree explicitly rejects the notion of waiting for the bottom; we buy when we can access value cheap.
• Even though there’s no way to say the bottom is at hand, the conditions that make bargains available certainly are materializing.
• Given the price drops and selling we’ve seen so far, I believe this is a good time to invest, though of course it may prove not have been the best time.

Marks still finds that there is an opportunity cost — even in the current perilous environment. “But is there really an argument for not investing at all? In my opinion, the fact that we’re not necessarily at “the bottom” isn’t such an argument,” he wrote.

Marks’ final comment is noteworthy and provides evidence that even in the most tumultuous of times, the underlying tenets of his investment philosophy remain unchanged.

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