Howard Marks on Investing After a Market Rally

The stock market has experienced a rally since its March low. For instance, the S&P 500 is currently trading 37% higher than it was at its lowest point in March.

However, investor sentiment is still weak. The VIX index, which is often described as the Wall Street "fear gauge," is currently trading at 29 points. That’s more than twice the level at which is started 2020.

Investors may currently be feeling unsure about the prospect of buying companies while the economic future is uncertain and after stock prices have risen.

One investor who has experienced similar situations during his career is Oaktree Capital co-founder Howard Marks (Trades, Portfolio). His focus on fundamentals and adapting his investment strategy may be key reasons for his long-term outperformance of the stock market.

Accepting an uncertain future

It is tempting to try and predict how the economy will perform in the future. However, the unprecedented nature of containment measures means that it is impossible to accurately forecast how specific industries will respond to a likely shift in consumer trends and behaviors.

Therefore, investors may be better off focusing on company fundamentals. Companies with dominant market positions, strong balance sheets and wide economic moats may be in a better position than their peers to adapt to an evolving economic outlook. Investing in them may be a more efficient use of your time and capital compared to seeking to predict the macroeconomic outlook.

Marks has previously described why he focuses on company fundamentals, rather than on trying to predict the future:

“One of the most important foundational elements of my investment philosophy is my conviction that we can’t know what the ‘macro future’ has in store for us in terms of things like economies, markets or geopolitics. Or, to put it more precisely, few people are able on balance to know more about the macro future than others.”

Investing in undervalued stocks

Investing after a stock market rally is, in some ways, the same as investing during any other period of time. Value investors should seek to buy quality companies at prices that do not reflect their intrinsic value. This provides them with a margin of safety in case the future performance of the business is disappointing.

It may be prudent to seek wider margins of safety than would normally be the case, given the uncertain outlook for the economy. A recession could, for instance, cause a decline in asset prices or slow earnings growth rates that makes valuing a business today more challenging than would normally be the case in a more benign operating environment.

Marks has discussed how he seeks to buy undervalued stocks based on their past prices and the valuations of their sector peers:

“What do value investors do? They strive to take advantage of discrepancies between ‘price’ and ‘value’. In order to do that successfully, they have to (a) quantify an asset’s intrinsic value and how it’s likely to change over time and (b) assess how the current market price compares with the asset’s intrinsic value, past prices for the asset, the prices of other assets, and ‘theoretically fair’ prices for assets in general.”

Adopting a flexible strategy

The changing outlook for the economy may require a greater amount of flexibility in your investing style. Many sectors could experience rapid changes in consumer behavior and trends resulting from the unprecedented containment measures that have been put in place.

Adapting your strategy does not mean abandoning your value investing principles. However, it may mean you are more open to investing in businesses that have lower fixed costs that enable them to respond more quickly to changing demand. Likewise, it may mean that you invest in companies with a greater online presence as consumers become more comfortable with purchasing goods online.

Marks has previously highlighted the need for all investors to be open to change:

“In investing, there is nothing that always works, since the environment is always changing, and investors’ efforts to respond to the environment cause it to change further.”

Read more here:

• Warren Buffett on Buying Stocks When Other Investors Are Selling Them
• Peter Lynch on Investing in an Evolving World​
• Bill Ackman on Managing Your Portfolio in a Volatile Market​

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