In a recent interview, billionaire investor Howard Marks (Trades, Portfolio) discussed the idea of market cycles. Marks has long been a proponent of the idea the market undergoes repeated cycles and that those who learn their financial history, either through first-hand experience or through study, are much more likely to do well over the long run. In the interview, he discussed why he believes these cycles exist, as well as why intelligence is not the deciding factor in who ultimately wins.
Why do cycles exist?
Human beings are fundamentally optimistic creatures. We want to believe the future will be better than the present, economic growth will continue and that our children will live better lives than we do. There is nothing wrong with that and, in fact, this optimism is arguably the reason why lending and credit can exist and why markets function. But optimism tends to excess, and this is the basis of Marks' reasoning:
âEveryone wants to get rich and they tend to succumb to things that they think will make them rich. So while we have the normal secular [growth] trend in the S&P of 9-10%, every once in a while people get more excited, and they start to upvalue the future, and stocks rise 10, 12, 14, 16, 18, 20%. Psychology takes over from fundamentals. Fundamentals donât change very much, they grow a few percent a year, and they never go up 30% in one year. What goes up is prices, because of a revaluation due to positive psychology. The fundamentals chug along and go up six, seven, 8% a year, Most people would call a year in which they go up 20% a year of âabove-average appreciation.â I would call it a year of excess. And eventually, when the excesses compound, and the optimism takes the price too high, relative to the fundamentals, then youâre riding for a fall and then youâll get a correction. Itâs easy to think of cycles as ups and downs, but I think itâs more helpful to think of cycles as excesses and corrections.â
These cycles are driven by human psychology, rather than any particular government policy or economic variable. This is why Marks believes the same cycles will continue to repeat time after time - different states, belief systems, ideologies and political parties will come and go, but human nature will remain the same.
Itâs not about intelligence
âIf you think about it, everyone has the same information. And I would say that the SEC takes it as one of its prime jobs to make sure that nobody has information that others donât have. Everybody has the same information, everybody is numerate, everybody is computer-literate, everybody is intelligent - everybody in our business - and everybody is highly motivated to make money. So if you think about that, itâs unlikely that data and its manipulation is going to hold the secret to above-average performance. I think itâs emotional control, psychological assessment of what others are doing, understanding excesses and corrections.â
This line of reasoning is not unique to Marks. Warren Buffett (Trades, Portfolio) has frequently said investing success requires no more than slightly above-average intelligence. What differentiates great investors from their peers is an ability to use this slightly above-average intelligence to think critically and differentiate themselves from the crowd when everyone else is moving in the same direction.
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