Howard Marks Latest Memo Key Takeaways

Howard Marks recently released a memo and here are some of the key things that he talked about:

-He talks about markets being a form of the pendulum which swings back and forth but there is a big difference between the pendulum of the market & mechanical pendulum.

The mechanical pendulum is governed by laws of physics and you can predict what exactly it is going to do at a particular time which is not the case with markets.

Markets are made up of a lot of behavioural biases and number of variables is so large that you can never predict what is going to happen if you shift one of the gears.

So as Mark Twain said, “History can never be repeated but it rhymes”, one can make some corollaries but can not exactly predict what exactly is going to happen next.

The causes of events vary, the consequences of events vary, and the form they take varies.?But there are things that recur like- if things go well, people become less risk-averse and do riskier things, use more leverage, borrow for short term as its cheaper and when the economy eventually turns its direction like the pendulum always does, those things produce outsized losses.

?-He then proceeds on the same argument that markets and economies all over the world are not at all Mechanical as there is no predictability there and people who are forecasting are somewhat wasting their own time.

He quotes Yogi Berra who once said, “In theory there’s no difference between theory and practice, but in practice there is.”

So, whatever we have learnt in schools is how things are supposed to work in ideal conditions but in reality, there is always a friction (in terms of mechanical systems) and a noise (in terms of electronic systems) which diverts the things from being ideal. So, teachers should always add that this is how things are supposed to work, but it doesn’t always work that way (taking a jab at efficient market theory here).

-Now comes the efficient market theory, which says that due to the concerted actions of so many investors, who are intelligent and numerate and computerized and informed and highly motivated and rational and objective and willing to substitute A for B, prices for securities are right, such that they presage a fair risk-adjusted return. But this requires that the participants be rational and objective. And in investing, they’re not.?And that’s what everybody keeps forgetting.

Investors are supposed to make decisions in a way that optimizes their wealth but they often do not because they have moods and those moods interfere with the right prices.

-People often believe that inefficiencies of the market would even out themselves (like two opposite forces) but they always forget about mass hysteria. It was mass hysteria in October 2021 where investors believed that prices would go only up and exactly the opposite of it is going on right now.

- The price of an asset is based on fundamentals and how people view those fundamentals.?And a change in an asset price is based on the change in fundamentals and the change in how people view those fundamentals.?So, facts and attitudes.?Any research that could capture changes in attitudes could do wonders.

-Which actually happened in the 2008 crisis. People went from- “The more risk you take, the more money you make, because riskier assets have higher returns,” to “Risk bearing is just another way to lose money.?Get me out at any price.”

This was how the pendulum swung and people’s optimism collapsed.

-Now this is the important one, so copying it as it is- I needed to raise some money to de-lever a levered fund that we had that was in danger of melting down due to margin calls, and I went out to my clients.?I got more money.?We reduced the fund’s debt from four times its equity to two times.?Now we’re again approaching the point where we can get a margin call.?Now I need to de-lever it from two times to one time.?I met with a client who said, “No, I don’t want to do it anymore.”?And I said, “You gotta do it.”

-He then talks about all the information being available to everyone, so how can some investors get superior returns in a so-called efficient market. His answer to that is- some people are able to do a better comprehension of the future and some are better at processing the present qualitative information. A superior investor has to do at least one of those two things better, and maybe both.