• Howard Marks
  • November 18, 2018
    Read, recorded or researched
The book is a study of market cycles. Where they happen, why they happen, and most importantly, how to position your portfolio for the range of outcomes ahead of you. Howard Marks is one my favourite investment writers, and while I prefer some of his other work, I still learnt a lot from this book.

The Best Points

Mastering the Market Cycle


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The Nature of Cycles

  • There’s no beginning or end to a cycle, there’s just a point in a cycle. And cycles have a causal relationship. One part of the cycle causes the next; a steep upswing will lead to a steep reversion to the downside. Just like when you swing a pendulum strongly.

The Regularity of Cycles

  • We live in a world that is beset by randomness. People don’t behave the same from one instance to the next, even when they mean to. That’s what created cycles in the past and means we can’t predict what shape they’ll take in the future. You know markets will rise and fall but you’ll never know when/how far/how fast etc.

The Economic Cycle

  • Output of an economy is the product of hours worked and output per hour. So the long term growth rate of an economy is determined primarily by fundamental factors like birth rate and productivity.
  • Short term economic growth follows long term average but oscillates around the trend line. People try to predict annual variations as a way of profiting. On average they’re right most of the time but few did it better than everyone else and fewer do it consistently better. So better not to try.

The Cycle in Profits

  • Link between economic growth and profit growth highly imperfect. Economic growth isn’t the only thing which influences sales. Two types of leverage are the main reasons for this. Operational leverage and financial leverage.
  • Operational leverage: higher where company has few variable costs, most are fixed costs. When sales increase, costs don’t rise proportionally, which increases the operating profit margin and so works well in good times. But when sales are in decline, the opposite can happen and profits fall further than sales.

The Pendulum of Investor Psychology

  • Market doesn’t spend much time at average, and when it’s bad it clusters.
  • The superior investor keeps the conflicting elements of fear and greed in balance. Unemotional is a great trait.
  • It’s not events themselves which cause the market to move, its investors’ interpretation of the events. And this depends whether they’re feeling positive or negative.

The Cycle in Attitudes Toward Risk

  • When investors in general are too risk tolerant, security prices can embody more risk than they do return. When investors are too risk-averse, prices can offer more return than risk.
  • Quants will say the market, over time, will average a secular trend. The reality is, the market spends about as much time at the extremes as it does at its happy medium.
  • Risk comes from the price of assets not profit warnings, poor economic data etc. Price is your due diligence.
  • Contrarianism and skepticism are essential for investing success.
  • Understanding how investors are thinking about and dealing with risk is perhaps the most important thing to strive for.

The Credit Cycle

  • Changes in the availability of credit is one of the fundamental influences on economies, companies and markets
  • The credit cycle is like a window; the place you go to borrow money. When the window is open, financing is plentiful. When it’s closed, financing is scarce.
  • Why is the credit cycle important?
  • The ability of companies to grow usually depends on the availability of incremental capital.
  • Capital must be available for maturing debt to be refinanced; companies generally don’t pay off their debts, they roll them over. But if a company can’t issue new debt when it’s existing debt comes due, it may default and be forced into bankruptcy. Where we stand in the credit cycle is the greatest determinant of whether debt can be refinanced at a given time. Most corporate assets (buildings, machinery etc) are long term in nature but businesses buy them by issuing short term debt because the cost of borrowing is generally cheapest on short maturities. This is fine when the credit market is open and functioning well, but when liquidity dries up and maturing debt can’t be refinanced, this mismatch can cause a crisis.
  • Banks/financial institutions are an exaggerated version of normal companies in terms of their reliance on the credit markets (think bank runs).
  • The credit cycle gives off signals that have a great psychological impact. A closed credit market causes fear to spread, even out of proportion to businesses’ negative realities.
  • The cycle: prosperity brings expanded lending, which leads to unwise lending, which produces large losses, which stops lending, which ends prosperity, and on and on.
  • Numerous examples where loose capital markets contributed to booms that became famous collapses. Too much cheap money is a recipe for disaster: real estate end of 80s, EM mid 90s, LTCM, VC firms with tech in 00s and mortgages in 08
  • Great recap of how the Global Financial Crisis unfolded on page 148.
  • One sign of a wide open credit market is increase in new issues.

The Distressed Debt Cycle

  • Unwise lending stacks the logs in the fireplace for the next bonfire.

The Real Estate Cycle

  • Housing starts vs starts per capita. Showed a huge fall off after ‘08 given demand for new homes was so low.

Putting It All Together – The Market Cycle

  • Our job as investors is simple:
  • Three stages of a bull market and “what the wise man does at the beginning, the fool does at the end.”
  • Buffett – “First the innovator, then the imitator, then the idiot.”
  • Any investment movement that’s built around a concept other than the relationship between price and value is irrational.
  • There’s no safe way to participate in a bubble, only danger. It should be noted, though, that overpriced doesn’t mean going down tomorrow. Many fads roll on well past the time they first reach bubble territory.

How to Cope with Market Cycles

  • We may never know where we’re going but we’d better have a good idea where we are.
  • How do we know where we are in the cycle?
  • Guide to market assessment – taking the temperature of the market.

The key questions can be boiled down to:

  • How are things priced?
  • How are investors around us behaving?
  • Description of the sub prime mortgage boom on page 223.
  • Before the global financial crisis, stocks weren’t at lofty multiples and the economy wasn’t booming but there were excesses in alternative investments as investors sought returns in a low interest rate world where they still distrusted equities
  • Reject the idea of waiting for the bottom to start buying.
  • No way to know when the bottom has been reached.
  • Usually as markets fall that you can buy the largest quantities of what you want from sellers who are throwing in the towel. At the bottom you face more competition as buyers come back to the market.
  • So when should you buy? When price is below intrinsic value.
  • Risk of losing money or missing opportunity?
  • The study of cycles is really about how to position your portfolio for the possible outcomes that lay ahead – one sentence to describe the book.
  • Stock selection, superior insight into intrinsic value from second level thinking

The Cycle in Success

  • “Don’t confuse brains with a bull market”
  • “Short term performance is largely a popularity contest” – bargains appear in things which aren’t popular.
  • Nothing can outperform forever – past success will in itself render future success less likely.
  • It’s all a matter of ebb and flow. It’s easy until it isn’t.