Howard Marks, billionaire co-founder of hedge fund Oaktree Capital, gave a fireside chat led by Joel Greenblatt, Co-CIO of Gotham Asset Management and author of The Little Book that Beats the Market.
This investor meeting was highly exclusive (only about 50 people in attendance). We were invited and took notes for you.
Superior investing is all about getting the odds on your side
In order to know the odds, you need to know where we are in the market cycle
When we're early in the cycle, be aggressive; when we're in late innings, be defensive
He thinks we're in late innings of this cycle, but is still constructive on the market
"I don't see euphoria in the market today; pro-risk behavior, but not careless risk-taking"
"Our best tool in figuring out where we're going is to figure out where we are today. Understand the cycle."
"Focus on what it important and knowable. The macro is not knowable, so why try to predict it?"
"The future is a probability distribution. It has odds. Play when the odds are in your favor."
Below is an excerpt from the full interview.
JG: Joel Greenblatt (Co-CIO of Gotham Asset Management)
HM: Howard Marks (Co-Founder of Oaktree Capital)
How He Invests
JG: How do you think about investing?
HM: Everyone wants to know if stocks are going to go up or down tomorrow. The goal is investing isn't to be an average investor. It's to be a superior investor. So for each thing, ask yourself: is this something you can be better than somebody else at predicting?
When it comes to macro, it's very important but highly unknowable. I cannot be an above-average predictor of it. I don’t believe in macro forecasting as a road to superiority.
JG: So if you don't predict the macro, how do you invest?
HM: You need to get the odds on your side. The future is not predictable or knowable, but it IS a probability distribution. It's the range of things that might happen and their relative likelihood of occurring.
If the future is a probability distribution, we need to ask ourselves: when are the odds in our favor and when are they against us? This depends on where we are in a number of cycles: capital cycle, profit cycle, emotional cycle, and attitude cycle.
Our best tool in figuring out where we're going is to figure out where we are today. Are we elevated in the cycle relative to the norm, or are we depressed? When we're high in the cycle, the odds are against us. When we're low in the cycle, the odds are in our favor.
Overpriced and "going down tomorrow" are not synonymous. People seem to think that if we're late in the cycle, it means stocks are going to crash soon. That's wrong. Stocks that are overpriced can keep getting overpriced -- eventually they form a bubble.
We want to understand cycles, what causes them, how people behave in the cycles, where we are in the cycle, and what that implies for the future.
What Causes Cycles
JG: Walk us through a typical cycle.
HM: There are numerous types of cycle, but let's do a simple example -- say late 2008-09.
The economic news gets better, corporate profits start to "beat" expectations, and asset prices begin to rise. The media recognizes it and starts reporting overwhelmingly positive news. The people who own assets are self-congratulatory and want to buy more. The people who don't own assets sit on the sidelines angrily and eventually throw the towel in and buy assets too. Asset prices rise, and so on.
Eventually we get to a cycle high. The last potential buyer buys and there are no more pessimists. People are euphoric and prices are at a high. That's the time to sell and be defensive, but of course there's no reason to sell because everything is going well. Then it works the other way in reverse.
How People Behave in Cycles
JG: How do people act in cycles?
HM: When things are going well, people say "risk is my friend. The more risk I take, the more money I make. Bring it on." But when things start going badly, people's attitudes change. "Risk is just another way to lose money. Get me out at any price, just don't let me lose any more money!"
When risk attitudes swing so violently, that's when we get the highs and lows in the cycle. Those observations of risk attitudes can help us figure out where we are in the cycle.
JG: Why do people act like this? Why don't they learn their lesson?
HM: Human nature. Most people want to be rich, so they'll believe stories that they think can make them rich.
Where We Are in the Current Cycle
JG: So where are we today?
HM: I don't see euphoria. Euphoria is usually what gets us to the top of the cycle, but I actually haven't seen it yet in this current cycle.
I remember a book published back in the late 90s called "Dow 36,000." The reality is, no one is acting that euphoric even after 20 years. No one is saying stocks will go to the moon, so we're not in a bubble.
We don't have risk obliviousness or care-free attitudes. The market seems constructive, and it's been that way for many years.
JG: Does that mean you're bullish?
HM: Well remember, the main reason we worry about euphoria is because of how it makes investors behave. Even without euphoria, people are still acting bullish even though they're not feeling bullish.
Why? Because the Fed took the risk-free interest rate to near zero. So investors couldn't get the returns they needed on cash and high-yield bonds anymore.
People are having to engage in risky behavior to get the returns they need in a low-return world. So the behavior is pro-risk even though attitudes are not.
What It Implies for the Future
JG: The Fed doesn't want to raise rates because it worries it will crush stock prices and economic growth. How do we get out of this mess?
HM: Economic growth is the birth rate multiplied by productivity per person. Both the birth rate and productivity have slowed. Birth rate is near the lowest level in history. So economic growth is naturally slowing, and it may not get back to the levels of the past century.
JG: What will it take to get growth back to historical levels?
HM: People always say "can't we just go back to normal?" But what if the economic growth we saw from 1945-2005 was actually not normal? We had tremendous boost from the post World War II era in the manufacturing sector as a global superpower. That may have been the exception, not the rule. We may just need to adjust to "lower for longer."