Ideas From Howard Marks

9 Jul, 2020 | People Notes, Economics, Investing


He is always thinking in probabilities, not in black and white. By thinking in probabilities he doesn’t go all in on one option but leans toward what he thinks is most correct.

Related, the major balance in investing is between defence and offence. If the market is risky, low-return, high value and greedy, you should be defensive. But when this reverses, you should be aggressive. Hence, you always need to be judging the market for these conditions.

All great investments start in discomfort.


On Economics

Are interest rate cuts always good? Well, not necessarily. Yes, they stimulate the economy. But it’s also an admission that the economy needs stimulating. You don’t give an adrenaline shot to a healthy patient (or at least you shouldn’t). And if the economy is going well, we should just leave it (On the Other Hand).

On Investing

“This time it’s different” - The most dangerous 4 words. People are saying it again now (Jun 2019). They are looking at factors that have historically been seen as a negative (e.g. long time without recession, high national debt) and saying that these need not be bad indicators. They are justifying high prices. Let’s go through each:

  • Will we not have a recession? Well, we are due one. Generally, 10 years is as long as we go without recession. And we are in the 12th month of 10th year. It could go on longer, but looking at it with a probabilistic mind, the odds are no longer in your favour.
  • Will Quantitive Easing continue to work? Well, firstly, QE  could in part be placebo-like. So with each round its effects weaken. Plus, it’s complex. Finally, do we even want to stimulate the economy like that? If recessions are natural, should we let them happen naturally, rather than let them build up into one bigger thing?
  • Are federal deficits okay? Well, historically they haven’t been. But governments are not servicing them and seem to use them to fuel their campaigns (not raising taxes). There are theories to suggest these deficits are benign, but thats it, they are just theories…
  • Are national debts okay? We used to doubt about this, now countries happily have debt. And maybe it is okay. But maybe it changes as the US gets more debt, doesn’t service. it. At what point to people question that? He wouldn’t bet that it lasts forever.
  • Can you have economic growth without inflation? Typically, as jobs are taken and unemployment rate goes down, inflation increases as workers have more bargaining power. But this hasn’t materialised in US. Could it continue? Perhaps. Would he bet on it? No. Inflation is mysterious.
  • Can interest rates stay low? Lower for longer has been a rallying cry. But can that always be the case? Seems unlikely. He compared his feeling here to mid-2007 levels (just before a crisis).
  • Is it okay for yield curves to invert? This is typically seen as a bad thing. It’s when short term yields (on say bonds) have higher payoffs than long-term equivalents. (In general, you’d expect the opposite, long = more risky = higher interest rate). And currently we have a flat or negative yield…
  • Can companies be successful without profits? Well, its okay to invest for the long term. But you want to make sure that long term is feasible and well-priced. We seem to be in an optimistic moment right now.
  • Can growth continue to outperform value forever? Growth asset classes have really succeeded last 10 years. But there is always some price where those companies become overpriced. And similarly, there is always some downturn where value companies (whose assets are more clear) are more attractive again.

The 9 beliefs above are all held together by optimism. Perhaps over-optimism. History doesn’t repeat itself, but it does rhyme. We shouldn’t unlearn lessons of the past (This Time It’s Different).

The world I probabilistic. Great decisions do not always mean great outcomes. This is due to a) possible missing information and b) some randomness and luck. Decision making is less about results and more about process and judgement. Hence, he’s always liked games of cards or risk. Inspiration for the memo is Thinking In Bets. General idea is to use a process increase your odds, but can never guarantee. You need to embrace the uncertainty and try to figure out how much is unknown. Games vary in 3 key ways a) hidden information (like what cards people have in poker) b) luck (backgammon has a dice role, chess does not), and c) skill (wheel of fortune has no skill). The point is, even in games of skill, there may also be some impact of luck. And the level of skill is also influenced by the level of information. Public market investing has all the above elements. Passive stock index tracking has none of the above elements. It’s important to recognise what market you are in. Efficient market hypothesis says no gains to be made. But it’s not fully applicable. In some markets it’s truer than others. So you need to know what market you are in. In one that’s completely efficient there is no skill, in others there is skill. Passive investing has become more popular because of the belief that there is no skilled money managers. Howard would like to think in his market there are all 3 elements. Part of the skill is to find the favourites - the ones that will do well. But importantly to make money, you also need to see that they are somehow mispriced. If the market has fair odds (efficient) every time then everyone loses what they win over enough games. You have to assess both the favourite and the proposition. In stock picking, the best company, but also the price left to run. “Success investing doesn’t come from buying good things, but buying well. What you pay matters”. Interesting, Buffet agreed price is important, but would still prefer buying great cos. Charlie Munger would extend, you have to bet big when the odds are in your favour (You Bet!). 

On Covid-19

Sometimes we have to make guesses, but remember they are just guesses. No one really knows what’s happening with the corona virus. Clearly it will impact business. But as always, the way to judge investments is the relationship between price and value. Price has dropped significantly in 2 weeks. So they maybe approaching fair value or undervalued, in which case, have the nerve to buy. His approach, to know how much he wants invested and begin buying over time (Nobody Knows II).

Impossible to call the bottom. But he certainly is seeing conditions for good value. Hence, they are buying. It may prove not to be the best time, but value is always a good time to buy (Latest Update).

Is it realistic for economy to make a v-shaped recover? People seem to be under estimating the range of outcomes still possible from here, including a long, slow recover (Which Way From Here).

In this memo he summarises the previous 4, providing a live update of how his thinking has evolved during the Coronavirus. He the summarises with a few interesting points: he never urged selling, as the damage was already done. He did argue for buying, as prices showed value in places. The check job of an investor is to choose between defence and offence. Consider the twin risks - risk of losing money vs risk of missing an opportunity. You are constantly balancing these two things. He riffs a Buffett-esq line about being more defensive when others are showing greed/froth. So time to begin switching from defensive, as the risks are more known and prices have changed, to offensive (Calibrating).

Everyone had the same data now, but we are still making guesses about the future. In investing, we try to make informed guesses uses previous models. But these extrapolations should be informed. We must ask ourselves, is this like previous times? We have a pandemic, an oil crisis, biggest loss since depression and biggest intervention ever. So perhaps we can’t? To stop the spread, we all have to go through the same process, slow it down, make growth negative, reduce cases. But in which of these steps do we return to work or restart the economy? We know by doing so, we risk accelerating cases again. But as with cars, there is always a balance between risk (for the few) and reward (for many). And what about the role of the FED? They’ve been doing some unusual things. And in helping companies, they are reducing the threat of bankruptcy. But they also teach bad lessons. Capitalism without bankruptcy is like Catholicism without hell. Markets work better when there is a healthy fear of losses. The FED are buying bad investments, protecting Wall St at the expense of Main Street (Knowledge of the Future).

We have 4 things that simultaneously make this difficult times to know: historic shock, health problem, oil price and government response. One of these alone would make it different, but all together mean this is like no crisis before. At best we as humans see patterns and make guesses about the future. “Our data is about the past and our decisions are about the future”.  In short, the future is unknowable. Well, not quite. We do know some things. For example, the economy grows 2% per year (US), the heating bills go up in winter and more shopping is going up online. But everyone knows these things. You need to know the stuff other people don’t, which is hard. So we must consider our biases. “Forecasting says more about the forecaster than the economy”. Most people seek information which conforms what they already think. It’s a sort of mental laziness. As well as acknowledging our bias, we also need to acknowledge what we don’t know. All great investments start in discomfort. You have to be prepared to bet against the crowd. Having a certain amount of fear when you’re investing can serve you well. It means you do your home work and only bet large when the possible winning warrants it. Yes, it means you may be too cautious in times of bull markets, but overall it focuses you and makes you better. You have to grapple with the uncertainty to arrive at the right level. It means having intellectual humility - having a belief but knowing you may be wrong. As well as having a prediction, you also want to have in mind a degree to which it is correct (remember Annie Duke - what percent?). A true expert knows there stuff, but they also know the limit of their knowledge and expertise. “People who are always sure are no more as helpful as people who are never sure” (Uncertainty). This post is an appreciation of uncertainty in the world and proclaims the value of intellectual humility - so that we can effectively navigate the unknowns.

We aren’t able to predict. But that doesn’t mean we can’t prepare. I times where conditions deteriorated we can be more cautious (Uncertainty II). An example, stop buying when priced get ludicrously high. That way you don’t but yourself in the position of needing crazy wins to offset high price paid.

When a market reaction happens, we have to evaluate the positives and the negatives. There are many of both. So we have to ask ourselves, are the positives actually credible? Are they based in value or technical? Are the negatives being properly weighted? Or is the market being lifted by too much optimism? He believes the risk/reward profile is not great for investors right now (Anatomy of a Rally). Again, it’s truth-finding. Of these reasons, which are real, which are not.


Howard Marks on The Knowledge Project

  • 8 - No such thing as “markets”. Just people that are trading. And hence it’s driven by emotion. Most things you buy at lows and sell at tops, but in markets people’s emotions get the better of them.
  • 13.30 - doesn’t use debt, like Warren Buffett. Not a recipe but a Mindset. Have risk control front of mind.
  • 15 - you can’t tell a good decision from the outcome (a la Annie Duke).
  • 21 - everything has two sides. This has been the slowest recovery ever. The downside is that is been slow. The good side is that it hasn’t been marked by excesses, and therefore it doesn’t need a correction. So perhaps it will be the longest recovery ever…
  • 31.15 - the greatest contributor to maximal economic prosperity is globalisation. As it allows for specialisation. In aggregate the world produces more, as people do what they are best at. Regulation and tariffs oppose this. What does it mean when we run a trade deficit? People see it as a bad thing. The economic reality is we’ve bought their goods because they are some combination of better and cheaper. 
  • 36 - Economic reality - Chinese don’t pay tariffs. The US consumers pay tariffs in higher prices of goods… so are they happier? 
  • 38 - Political reality is that politicians promise everything and ignore the reality. Not actual economics.
  • 45 - we have to admit the role of getting lucky. Lucky in my IQ. Luck in where you were born. So luck is a real thing. 
  • Getting Lucky - most popular memo
  • Buffet Ovarian Lottery
  • 50 - we get more from work than just income. So universal basic income could possibly create some bad habits (bad incentives). It will only feed the physical needs. 
  • 52 - automation and the elimination of jobs. He’s not positive on it. He can’t imagine a world where all truck drivers become something else… In the Information Age we need fewer people to make GDP. Where will all those people go? People say we lost jobs to China, but we’ll lose far more to self driving cars. Not just drivers. But also all the associated industries (car cleaners, car sellers, insurance as less accidents, etc). “Optimists say that we’ve been through this before, but I don’t have that good an imagination”. 
  • 1.05 - for investors, risk comes in two main forms. Risk of loss. But also risk of forgone profit. But generally LPs are more emotionally attached to loss.
  • 1.15.30 - To be a great investor, you need to see the same things other people do and think differently. This relates to first vs second order thinking. First order thinker - this is a good stock, Lets buy it. Second order thinker, this is a good stock, but some of the reasons why people love it don’t hold, so the price is actually boosted, let’s sell it. Clearly the second order requires so extra thinking.
  • Dare to be great memo 
  • 1.22 - “Who doesn’t know that?” If everyone else thinks it, it’s already baked in. So you need more, another layer. How is what I honk different? 
  • 1.24 - we always talked about money (in relation to children). Don’t insulate your children from money. It’s essential they develop good attitudes. Also, don’t overstate the importance of money - it shouldn’t define who they are. Also - give them a feeling of finiteness. That’s enforcing economic reality (even if they are very wealthy). Of course we want our kids to have everything, but we also need to teach them to be responsible.
  • Erik Erickson - the stages of man 
  • 1.29 - when parenting, if the choice is non-lethal, let the child make the choice (sort of like good management). Let them learn from mistakes. Don’t insulate them.

Howard Marks on Tim Ferriss Show

  • Go back to memo you can’t predict you can prepare - essence being that you should try to cover for some of the downside scenarios
  • 11.30 - “when others act with less prudence we should act with more” because now there are irrational actors at play. In response to 08 crash. They sold a lot, became more selective and raised cash for distressed investing. But they never predicted that subprime ortgaged would be the catalyst. 
  • 16 - where we are in the cycle is a huge determinant of risk. Early in a cycle (after a bust) it’s a good time to be aggressive and put funds to work. You need to read your own bias. If you were smart to be cautious into a slump you then have to turn and be aggressive in the downside, that’s when you make money. (“Like catching falling knives”).
  • The best investors are unemotional in markets. 
  • 22 - can you teach yourself to be unemotional? Perhaps, but its easier if its comes natural. Becoming unemotional is going against human nature. So its hard.
  • 32 - on a partnership
  • First, only go into partnership with people you respect
  • No assholes rule
  • Humility - start with what you don’t know and open yourself up to the chance someone else might be right
  • 38.30 - all predictions shouldn’t be treated equal. You should weight them by how likely/predictable they are (similar to Annie Duke, Ray Dalio philosophy)…the future is a distribution, with many possibilities. So we should behave that way. We can’t hold the same degree of conviction on all our opinions. 
  • Fooled by Randomness recommend
  • 43 - sometime you have to look back at things and decide, how much of it was subject to randomness? (Creativity Inc, on hindsight not being 20/20).
  • The short history of financial euphoria 
  • 48 - Mark Twain - “it’s not what you don’t know that gets you in to trouble, it’s what you know for sure that just ain’t so”. I.e. know your limitations. If a stock goes down, buy at 80. Then it drops again. Should you buy? Or maybe you got it wrong and the market is right? You have to revisit your analysis. You have to find a balance.
  • Memo - it’s not easy - it all comes down to judgement. Investing can’t be put into just a single rule. 
  • 59 - it’s not what you buy, it’s what you pay (Ben Graham! This is why fundamentals are needed). There is no asset that is so good that it cannot be over priced (bear this in mind with the FAANG stocks). There are very few securities which are so bad they can’t be under priced (basically you can only rule out those which you feel are destined for death). How to you get low price to value? Seek low optimism. I.e. if everyone feels good about it, likely to be over priced. We make money from surprises - surprise being the key word. 
  • He is a value investor - says it himself.  Mainly in credit (non gov issued bonds etc). Professionally doesn’t deal inbthe stock market so much.
  • 1.08 - we are in the 8th inning. But unlike baseball (9 innings) there is no finite amount of innings. It’s always changing. But 10 years is a long time for a bull. So we have to think in probabilities - an probability would suggest it’s getting less and less likely to continue. But the economy is still functioning at a high level. 
  • 1.13.30 - You need to assess people’s comfort levels. They need to be comfortable, otherwise they’ll sell during the lows which is the cardinal sin of investing…the outlook is no so bad (prices so high) that you should go to maximum defensiveness, cash (and suffer a 1% return). But also not so low to be aggressive…As an investor there are two key risks, 1. Losing money (obvious) 2. Missing opportunity (more subtle). So you need to balance between the two. 
  • The Warren Buffet Way - his forward 
  • Memo - it is what it is (mujo)
  • 1.28.30 - You need to deal with the world as it is. If you’re living in a low return world, to get high return you’d need to take extra risk. So to acknowledge the world as it is may impact your behaviour. (Ray Dalio on realism)
  • 2006 memo - Risk 
  • Factfilness 
  • 1.40.30 - on Bitcoin. He is a value-investor, which means you need to know the underlying price or intrinsic value of something. And there are some assets where you cant do that (Oil, Gold, Diamond and … Bitcoin). So he doesn’t like it because he doesn’t know how to value it. To value it, you need cashflow and customers (like property, stocks and businesses). For a value investor a stock that goes from $1k to 19k then back to $6k in one year seems like some speculation must be involved.
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