- Howard Marks is a renowned investor and co-founder of Oaktree Capital Management. In his new book "Mastering the Market Cycle", he emphasizes the importance of understanding where the market stands in its cycle and managing risk accordingly. - While it is impossible to precisely predict market movements, Marks believes investors can gain an edge by studying historical cycles and assessing the current environment to determine if conditions present better or worse odds. This allows calibrating risk exposure along a continuum rather than reacting with all-in or all-out approaches. - A key theme is that periods of excessive optimism and high valuations late in an upcycle pose risks, while times of pessimism and recovery early in a cycle offer comparatively better

1. Lessons from Howard Marks’ New
Book: “Mastering the Market Cycle
– Getting the Odds on Your Side”
Tren Griffin
Howard Marks is co-chairman and co-founder of Oaktree Capital Management, an
investment manager with more than $120 billion in assets under management. How
smart is Marks and how sound is his judgment? Charlie Munger once said “I
probably know Howard Marks as well as I know anybody and he is a very smart
man….[For example] you have to believe in the tooth fairy to believe [Bernie
Madoff] was having those figures by the methods he claimed to be using. You
wouldn’t have gotten that one by Howard Marks for two seconds. I mean you
wouldn’t have finished your sentence before he noticed it couldn’t be true. But
people don’t think like Howard Marks.”
Marks said in a recent Barry Ritholtz podcast that he believes: “Recognizing and
dealing with risk and understanding where we are in the cycle are really the two
keys to success.” In a masterful review of Mastering the Market Cycle, Jason
Zweig writes:
Mr. Marks admits his book is a kind of tug of war between his certainty that “we
don’t know what the future holds” and his belief that “we can identify where the
market stands in its cycle.” By studying how the economy, the markets and the
psychology of investors all move in long cycles of expansion and contraction, Mr.
Marks and Oaktree have been better able to cut back risk near market peaks and
ramp it up near market bottoms, he says. But Mr. Marks doesn’t think you can use

2. that sort of understanding to go all in or all out of markets again and again. He likes
the book’s subtitle—“Getting the Odds on Your Side”—better than its title, he
quips. “Recent performance doesn’t tell us anything we can rely on about the short-
term future,” he says, “but it does tell us something about the longer-term
probabilities or tendencies.”
It is worth reading what Zweig wrote above is his review of the book at least twice
since it represents the core message of Mastering the Market Cycle.
Marks explains in his new book that by doing things like reading widely, studying
history and paying close attention to the state of the world right now, an investor or
business person can be generally aware of where the cycle might be even though
they can’t predict precisely when it will shift in the short term. By doing this work
an investor or business person can increase their margin of safety by “getting the
odds on their side.” Marks believes that the right way make this analysis is to think
probabilistically.” Marks suggested in an interview with Zweig that investors
calibrate their exposure to risk using: “a continuum from 0 to 100, he says, with 0
being completely out of the market and 100 being completely in using aggressive
techniques like investing with borrowed money.” Having said that, Marks is very
wary of attempts to quantify probability given risk, uncertainty and ignorance. He
writes in his latest memo:
“while they may not know what lies ahead, investors can enhance their likelihood
of success if they base their actions on a sense for where the market stands in its
cycle….there is no single reliable gauge that one can look to for an indication of
whether market participants’ behavior at a point in time is prudent or
imprudent. All we can do is assemble anecdotal evidence and try to draw the
correct inferences from it.”
Making this determination requires judgment and there are no recipes for success.
An investor has a lot of information about the past and the present, but by
definition has zero information about the future. Marks describes this tension by
writing in his latest memo: “While the details of market cycles (such as their
timing, amplitude and speed of fluctuations) differ from one to the next, as do their
particular causes and effects, there are certain themes that prove relevant in cycle
after cycle.” Given this reality, how does an investor or anyone making a decision
in life “get the odds on their side”? One of the most important themes of Mastering
the Market Cycle is reflected in a quote attributed to Mark Twain: “History doesn’t
repeat itself, but it often rhymes.” Marks believes that if you read widely and pay
attention to what is happening in the world by reading and doing the right research
is it possible to see patterns that can inform an investor about the current state of
the cycle. Charlie Munger is quoted as saying in a blurb for the new book: “There’s
no better teacher than history in determining the future.’ Howard’s book tells us
how to learn from history . . . and thus get a better idea of what the future holds.”
The words “better idea” are critically important part of that Munger quote are since
the objective is find opportunities that reflect favorable odds since decision making

3. certainty is simply not possible to achieve. What Marks is saying is that having the
same degree of conviction about all of opinions is dangerous. In an excellent
podcast interview with Tim Ferriss, Marks pointed out that: “Nobody ever says,
“My opinion is X, and I think I’m wrong.” We all think that our opinions are
correct.” It is one thing to have an opinion, but quite another to believe that it is
necessarily right.” Marks believes in the value of humility in relation to the markets
as he notes here:
There are two things I would never say when referring to the market: “get out” and
“it’s time.” I’m not that smart, and I’m never that sure. The media like to hear
people say “get in” or “get out,” but most of the time the correct action is
somewhere in between. Investing is not black or white, in or out, risky or safe. The
key word is “calibrate.” The amount you have invested, your allocation of capital
among the various possibilities, and the riskiness of the things you own all should
be calibrated along a continuum that runs from aggressive to defensive.
Tim Ferriss just recently posted a fantastic podcast with Mark on this web site in
which Howard Marks gives this answer:
One of those most important things is knowing where we stand in the cycle. I don’t
believe in forecasts. We always say, “We never know where we’re going, but we
sure as hell ought to know where we are.” I can’t tell you what’s going to happen
tomorrow, but I should be able to assess the current environment, and that’s the
kind of thinking that helped us prepare for the crisis. I think that the two most
important things are where we stand in the cycle and the broad subject of risk, and
in fact, where we stand in the cycle is the primary determinant of risk.
What Getting the Odds on Your Side means is that we don’t know what’s going to
happen – nobody can tell you – but there are times when the outlook for the future
is better and there are times when it’s worse, and it’s largely determined by where
we stand in the cycle. When we are low in the cycle – that is to say, we’re coming
off a bust – the economy is starting to warm up. Investors are just barely starting to
switch from pessimism to optimism and prices are starting to rise. Clearly, the odds
are in your favor. The outlook is better. It doesn’t mean you’re going to make
money, but the chances are good.
On the other hand, when the upcycle has gone on for a long time, when valuations
are high, when optimism is rampant, when everybody thinks everything’s going to
get better forever, when the economy has been moving ahead for 10 years and it
looks like it’s never going to stop, then usually, the enthusiasm has carried the
prices to such a high level that the odds are against you. Just knowing that is a huge
advantage in investing. You should know that when we’re low in the upcycle,
that’s a time to be aggressive, put a lot of money to work, and buy more aggressive
things, and when the cycle has gone on for a long time and we’re elevated, that’s
the time to take some money off the table and behave more cautiously.”

4. The link to this Tim Ferriss interview of Howard Marks is in the End Notes to this
blog post as is usual. I highly recommend reading the podcast transcript or listening
to it. I did both. Twice.
Why economies cycle between better and worse performance is something Marks
has thought about a lot. In Mastering the Market Cycle he writes: “The themes that
provide warning signals in every boom/bust are the general ones: that excessive
optimism is a dangerous thing; that risk aversion is an essential ingredient for the
market to be safe; and that overly generous capital markets ultimately lead to
unwise financing, and thus to danger for participants.” Marks quotes a Warren
Buffett on this point: “The less the prudence with which others conduct their
affairs, the greater the prudence with which we must conduct our own.”
What Marks say about the cause of the great financial crisis is a great illustration of
what he writes about in this new book. Starting in 2005 and 2006 Marks and his
partner Bruce Karsh started to see deals get done on terms that were a “piece of
crap.” That investors were buying the offerings anyway made the two partners
conclude that something was wrong. Marks admits:
… you can prepare; you can’t predict. The thing that caused the bubble to burst
was the insubstantiality of mortgage-backed securities, especially subprime. If you
read the memos, you won’t find a word about it. We didn’t predict that. We didn’t
even know about it. It was occurring in an odd corner of the securities market. Most
of us didn’t know about it, but it is what brought the house down and we had no
idea. But we were prepared because we simply knew that we were on dangerous
ground, and that required cautious preparation.
This graphic below appears on page 216 of the new book. It is a graphic
representation of why Marks believes that there is value in knowing roughly where
the cycle might be even if you can make short term forecasts about where it is
going. Marks explains:
“Since market cycles vary from one to the next in terms of amplitude, pace and
duration of their fluctuations, they’re not regular enough to enable us to be sure
what’ll happen next on the basis of what has gone on before. Thus from a given
point in the cycle, the market is capable of moving in any directions, up flat or
down. But that does not mean that all tree are equally likely. Where we stand
influences the tendencies or probabilities, even if it does not determine future
developments with certainty…. Assessing our cycle position doesn’t tell is what
will happen next, just what’s more or less likely. But that’s a lot. “

5. Marks is not the only person who thinks in terms of cycles. Ray Dalio, who writes
a very favorable blurb for the new Marks book, believes: “In the business cycle, [a
recession] that happens when capacity is constrained and inflation is accelerating
and tightness of monetary policy … the long term debt cycle I think is pretty
stretched.” One of the cycle charts Dalio uses is:
In his first book The Most Important Thing (which had sale to date of more than
750,000 copies) Marks wrote:

6. “Cycles will rise and fall, things will come and go, and our environment will
change in ways beyond our control. Thus we must recognize, accept, cope and
respond. Isn’t that the essence of investing?” “Processes in fields like history and
economics involve people, and when people are involved, the results are variable
and cyclical. The main reason for this, I think, is that people are emotional and
inconsistent, not steady and clinical. Objective factors do play a large part in
cycles, of course – factors such as quantitative relationships, world events,
environmental changes, technological developments and corporate decisions. But
it’s the application of psychology to these things that causes investors to overreact
or underreact, and thus determines the amplitude of the cyclical fluctuations.”
“Investor psychology can cause a security to be priced just about anywhere in the
short run, regardless of its fundamentals.” “In January 2000, Yahoo sold at
$237. In April 2001 it was $11. Anyone who argues that the market was right both
times has his or her head in the clouds; it has to have been wrong on at least one of
those occasions. But that doesn’t mean many investors were able to detect and act
on the market’s error.” “A high-quality asset can constitute a good or bad buy, and
a low-quality asset can constitute a good or bad buy. The tendency to mistake
objective merit for investment opportunity, and the failure to distinguish between
good assets and good buys, gets most investors into trouble.” “It has been
demonstrated time and time again that no asset is so good that it can’t become a
bad investment if bought at too high a price. And there are few assets so bad that
they can’t be a good investment when bought cheaply enough.”
Marks doesn’t believe anyone should have the same degree of conviction about all
of their opinions. To combat a tendency to think in binary terms he advocates that
people calibrate risk. Marks recommends thinking about the future as a probability
distribution. As an aside, Marks has said he first encountered probability
distributions at a World’s Fair in Flushing New York just as I did at the Seattle
World’s Fair. In each case there was an exhibit at the fair that dropped balls from
the top of a box with regular spaced pegs pegs in it and the resulting cascade
produced a bell curve distribution as in the picture below.

7. What the display at the fair did not teach us is that often the distribution is not a
bell curve and that these cases can be extraordinarily important. People like
Mandelbrot and Taleb would arrive later and help us understand their impact.
Charlie Munger describes what can go wrong:
What they did was, they said, ‘Well, financial outcomes in securities markets must
be plottable on a normal curve,’ – [a] so-called Gaussian curve, named for probably
the greatest mathematician that ever lived. Gauss must be turning over his grave
now with what’s happening. Of course, the math was very helpful because you
could come up with numbers and results that would make people feel confident
with what they were doing. There was only one trouble with the math: The
assumption was wrong. Financial outcomes in securities markets are not plottable.
It is not a law of God that outcomes in securities prices will fall over time on a
curve and [follow] reality according to Gauss’s curve. Quite the contrary, the tails
are way fatter…. People were actually making decisions about how much risk to
take, based on the application of correct math, based on an assumption that wasn’t
true. And by the way, people gradually knew it wasn’t true.”
Marks tells a great story about one situation when he and his partner were worried
about buying distressed asset after the great financial crisis. They eventually
decided to keep buying assets and distressed prices since if the prices did not
recover nothing really mattered financially anyway. This presented a situation with
a huge potential upside and a very small down side from the investments
(optionality). On the subject of today’s markets, Marks believes that the baseball
inning analogy he has used several times is not a good one since there is no set
number of innings when it comes to the cycle. His most current statement on
valuation is:
“equities are priced high but (other than a few specific groups, such as technology
and social media) not extremely high – especially relative to other asset classes –

8. and are unlikely to be the principal source of trouble for the financial markets….
Oaktree’s mantra recently has been, and continues to be, “move forward, but with
caution.” The outlook is not so bad, and asset prices are not so high, that one
should be in cash or near-cash. The penalty in terms of likely opportunity cost is
just too great to justify being out of the markets.”
One of my favorite parts of the Tim Ferriss podcast is when Marks makes a point
that has been a consistent theme of this blog: “there are many ways to invest; there
are many people who engage in activities that I think can’t be done, and there are
many people in each one who do very well. I don’t say mine is the only way.
Venture is an example.” Marks agrees with Charlie Munger on the importance of
“the discipline of mastering the best that other people have ever figured out. I don’t
believe in just sitting down and trying to dream it all up yourself. Nobody’s that
smart.” During a lunch with Marks Munger once said: “It’s not supposed to be
easy. Anyone who finds it easy is stupid. There are many layers to this, and you
just have to think well.” But it can get easier if you work hard and stay humble by
recognizing what you do not know. As Michael Mauboussin likes to say: “the best
long-term performers in any probabilistic field — such as investing, sports-team
management, and pari-mutuel betting — all emphasize process over outcome.”
Speaking of probabilistic bets, Marks believes that the best games for improving
decision-making involve uncertainty and ignorance. Annie Duke explains:
Trouble follows when we treat life decisions as if they were chess decisions. Chess
contains no hidden information and very little luck. The pieces are all there for both
players to see. Pieces can’t randomly appear or disappear from the board or get
moved from one position to another by chance. No one rolls dice after which, if the
roll goes against you, your bishop is taken off the board. If you lose at a game of
chess, it must be because there were better moves that you didn’t make or didn’t
see. You can theoretically go back and figure out exactly where you made
mistakes.
Marks meets with Munger now and then and I wish he would write a post about
Charlie. Marks describes what makes Munger so interesting and effective as an
investor as follows:
“The main thing is that he has read more broadly. He’s had another 22 years to read
further, and he was probably always a broader reader than I was, and so it’s his
ability to call on these references. In a way, it’s kind of silly to think that we can
reinvent all the wisdom in the world. It’s great to borrow from others, and Charlie
does that broadly, and I try to do it, but he just knows more.”
Marks has over 100 memos on his web site. And he says: “The price is right, since
it is free.” When asked by Barry Ritholtz why he writes, Marks responded:

9. “For ten years I never had a response [to my memos]. Not only did nobody say they
thought they were good, nobody even said that they got it. The interesting question
is: What kept me going? I have no idea. The answer I think is that I was writing for
myself. Number one, it is creative and I enjoy the writing process. Number two, I
thought that the topics were interesting. Number three, writing helps you tighten up
your thinking.”
My motivation in writing over a million words on this 25IQ blog is the same. I
would be writing even if no one was reading.