Howard Marks | The Knowledge Project #53

KEYPOINTS

• 01

  In 2008 the logic for investing was simple: if the system melts down, nothing matters.

  After Lehman Brothers collapsed in September 2008, many people believed the financial system was melting down. Marks reasoned that this couldn’t be analyzed or known, that anything done to prepare for a meltdown would be a disaster in any other case, and that ‘most of the time the financial world doesn’t end.’ If Oaktree invested and the world ended, its choices wouldn’t matter. If it held back and the world survived, it would have failed clients during the best buying environment there could be. So over the last 15 weeks of 2008, Oaktree invested an average of $650 million a week, about $10 billion in total, sometimes feeling it was moving too fast and sometimes too slow.

• 02

  Markets are people, and people’s feelings make them buy at the top and sell at the bottom.

  Marks quotes Richard Feynman: physics would be much harder if electrons had feelings. ‘There’s no such thing as a market,’ just people trading on their views. In most of life we buy more when prices fall, but in markets, rising prices, good earnings and upbeat headlines pull in buyers until the last one has spent his money and the market peaks. On the way down, people sell to stop the pain until the last panicked seller is out. Psychology swings from ‘perfect’ to ‘no chance of survival’ while the real world moves only between ‘pretty good and not so hot.’

• 03

  Acting against the crowd takes practice, temperament and a culture that doesn’t punish mistakes.

  Marks and his distressed-debt partner Bruce Karsh had already lived through severe downturns in 1990–91 and 2002, and buying bankrupt companies is contrarian by nature. In 31 years as partners, neither has told the other ‘boy, that worked out badly.’ Even a great investor will be right only 60–70% of the time, and second-guessing makes people afraid of mistakes. Oaktree’s motto is ‘if we avoid the losers, the winners take care of themselves’; it has earned about 16–17% a year in distressed debt over 30 years without leverage. It deliberately hires people without much ego or hubris.

• 04

  Cycles come from excesses and the corrections that overshoot them.

  US growth averages about 2% a year but swings between negative and 4% because people overdo things. Coming out of a recession, every company in an industry builds a factory, hires a thousand workers and stocks up on inventory at once, producing a boom year. Then they discover they overbuilt and cut back, producing a bust. Success sows the seeds of its own failure. Marks expected the slow post-2009 recovery to become the longest on record precisely because it lacked excesses. He called the 2017 cut in the corporate tax rate to 21% overstimulative: ‘doctors do not give adrenaline to healthy patients.’

• 05

  Economic reality always wins in the end.

  Governments don’t make anything; they collect and redistribute. Tax rates can’t ignore the rest of the world: France’s 75% top rate pushed wealthy people out, and many ‘New Yorkers’ Marks meets claim Florida residence and stay 181 days. Venezuela capped toilet paper prices, so production fell and it got even scarcer. Politicians promise two $10 hamburgers for nothing, but economics is the science of choices. Marks calls the idea of a ‘fair share’ of taxes a philosophical claim, not an economic one.

• 06

  Trade and productivity explain more than China does.

  With specialization, a sheep-raising country and a shoemaking country make 100 pairs of shoes together; ban trade and each manages 40. A trade deficit is like paying a barber $20 for a haircut. Tariffs are paid by American consumers, not the Chinese, and protecting steelmakers hurts American motorcycle makers who buy foreign steel. Marks says US manufacturing output roughly doubled in 40 years while jobs fell from about 19 million to 12 million, so productivity cost about 24 million jobs versus roughly 3 million lost to China. He’s not optimistic about self-driving cars: cars sit idle most of the day, so sharing them could shrink the fleet and the jobs that depend on it.

• 07

  Risk is the chance of bad outcomes, including missed gains, not volatility.

  Academics use volatility because it can be measured. Marks defines risk as the probability of bad outcomes, and missing out on gains counts as one too, even though managers get fired mainly for losses. He quotes Elroy Dimson: ‘Risk means more things can happen than will.’ With two dice, seven is the most likely total, six chances in 36, yet you can’t know the next roll. Even with the right odds you don’t know the outcome. And the choice with the highest expected value may include outcomes you can’t survive, which is why he doesn’t go cliff diving.

• 08

  Second-level thinking: be different, and be right.

  Anyone can be average cheaply with an index fund. To beat the market you must think differently from the crowd, but the crowd is usually close to right, so you also have to be correct. A first-level thinker says ‘great company, buy the stock.’ A second-level thinker says ‘great company, but not as great as the price assumes, so sell.’ When Marks’s son pitched Ford because of an exciting new Mustang, Marks always asked, ‘Who doesn’t know that?’ You must dare to be different, to be wrong, and to look wrong, because even right calls can look wrong for a while.