Go read Howard Mark’s latest memo

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Howards Marks of Oaktree Capital just dropped his latest memo (“The Seven Worst Words In the World“). It may be somewhat of a promotional material for his upcoming book but if you are a serious investor, please go and read it. If you are a beginning investor, please go and read it.

If you care about money at all, please go and read it. It’s probably the most important thing you’ll read this week.

He makes very pertinent points on market cycles and he backs up a lot of what thinks about the current state of affairs with evidence that he sees in the markets today. It’s interesting that he also points towards SoftBank’s $100 billion venture-cap fund as a sign of the times. Guess who else pointed that out some months ago?

The funny thing is that I was also going through Ray Dalio’s “A Template For Understanding Big Debt Crises” and Dalio pretty much makes the same point as Marks does in his latest memo.

The point is that we want to be careful when there is too much money chasing too few deals.

But, but..Isn’t that Market Timing?

For those that think that this is market timing, it isn’t.

Timing the market means that one believes that one can predict exactly when the market is going to turn up or down. This is something that most of us in the fundamental camp don’t presume we’ll be able to do.

In fact, Marks makes it very clear in his memo that he doesn’t know exactly when this will happen. It’s just that, to him, it’s very clear that we aren’t in the part of the cycle where pessimism rules the day and bargains are aplenty.

In this environment, it’s more likely than not that bad deals are going to be done because prices (and the assumptions that the price hinge on) are too optimistic. The details of the mechanics behind why these sort of deals are done can be found in Dalio’s book.

For those that worship Warren Buffett, you should also realise that Buffett is keenly aware of these cycles. He famously shut down his partnership in the late 60s when there weren’t bargains to be found. Warren Buffett also tends to let cash accumulate when deals can’t be made at good prices.

His partner at Berkshire, Charlie Munger, also once said that the way they ran their insurance business was very counter-cyclical to other people. When too much competition drove prices down, they chose NOT to underwrite policies at discounted prices because they knew that these prices would eventually come back to haunt their competitors in a downturn and that’s when they would want to be writing policies.

Do Yourself A Favour

Having said all of the above, please DO NOT take what I’ve said as a signal to go to cash or gold or whatever other asset class. You have to remember that being completely out of the markets has a cost — You give up the returns that you could have got by holding risky assets.

A good example is a colleague of mine who has been (mostly) out of the markets since 2015. He’s missed out on what is probably a 5% per annum return on his capital as well as the 20% growth in the markets last year. For a person with his amount of capital to compound, that opportunity cost might easily be six-figures large.

To conclude, do your future self a favour and go read Mark’s latest memo and Dalio’s latest book.

Market cycles matter

I know I run the risk of being wrong but for what it’s worth, this is my honest opinion. After all, it’s very difficult to spot bubbles except in hindsight.

Recently, I’ve been talking a lot of shit about cyrptocurrencies and I think many people have mistaken my comments about cryptos as a sign that I think they are a total scam.*

I don’t. In fact, with my cursory understanding of the technology, I think they the Blockchain technology that all cryptos are based on could fundamentally change the way some business is done. There seems to be a lot of promise in reducing the fees that many financial intermediaries earn or ensuring the integrity of the supply chain of a product.

The problem I had with cryptos is the fact that almost everyone seemed to be buying into the hype. In fact, my boss asked an innocent question, “Why was there suddenly so much attention on bitcoin when the thing itself is almost 10 years old?”

I thought the answer was simple.

The only reason why 2017 was the year of bitcoin and cryptos was that there was so much money that was made (whether the money was real or illusional is another matter altogether).

That fact in itself made the intended use of cryptos irrelevant. All that was relevant (and still is for some people) was whether the price of cryptos was going to go up or down. Now, that is something interesting to me because it is the same with any other investment. If there are too many people chasing after the same returns, they are going to bid the price up and sooner or later, no one is going to believe that the price will keep going up and that will be the beginning of the end for the inflation in prices.

The people that believe that it could be otherwise just haven’t read enough.

It was the same for financial assets and real estate (‘08/09), internet start-ups (00s), Asian real estate and stocks (‘97), Nifty Fifty stocks (60s), equities (1929), the South Sea Company, tulips and so on and on.

Stage one: nascency

People who invest in anything, in general, need to be more aware of the fact that ALL markets move in cycles. In general, any cycle starts with a small segment of investors in some new or previously unloved asset class. These investors get called all sorts of names- whackos, gamblers, speculators or what-have-you.

Stage two: some people make decent money

Eventually, these guys start making some money and people start to take notice. As more people chase after the same returns that these guys have gotten, the initial group of investors starts to make outsized returns. It doesn’t help that this initial group seem like average Joes and Janes to their neighbours. People start to think that if these people can make 1000% returns, I can too.

Stage three: envy draws everyone

Investors in other asset classes, which have returned nowhere close to the returns from this asset class, then wonder what the hell they’ve been doing, getting tiny returns while these people that they thought were whackos are proving them wrong. It doesn’t help that some “whackos” make all this money that is many multiples of what their full-time job pays in a year. Some of the investors start becoming converts.

Eventually, many people who have no business investing in anything start putting in tiny bets into this new asset class. The bets pay off. They then put their entire nest egg into this ‘sure thing’.

Stage four: beginning of the end

Then, without warning, prices start to collapse.

Entire nest-eggs and paper fortunes worth several lifetimes evaporate. Those with gains start selling furiously, desperate to hold on to whatever gains that they have. This compounds the selling. The die-hards are telling everyone else that this is just a dip. It’s a chance to buy even more they say. What they forget is that some people have already put all they have into this one thing.

Stage five: back to earth

Prices start to stablise and provide some relief. But as corporate bankruptcies due to losses in this asset start to filter, everyone starts to realise that it’s over. All they can now do is lick their wounds.

While it seems like the easy answer is get it at stage one or two, the unfortunate thing is that there’s no way to predict which asset to get into or when it’s going to take off.

Many other experts on investing have written about bubbles, market euphoria and how to spot these things. My favourite person on the topic is Howard Marks of Oaktree Capital and I understand he has a whole book devoted to market cycles coming out later this year. I’ll be sure to read it.

Revisiting the crypto craze

If you cast your mind back cryptos, very few people were talking about it prior to 2017. Only the people who kind of understood or were willing to explore the technology were invested before 2017. I dare say that prior to 2013, the people in it were mostly the people who were working on the technology itself.

Only after a certain group of people had already made outsized returns on their investments did cryptos start to attract the kind of attention it did in 2017. It probably also helped that 2015 and 2016 weren’t exactly good years for stocks. This made the gains in crypto seem all the more attractive. Everybody from South Korean students to Japanese salarymen started buying bitcoin too, thinking that they’re all bonafide investors now. My boss was also asking if we could do a presentation on the economics of bitcoin.

That’s basically when I knew that cryptos were done. I didn’t know if prices would continue to go up or not but I knew cryptos were now a major bubble.** The point here is not about cryptos per se. The point is that if we look back at the Global Financial Crisis (GFC) in ‘08/09, there was a similar story that played out in US real estate (in ‘04-’06) which led to the financial crisis.

Next time, if someone asks you for money to invest in something, you probably want to ask yourself: “Which part of the cycle are we at right now?”

Notes:

*Funny enough, there’s actually one called Super Cool Awesome Money (SCAM).

**After some colleagues and I discussed how ridiculous the price increases in crypto had been, the price of bitcoin more than doubled over the next three weeks. It goes to show how difficult timing markets can be. Crazy can get crazier. Lord Keynes has been quoted to death on this but it bears repeating: “The market can stay irrational longer than you can stay solvent.”