by If you ask Howard Marks how he made his $2.2 billion fortune, he could describe decades of work as an analyst at Citicorp (a subsidiary of Citigroup). 90s, or even his lucrative investments in luxury properties. But of course, the main calls Marks made after founding Oaktree Capital Management in 1995 are what earned most of his earnings. In fact, he now says that just five prophetic predictions have built his reputation as a street legend.
The Seventies described these five specific market calls between 2000 and 2020 in a new memo titled Take the temperature Monday. The mostly contrarian shots netted Marks billions, but the lessons learned may be even more valuable.
For Marks, a good investor is able to use his knowledge of economic history, the inner workings of financial markets, and psychology to get a sense of the current mood or temperature among investors. When that mood becomes too optimistic, it’s time to seek safety. But when it’s overly bearish, it’s time to look for bargains. It’s a contrary riff on Warren Buffett’s famous quote, “be afraid when others are greedy, and greedy when others are afraid.”
In the five cases described below, including his prescient warnings prior to the global financial crisis and the dot-com bust, Marks noted that “the markets were either insanely high or massively depressed,” which enabled him to “recommend more defensive or become more aggressive with a good chance of being right” and commit murder in the process. He wrote that he learned several lessons from looking back at his five big calls, and Fortune has highlighted three of the most important.
1 – 2000, the dotcom bubble
In 1999, as the dotcom bubble grew day by day, legendary financial journalist Edward Chancellor released a book that helped establish his reputation: Devil Take the Hindmost, chronicling the history of speculation from ancient Rome to the railroad mania of the 19th century. Reading Chancellor’s book that year, Marks wrote that he was “struck by the similarities” between the speculative bubbles of yesteryear and the meteoric rise of technology stocks at the time.
Seeing this market disruption, Marks wrote a memo to customers titled bubble.com in January 2000, just two months before the bubble burst, warned that Internet-related stocks were overvalued and that speculative mania had taken hold of investors.
“The lure of easy profits, the willingness to give up your job to make money, the ability to happily invest in money-losing companies whose business models you can’t explain—all of these felt like themes that have changed throughout financial history. , leading to bubbles and their painful bursting. And they were all visible in investor behavior as 1999 drew to a close,” he wrote.
Following Mark’s warning, the S&P 500 fell 46% between March 2000 and October 2002, while the tech-heavy NASDAQ Composite fell about 80%.
2 – 2007, the global financial crisis
Between October 2004 and July 2007, Marks repeatedly warned that a “slowly developing trainwreck” was coming. He noted that after the dot-com bubble burst, the Federal Reserve moved to an accommodative monetary policy, causing savings accounts and typical safe-haven assets to yield poor returns, pushing investors into riskier investments. And eventually, the belief that “housing prices are only going to rise” began to permeate consumers in a replay of speculative bubbles of the past.
In July 2007, Marks published a memo sarcastically titled It’s all right, where he warned that investors were being overly optimistic and ignoring risk, meaning a recession was likely imminent. Five months later, the global financial crisis (GFC) set in, causing Bear Stearns and Lehman Brothers to collapse and the S&P 500 to fall 53% from its 2007 high to its June 2009 trough.
Marks explained that he had no foreknowledge of the problems in the subprime mortgage market that ultimately led to the GFC, and that his “cautious conclusions” were simply based on “taking the temperature of the market” — essentially acknowledging when investors have become, to paraphrase former Federal Reserve Chairman Alan Greenspan, irrationally exuberant.
3 – 2008, Buying the GFC Dip
Marks, always contrarian, decided it was time to buy after the subprime mortgage crisis crippled the US housing market and sparked the GFC. He described how Oaktree accumulated an $11 billion “reserve fund” between January 2007 and March 2008 to buy distressed debt, and began shopping in September 2008.
“I think the outlook should be binary: is the world going to end or not?” Marks wrote in a memo at the height of market pessimism in 2008. “We will invest on the assumption that it will continue, that companies will make money, that they will have value and that buying claims against them at low prices will work on the long term. What alternative is there?”
Of course he made billions buying all those distressed assets. And the S&P 500 is up about 500% since the GFC lows.
4 – 2012, Ignoring the exaggerated death of stocks
In 2012, many investors were still reeling from the GFC. Marks commented at the time that it “weighed heavily” on their psychology. This excessive bearishness led him to remember a 1979 Work week article titled The death of stocks. He said the piece followed years of sustained inflation and poor stock market returns and extrapolated a pessimistic outlook from the current environment. But 1979 was by no means the end of stocks. The S&P 500, for example, is up nearly 4,000% since the end of that year.
In 2012, Marks saw all the same patterns in investor psychology that had led to overly bearish market forecasts in the late 1970s, so he wrote a piece titled Déjà Vu all over again stating his belief that “positive scenarios” for stocks were more likely than another downturn.
“From 2012 – the year of Déjà Vu All Over Again – through 2021, the S&P 500 returned 16.5% per year,” he noted. “Once again, overly negative sentiment has led to big gains. It’s that simple.”
5 – 2020, Buying the COVID dip
As COVID-19 began to spread around the world in early 2020, Marks, like everyone else, was uncertain about what the future might hold. But as the stock market crashed and panic began to spread on Wall Street, the billionaire felt it was time for a rebellious stance once again. His optimistic view was confirmed after a trader on his team, Justin Quaglia, said he saw forced sales of bonds from companies that needed the cash to stay afloat while the economy was in lockdown. “We finally snapped the rubber band,” said the trader. For Marks, it was a contrarian buy signal that meant the worst was probably over.
“We are never happy with the events that cause chaos, especially the events that are taking place today,” he wrote in a memo dated late March. “But it’s the sentiment described by Justin above that fuels the emotional selling that allows us to access the best bargains.” Again, Marks was right, as the S&P 500 is up more than 90% since its March 2020 COVID lows.
Learned 3 important lessons
Drawing on his decades of experience in the markets, Marks laid out some of the most important lessons for investors at the end of his memo.
First and foremost, the billionaire said investors should be history students — only then can they “apply pattern recognition” and begin to take advantage of the often predictable nature of business cycles by “taking the temperature of the market.”
“Ironically, investor psychology and thus market cycles — which seem volatile and unpredictable — fluctuate over the long term in a way that approaches reliability,” he wrote.
After becoming a student of economics and market history, Marks said investors will come to u
nderstand another important lesson: All business cycles come from “excesses and corrections.” He argued that markets are primarily driven by investor emotions, rather than mechanical processes, meaning there are times of excess when people become so optimistic that they try to “justify the dangerous notion that ‘no price is too high ‘”. these overly bullish periods are usually followed by a correction as investor psychology turns to fear.
“[A] a strong move in one direction is more likely – sooner or later – to be followed by a correction in the opposite direction than a trend that ‘grows to the sky’,” he explained.
Second, in times of market excess or bearish corrections, Marks wrote that he believes investors should be able to control their emotions and avoid falling victim to peer pressure. He noted that illogical stories often emerge during these periods, such as “there is no price too high” or “stocks have fallen so far that no one will be interested in them”.
“Remember that in extreme times… the secret to making money lies in being contrary, not conforming,” he wrote. “If you come across a commonly accepted statement that makes no sense or that you think is too good to be true (or too bad to be true), take appropriate action.”
Finally, and perhaps a little ironically, Marks stressed over and over in his lengthy memo that trying to predict the future of the global economy, even for the best asset managers, is an almost impossible task and should not be done often.
“[T]The bottom line is that at Oaktree we approach these things with great humility and only deviate from our neutral assumptions and normal behavior when circumstances leave us no other choice. ‘Five times in 50 years’ gives you an idea of our interest in being a market clock. The fact is that we are hesitant to do so,” he wrote.
For the sports fans, Warren Buffett has an analogy that perfectly describes Marks vision. In the 2017 HBO documentary becoming Warren Buffett, the billionaire says investing is like being a batter in a baseball game where there are no called strikes. “The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one that’s right in your sweet spot. And when people yell, “Swing, motherfucker!” Ignore them.”
This story was originally on Fortune.com
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