Howard Marks

A good pundit on the economy and investing is Howard Marks, founder of Oaktree Capital. Occasionally, maybe once per quarter, he writes a memo that can be found here (which was also made into a podcast this week). Incidentally, I started writing memos to myself and then publishing them as a direct result of his influence.

Aside from reading his past memos, I have also read his two books as they summarize the methodology that informs his firm’s investing practices:

If a reader is looking for a formulaic approach to investing, unfortunately he will not be the source. Instead, he largely acknowledges that investing is hard, the future is largely unknown, and one simply needs to take action with the information they have at their disposal. Reading through these two books, below are a few highlights.


The mood swings of the securities markets resemble the movement of a pendulum. Although the midpoint of its arc best describes the location of the pendulum “on average,” it actually spends very little of its time there.

The common thinking is that the stock market reliably delivers returns of around an average of 7% (since 1960) each year. Of the 59 years since 1960, can you guess how many years the S&P 500 had returns that averaged somewhere between 2% and 12% (a reflection of 5 percentage points either way from the average)? 

11 Years.

Similarly, the number of instances during those 59 years that the market showed abysmal annual returns of minus 10% or more was 10 years.

The amount of time the same index did very well and returned more than 20% annually to the investor was 15 years. 

Totaling those up and down years, there were 25 years where the performance of the S&P 500 was extreme. This is mostly to say that there is no reliable return one can get in the stock market, though there is an upward trend in the long run.

Knowledgeable Contrarian

It can’t be “the investor’s default position that the market knows more than he does… (on the other hand) he mustn’t always assume he is right and the market is wrong – and thus hold or add without limitation and without rechecking his facts and reasoning.  

You must do things not just because they’re the opposite of what the crowd is doing, but because you know why the crowd is wrong.

There is a distinction between an active professional investor and a passive layperson. For someone to make their living at investment, they must be confident that they have an informational advantage over the overall market. Without this advantage, someone is merely pretending to be a professional investor with hopes that they will get lucky and make it. This is not to say that professionals earn better returns than laypeople, as some professionals are lousy.

Being a pioneer or contrarian requires healthy paranoia in any discipline. In investing the person wearing such a hat should be continuously reassessing to make sure that their bet is correct given their perspective. This is true when their bet is going well and when it isn’t. 

For instance, a bold bet can be against a currency. Specifically, the country behind the currency will experience inflation or be unable to pay its debts. When that country does not hit turmoil, the investor must look at their information and premise repeatedly.

David Einhorn and Kyle Bass have had such a bet on the currency in Japan. Their thesis is sound given that a) Japan has maintained low-interest rates for a long time, b) government debt has continued to climb as compared to GDP, and c) the working population is old and shrinking (leading to the question of how are they going to pay off their debt). For decades, with all of those trends pointing to a logical outcome, Japan has yet to crumble, even during this pandemic. Doubling down on that Japanese currency bet takes moxie.

The other side is when a bet is going well. 2019 was a banner year in the stock market and at the end of the longest expansion that was on record. The crowd clearly thought the good times would continue as there was no correction in stock market pricing until the pandemic. In January 2020, was the crowd right or wrong? Should a professional investor have followed along or retreated to safety? Other than simply bucking the trend, being contrarian for its own sake, what would have been the reasons for changing strategy?

Capital Allocation

The investor’s goal is to position capital so as to benefit from future developments. 

it’s essential to arrange your affairs so you’ll be able to hold on—and not sell—at the worst of times. 

For those that are not professional investors without a competitive edge, passive index investing is the best you can do. Most people do not have an informational advantage to know that an investment opportunity is available and “benefit from future developments.” They are better suited to increasing their output in their standard line of work. For those laypeople, limiting fees and smoothing portfolio value ascent is the primary concern; maximizing returns should not. They should also not be worried about buying or selling disproportionately based on market fluctuations or hunches, but instead invest regularly.

Active investing, on the other hand, is not about consistently making bets in safe funds. The secret is that, for more professional bet-makers, most of their time is spent doing nothing except preparing for a time to act. When that time comes, the capital should be available to pounce on an opportunity. Taking massive action towards an investment is what outsized returns are made of.

To be clear, there are two simplified tasks that investment professionals do :

  1. Stockpile capital
  2. Take massive action when an opportunity strikes

Here are a few quotes from the old sages at Berkshire Hathaway on this idea:

“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”

“If you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.”

“You’re like a man standing by a stream, trying to spear a fish and the fish only comes once a week, or once a month, or only once every 10 years. And you’ve got to be there to throw that spear fast before the fish swims on.”

Portfolio Construction

The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst. The raw materials for the process consist of (1) a list of potential investments, (2) estimates of their intrinsic value, (3) a sense for how their prices compare with their intrinsic value, and (4) an understanding of the risks involved in each, and of the effect their inclusion would have on the portfolio being assembled.

An investor can obtain margin for error by insisting on tangible, lasting value in the here and now; buying only when price is well below value; eschewing leverage; and diversifying.

The above process for building a portfolio seems simple. It is not. 

  1. Requires that one has criteria that they filter out all investments with. 
  2. Relies on the skill of valuing an asset which is usually honed over decades. 
  3. This comparison actually requires patience. The intrinsic value needs to be greater than the price, which can be found readily, but a significant margin between the two needs to exist. Most times, this gap is elusive.
  4. Portfolio theory is such that investments need to be diverse enough to weather storms so that one macro-event does not take all of your investments down. Owning all of the FAANG stocks is not diverse, though has lately been lucrative.  Buying up rental houses is not diversified.  A good investor, in order to diversify, needs to be an expert on various opportunities in multiple types of investments. That is really hard, particularly in light of steps 1-3.

Don’t Trust Forecasts

The sum of this discussion suggests that, on balance, forecasts are of very little value…you can’t know the future; you don’t have to know the future; and the proper goal is to do the best possible job of investing in the absence of that knowledge.

Forecasts are wrong. 

Avoid forecasts. 

Am I clear? Howard has hammered that point home; forecasts are the new forbidden F-word.

Anyone that claims to confidently tell you what will happen next is going to mislead those listening to them. I have to remind myself to put little or no stock in forecasted outcomes when they are offered. Forecasts are like get-rich-quick schemes and one should be extra wary of them.

Does this mean that investors should blindly make bets about the future? Does this mean that the information found within a thoughtful forecast is meaningless? There is a nuance in forecasts because the answers to both questions are “no.”

Investors looking to place capital for future events should keep an eye out for pressures. This is the tendency, due to external forces, for asset performance or values to have positive or negative outcomes. 

In recent months I have spoken of inflation and to the point of toying with the forecasting line. Governments around the globe mostly peg inflation to a 2% standard. One can look at economic news and infer that external pressures will result in inflation being greater or less than 2%. My take, based on reasoning, is that we will see a divergence from that 2% baseline.

Be alerted though when a forecaster says that inflation will be 6% or -2%. The specificity behind the guess is the real danger. While I have not tried to forecast specifically, I have endeavored to make reasonable assumptions about the future so that it is useful. Still, a reader could take away my rationale that a metric should trend in a certain direction due to pressures, but not be legalistic about numbers that I use.

Additionally, taking one forecast as a prophecy is dangerous. An investor, if they do decide to have pundits weigh in on their decision making, need to take in multiple perspectives on the future…and be skeptical of them all. These inputs should only augment an individual’s assessment of how an investment will perform. Investors can make their own bets once they have a well-rounded picture of the future.

Finally, future prospects should not be the primary consideration for an investor. The quality of the investment and its managers, the manner in which it is financed, its past performance, and the price paid for that investment are more important and quantifiable than conjecture about the future. 

Some Questions

  • Do I need for my investments to make a specific return each year or is my strategy long-term? For instance, will I need that $10,000 for a purchase in the next year? If so, maybe I want to put it in a boring savings account rather than play the roulette wheel with stocks.
  • Am I making investment decisions based on hunches, what I read on the internet, or what some guy just told me?
  • Am I convicted behind a certain investment and is my confidence based on sound research?
  • Do I have an informational advantage?
  • Am I more efficient learning about investing and doing my homework repeatedly, or would my time be better spent doing my day-job better? Probably the latter.
  • Do I have a strong capital position from which I can take impactful action?
  • Do I have the guts to take such action when an opportunity arises?
  • Am I skillful and patient enough to build a strong and diversified portfolio? Could I get decent diversification quickly instead? Am I okay with earning steady but smaller returns? There is a trade-off between these two paths. The quick and steady route is probably best for 99% of people.
  • Always ask yourself if you are putting faith in a forecast. Having an opinion about a direction that things may go shows that one is informed, but having an emphatic and quantifiable belief in future outcomes is foolish.