A review of the important ideas from The Most Important Thing: Uncommon Sense for The Thoughtful Investor by Howard Marks.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
Corsair Capital was down by about 3.5% net for the third quarter, bringing its year-to-date return to 13.3% net. Corsair Select lost 9.1% net, bringing its year-to-date performance to 15.3% net. The HFRI – EHI was down 0.5% for the third quarter but is up 11.5% year to date, while the S&P 500 returned 0.6% Read More
The Most Important Thing By Howard Marks
The most important thing is based on decades of memos that billionaire value investor Howard Marks has written throughout his investment. It has a knack of succinctly eloquently describing perspectives on investing that make you think. I never thought of it that way. And given the amount of time and success he's had in the markets his opinions on them have become really sort of his first point on markets that they are quick to reflect the consensus view but the consensus view is not necessarily right. He's kind of in between agreeing and disagreeing with the efficient market hypothesis which says that stocks are always efficiently priced so they are NEVER UNDA or overvalued. Take the New York Stock Exchange. You have millions of people looking at the stocks and mispricing won't often happen but they will happen and that's his point. There's tons of examples of just look at how the market valued Yahoo. During the dot com bubble it went from two hundred thirty seven dollars a share in January 2000 to eleven dollars a share. In April 2001 the idea. I mean the idea that the market correctly valued Yahoo. On both of those occasions pretty ridiculous. And this is a clear example of where the market quietly reflected a consensus view. But the consensus was wrong and it's by differing with consensus that you make money in the market. You have to hold none consensus views and they have to be accurate. That's not easy. Stock prices already reflect the consensus so if you share that view you'll probably own the average market return to beat the market. You have to have none.
Consensus views that are right. The problem is stock market valuations depend on what happens in the future. And we as humans at predicting most forecasts extrapolate the recent pause and assume the future will mirror most of the time which is pretty similar to the recent past and those forecasts are generally correct. But they're not valuable because everyone expects that but then soon enough there's an unexpected extrapolation stops working and non consensus forecasts are correct become hugely valuable because they are not priced in by the market. The problem with this is it's really difficult to consistently make accurate non consensus forecasts. I mean let's take 2008 and the financial crisis. Some investors and economists correctly predict. But how many of them then correctly predicted the recovery to start in 2000 no matter how many predicted interest rates to remain low nearly a decade later. Very very predictions are most useful when they correctly anticipate change but we suck at predicting changes in the course of history. This is one of the reasons why Marx prefers to look bottom up instead of top down. You can learn more than your neighbor but individual companies but that becomes a lot harder to do when you start looking at the whole economy. Now we can't predict the future but we can keep tabs on where we are not just because we can't predict it doesn't mean we can not prepare and the way we do this is by monitoring the current vestment environment to get a feel for what kind of market we're in now. You can do that by keeping tabs on risk premiums.
The credit cycle and how people in the markets are behaving for a stock. The risk premium is the amount of additional return that investors demand from stocks compared to government bonds because government bonds are considered risk free. That extra return from the stock is what investors demand to take on the risk associated with stocks instead of sticking with risk free bonds. Keeping tabs on risk premiums is important because small risk premiums suggest that investors aren't being risk averse which may suggest an overheated market. It's a similar thing with the credit market. Keeping tabs on the supply demand for investable funds and how eagerly investors are investing them can give hints on where we are in the stock market cycle when there's not enough money around. Investors are nervous about investing in the economy usually slows down and we have a critical. Conversely they can also be too much money chasing too few ideas. Marx wrote a memo in July 2007 as well as several others where he noted the high degree of risk in the market although that memo was well timed. It had nothing to do with predicting the future. He was able to see what he needed to just by being aware of what was going on at the time. Then this might sound like the same thing but being aware of the temperature of the market is very different to predicting what the market will do next week next month even next year. Prices are too high is a very different statement to the markets going down next year. Shares can be undervalued for a long time and that's a part of what makes predictions so difficult to do.
Depending on where the market is you have to balance Grishin and caution your investments. OK so let's play a hypothetical Let's say that you can consistently predict the direction of the market you're the next genius how should you construct your portfolio and invest. The answer becomes obvious. You should be really aggressive when you think we're about to enter a bull market and super defensive when you think we are about to enter your investment style would mirror American football. We have an offensive line up and you have a defensive. The offense has four attempts to go ten yards. If they don't they leave the field and the defense comes on to stop the other team from advancing the ball. Now investing doesn't work. You don't get a heads up telling you when it's time to play offense and when it's time to play defense. It's a lot more like football outside the United States in a soccer game. You have 11 players who collectively are responsible for attacking and defending. Some focus more on attack in defense and vice versa. But the team as a whole has to strike the right balance between attack and defense. That's a lot like what investing you have to balance aggression and caution in your portfolio. There may be times where you should be more aggressive like a financial crisis in 0 8 where SS was selling supercheap but there are also times where you need to be more defense like the years leading up to the crisis where risk premiums kept shrinking the credit cycle was reaching a top and investor behavior was getting a little crazy. Now in general it's easier to win the game of investing by playing defense than it is playing.
That's because investing is a loser's game where you win by avoiding mistakes and other sounds kind of weird but a great analogy for this is the game of tennis in professional tennis you have what's basically equal game. The victor is generally the player who can hit the most wins but when you and I go play tennis as amateurs. Tennis is really a losing game. The winner is generally the player who hits the fewest loses when we play tennis as amateurs. The focus is just on getting the ball above the net points onto one lost and that's home Howard Marks approaches investors by avoiding looms over his investment career of more than 35 years. There are very few competitors still standing. None of them tried to hit too many winners instead of just getting the ball back over the net. What does trying to get win is look like in the investment world taking on debt concentrating that is being under diversified and holding expensive growth stock. What does avoiding losers look like from the investment it's avoiding being while diversified and requiring a margin of safety and the prices you pay the price is everything. Investing is not about buying good things. It's about buying things. It's about finding good buys not good assets and the difference between the two comes down to the price you pay for them. It's on this point that Howard Marks made the most emphatic and insist and given his investment record it's hard to argue.