One of the most insightful books ever written on the markets was Mastering the market cycles. It was bound to be insightful because it was written by none other than Mr. Howard Marks. One of the truisms of markets is that "what goes up must come down'. Over a period of time, these movements become part of a larger pattern and are often identified as cycles. In his book, Haward Marks clearly articulates why being attentive to cycles is one of the most important things for an investor. Even though the concept of macroeconomics is usually ignored when valuing a company, having an understanding of it helps evaluate a company better.
Mark believes that while cycles may arise from external events, they are more inclined to be influenced by the ups and downs of human psychology and the results of human behavior. Writing in a clear, lucid, and engaging manner, the book provides invaluable insights into the concepts of market cycles, their occurrence, and how an investor can profit from them.
THE NATURE AND IMPORTANCE OF CYCLES:
We live in a world that is prepared by randomness and is strongly influenced by both domestic and global events. Add to that the behavioral biases of investors, and we have a recipe for erratic movements. However, as you observe these movements over a period of time, you will see the emergence of a pattern that moves from excess to correction and then from correction to excess. One of the biggest contributors to the formation of cycles is human behavior. Investor psychology tends to swing like a pendulum, swinging from extreme pessimism to extreme optimism.
Consequently, most positive trends eventually reach excess, and those excesses eventually correct on their own or are corrected. Over a period of time, this becomes a cycle, and the ability to reasonably identify the stages in the cycles can be very profitable for an investor. "Mean Reversion", a concept well known among students of mathematics, science, and economics, holds similar values and importance when markets are concerned. Cycles tend to follow this universal rule of "reversion to mean" and oscillate around the midpoint, even if they are intermitted cycles in a secular trend.
The interdependency of the global markets teaches a keen observer that the events in the life of a cycle shouldn't be viewed merely as each being followed by the next but, more importantly, as each causing the next. It is important to recognize the dependability of the cyclical patterns of extreme optimism and pessimism as two sides of the same coin. Even though the underlying dynamics are usually similar, the timing, duration, speed, and power of the swings, and most importantly, the reasons and impact, vary.
RISK: JUST AN ADJECTIVE?
It wouldn't do justice if I talked about markets and ignored what adds that spicy flavor to the markets: risk. The basic essence of investing is bearing risk in pursuit of profits. It is the downside that should be handled. The upside takes care of itself. There is a Gujrati saying that goes like, "Teji me sab ka bol bala aur mandi me sab ka muh kala". It basically translates to, "Everyone pretends to be M.S. Dhoni on their own field, but in the stadium, there is only one MS Dhoni". "Risk" is the main moving piece in investing. At any given point in time, the way investors collectively view risk influences market sentiment and shapes the trend. I'll give you a perfect example of this. During 2020, Indian markets went down by 30%, and even during this turmoil, it only took 2 months for our markets to recover and 6 months to break the previous high. Risk is just a perception, and it varies from person to person depending on their behavior and experience. That's why a precursor to becoming an investor is to become a student of history and psychology.
THE UNFOLDING: On the way up, as the economic fundamentals start to improve and earnings increase and start to beat expectations, optimism starts seeping into the markets. The media reports only good news, further fueling this optimism. The rise in inflation is compared to two years ago's inflation numbers, and this acts like validation for the markets. As a result, expectations rise, investor psychology strengthens, and people perceive only favorable developments. The Baader-Meinhof phenomenon gets activated. This goody-goody environment inflates asset prices, capital becomes readily available, and investors or speculators start embracing more risk. When even a taxi driver asks your opinion on Reliance Share, celebrate, my friend, because you have discovered the point of exiting the markets. However, at a certain point, people are highly euphoric and tend to throw caution to the wind.
Which is why, when prices start declining, most investors are taken by surprise. On the way down, economic fundamentals start deteriorating, and earnings decline and fall short of expectations. In this situation, the media only reports bad news, fueling this bear market. You get the point.
TYPES OF CYCLES:
1. The Economic Cycle: Economic cycles are self-explanatory. Here, the focus should always be on long-term economic trends. Most of the cycles that attract investors attention consist of oscillations around a secular trend or central tendency. While those oscillations matter a great deal to companies and markets in the short run, changes in regard to the underlying trendline will prove to be of much greater significance. The economic cycles can have profound effects on some companies' sales but less on others. This is primarily due to differences in operating and financial leverage. Some respond a lot, while others respond just a little. Understanding a company's financial and operational leverage can help investors identify the best companies in each phase of a cycle.
2. The Credit Cycle Credit is the lifeline of an economy. No economy can function without the availability of credit, let alone flourish. Credit is like oxygen to the economy, and one can imagine what happens when it dries up. It takes only a small fluctuation in the economy to produce large fluctuations in the availability of credit, which have a great impact on asset prices and, subsequently, the economy itself.
3. The Distressed Debt Cycle: The hype caused in the markets persuades the lenders of capital to do dumb things as well. Lenders start neglecting the best lending practices. They finance "less deserving" borrowers, borrowers whose credit scores are as low as Pakistan's self-esteem, and accept weaker debt structures. Many bonds that are issued lack the required margin of safety, indicating that they won't be able to be serviced if the general economic conditions worsen. The crash of 2008 was fueled by these types of loans. Loans that were called subprime, became a significant part of the lender's balance sheet. Innovative loans like "NINJA" loans were distributed. NINJA loans are an abbreviation for loans given to people with no income or job. This 'unwise' extension of credit can offer interesting investing opportunities.
4. The Real Estate Cycle: Up until this point, you might have figured out that cycles can emerge in any asset class. Real estate is a much-favored asset class among investors, as many believe that it has a myriad of benefits, chief among them being its ability to serve as a hedge against inflation. What people eventually learn is that regardless of the merit behind these statements, they won't protect an investment that was made at too high a price. "Price is what you pay, and value is what you get".
Putting it all together, this book talks about identifying these cycles and trying everything to get the odds in your favor. The greatest profits come from seeing things better than others do, and if cycles were totally dependable and predictable, there would be no such thing as superiority in seeing them. The whole idea behind studying cycles is about how to position your portfolio for the possible outcomes that lie ahead. Positioning and selection are the two main tools in portfolio management. The formula for investment success should be considered in three main pairs:
1. cycle positioning and asset selection.
2. Aggressiveness and defensiveness
3. Skill and luck
"In investing, there's a complex relationship between humanity and confidence. "Success isn't good for most people". It changes people, and usually not for the better. Everything that produces unusual results and profitability will attract incremental capital until it becomes overcrowded and fully institutionalized, at which point its prospective risk-adjusted return will move towards the mean (or worse)". Howard Marks.
HOW TO STACK ODDS IN YOUR FAVOUR?
Start from reasonable expectations and
............................................................................................................................................. call Utkarsh Bhagwat (8340855678) for further details.
Happy Investing.
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