Howard Marks’ latest sharing: The investment cycle turns with the rhythm of the bull market

Howard Marks, co-founder of Oaktree Capital, pointed out in a recent article that psychological factors have a significant impact on investor decision-making, which can largely explain why the market fluctuates. The following is an excerpt from his latest investment memo, Bull Market Rhymes:

As an investor, I have been through several important cycles. However, when I was about two-thirds of the way through my last book, a question hit me that I hadn’t considered before: Why do we have cycles?

After thinking about this for a while, I found what I think is an explanation: transition and correction. If the stock market is a machine, it’s reasonable to expect it to perform consistently over time. On the contrary, psychological factors have a significant impact on investor decision-making, which can largely explain why the market fluctuates.

Everyone knows (or should know) that after a parabolic rise, the stock market typically falls 20% to 50%. However, these rallies continue to occur and recur, fueled by skepticism.

Bull markets, by definition, are characterized by exuberance, confidence, gullibility, and a willingness to pay high prices for assets—all prices that have proven exorbitant in hindsight in retrospect. History generally shows that all things should be kept in moderation. Because of this, the theoretical or emotional underpinnings of bull markets are often based on new things that history cannot judge.

Think FAAMGs (Facebook, Apple, Amazon, Microsoft, and Google) with unprecedented market dominance and the ability to scale.

FAAMG’s dramatic performance in 2020 caught investors’ attention and turned from generally supportive to broadly bullish. In September 2020, the stocks have nearly doubled from their March lows and are up 61% from the start of the year. It’s worth noting that these 5 stocks are heavily weighted in the S&P 500, so their performance has also contributed to a good overall gain for the index, but it distracts from the underperformance of the other 495 stocks force.

Or we can take another look at cryptocurrencies. Bitcoin has been around for 14 years now, but it has only been in most people’s consciousness for about 5 years. It fits with economist John Kenneth Galbraith’s skeptical description of the type of financial innovation in bull markets, while previous generations were considered “unappreciative.” Bitcoin price surged sharply from $5,000 in 2020 to a high of $68,000 in 2021, before falling back to around $24,000 this year.

The astonishing performance of cryptocurrencies and “super stocks” and tech stocks in general over the past two years has added to the general optimism among investors, allowing them to ignore concerns about the persistence of the outbreak and other risks.

It is risk aversion and fear of loss that keep markets safe and sane. But when a bull market heats up, caution, selectivity, and discipline tend to be sidelined. Bullish sentiment tends to exaggerate the virtues of bull market winners. This pushes the price of the security too high, and since this upward trend doesn’t last forever, it becomes vulnerable.

We often see negative fundamental developments persist for a period of time without any reaction in security prices. But then there is a tipping point – either fundamentally or psychologically – all of which is suddenly reflected in, and sometimes exceeds, prices. And stocks that rose the most in up years tended to fall the most in down years.

Some people may think that asset prices are related to fundamentals, but this is not the case. If market prices are determined by smart investors’ consensus based on fundamentals, why have many once-boom tech/digital/innovation stocks dropped such a large percentage in recent months? Do you really believe that many businesses have lost more than half their value in this short period of time?

The price of an asset is formed based on fundamentals and people’s perceptions of those fundamentals. Changes in asset prices are based on changes in fundamentals or changes in people’s perceptions of those fundamentals. Attitudes towards fundamentals are psychological as well as emotional, are not subject to analysis or forecasting, and may change faster and more dramatically than the fundamentals themselves.

All the market trends I’ve discussed have nothing to do with fundamental developments. Rather, their causes are largely psychological, and the ways in which psychology is affected are unlikely to be arbitrarily altered. This is why I believe that as long as humans are involved in the investing process, we will see these trends appear again and again.


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