- You Can't Predict. You Can Prepare.
Howard Marks is a legendary investor whom I admire greatly. He's also a phenomenal writer. If you don't read Howard Marks's quarterly memos, you should drop everything and go spend the entire weekend reading his work.
Tech stocks have been getting some pounding lately while Bitcoin hit another all-time high. I think it's a good time to reflect back on one of Marks's past memos where he talks about cycles and how to better prepare for them.
The Three Stages of a Bull Market 🐂
- First stage: Only a few unusually far-sighted people could imagine the possibilities of improvement, it's hard to think about improvement when the economy is down
- Second stage: Most people accept improvement is taking place, you could see on the news every day
- Third stage: Everybody believes that things can only get better forever. That's when the market reaches it's top.
- If you could buy in the first stage, when no one is optimistic, prices will be low and you could get a good bargain. But it's hard when there's little optimism in the world
- If you buy in the third stage when there is optimism everywhere, you'll pay high prices because the optimism will contribute to high prices. And when some negative events does occur which is inevitable eventually, then your high asset prices will be very vulnerable
Cycles in general 📊
- Cycles are inevitable. Every now and then, rallies and corrections go to great extreme and people start to say "this time is different", citing the new changes in technology or behaviour. And then it turns out that the old rules do still apply - most phenomena turns out to be cyclical.
- Cycles' clout is heightened by the inability of investors to remember the past. With the new young generation coming into the financial and economical world, they don't recognize the recurring patterns in the market thus giving the cycles it's inevitability.
- Cycles are self-correcting. The reason they don't go on forever is that trends create the reasons for their own reversal.
- Cycles are often viewed as less symmetrical than they are. Negative price fluctuations are called "volatility" while positive price fluctuations are called "profit". Collapsing markets are called "selling panics" while surges are described more kindly.
No one knows when the bubble will burst, that's why it's important to get a sense of where we are in the cycle. You can't predict but you can prepare. Based on where we are on the cycle, you can take action to reduce the exposure in your portfolio. Now you'll likely do it too early but would you rather be too early or too late? As long you're not trying to do something extreme, it's always wise to be early.