This month, I took the time to read all 8 of Howard Marks’s letters to investors (memos) and summarize them for the average investor.
Hopefully you find these lessons to be instructive, and that they make you a better investor.
I also highly recommend reading these memos yourself—we’ve included the links at the end of each section. This post will summarize the following letters:
- Selling Out
- The Pendulum in International Affairs
- Bull Market Rhymes
- Conversation at Panmure House
- I Beg to Differ
- The Illusion of Knowledge
- What Really Matters?
- Sea Change
The first letter we will look at is from January 13, 2022, about one of the toughest decisions that investors have to make.
This memo is all about when to sell.
Howard Marks observes that investors tend to sell for two reasons:
- Because a stock has gone up in price
- Because a stock has gone down in price
Either reason, in reality, is a poor reason to sell.
What investors should really think about is the underlying asset itself; in other words, the business which a stock represents.
As Marks relates about his conversation with his son, investors should be slow to sell a stock even if it becomes a large concentration of a portfolio.
It’s a good idea, for a couple reasons:
- Investors tend to only get a few great ideas over a lifetime
- Selling a good stock comes with two hard decisions: when to sell, and what else to buy
In fact, it is the emotional side of investing that drives people to sell.
We REALLY don’t want to feel emotions of regret and embarrassment. So we’ll sell a stock to “lock-in the gains”; to avoid the embarrassment of seeing unrealized gains disappear.
We feel the WORRIES of watching losses compound, especially as a stock continues to fall. See enough unrealized losses, and greener pastures look better and better.
Instead of succumbing to emotions, we should flip our mindset.
The greatest compounders of wealth come from wonderful businesses with iron-clad moats.
These are hard to find.
They will, by definition, have the most gains and most opportunities to take profits.
Remember the words of Howard Marks’s son. As long as a business has not fundamentally changed, it still has great potential, and you’re in it for the long term—then selling just because a stock has swelled doesn’t make much sense.
Now you also don’t want to build a one-asset portfolio, which is too risky. So there is some balance if you really find a massive compounder.
In that light, Marks concludes that the right answer for when to sell comes down to subjective judgement…
In other words, it depends.
2—The Pendulum in International Affairs
Howard Marks admitted that he is obsessed with pendulums. Many things in our world swing on pendulums instead of cycles.
A great example is regulation versus free markets.
When laissez-faire capitalism goes too far, like in the Great Financial Crisis, heavy regulation often follows. That can cause its own adverse effects in an industry, leading to deregulation again (will we see loosening in the banking industry after the 2023 crises??).
Similarly, we may be seeing a pendulum swing in globalization.
It’s important to note this memo was written in March 23, 2022, in the thick of a fresh conflict in Ukraine against Russia.
Europe became so dependent on Russian energy, making effective sanctions hard. The EU got 47% of its natural gas from Russia in early 2021, compared to just 30% in 2016.
A similar offshoring happened with American companies and low-cost Asian countries.
This contributed to ultra-low inflation from 1995 (when China really entered the game) to 2020. We saw just a 1.8% annual growth to Personal Consumption Expenditures (PCE) from 1995-2020.
After the pandemic snarled supply chains, we are seeing a resurgence in manufacturing onshoring.
Is the offshoring pendulum swinging the other way?
We could face a new era of persistent inflation, and a rebirth of the middle class, if that’s so (my thoughts, not Howard Marks). I find it interesting that he mentions a similar “offshoring” inside the U.S. happened, with factories gravitating to low-cost areas when the railroads were built. If you notice, a long period of declining interest rates followed.
A chart of long term interest rates in the U.S. is quite constructive (looks like a pendulum you might say?)
Note how the various time periods of American history happened to be characterized by the changing of the pendulum in interest rates:
Anyways, Howard Marks makes an astute conclusion.
It makes sense to why we see these pendulums.
Everything in economics involves tradeoffs. There’s no perfect solution to anything. So, because there are no perfect, permanent solutions, this is why we have swinging (always moving) pendulums.
3—Bull Market Rhymes
We often forget that the stock market is very emotional. Because it is made up of people, the psychology of people drives prices to excessive extremes.
The 2020 – 2021 boom and 2022 bust is a cycle that Howard Marks has seen over and over again.
During a bull market, when prices are high, investors throw caution to the wind. As Marks puts it, the fear of missing out overrides the fear of losing money.
Investors’ perceptions of company fundamentals can drive stock prices more than the fundamentals themselves.
It’s just human psychology.
The most important thing about bull market psychology, as stated in the memo:
Most people take rising stock prices as a positive sign of things to come.
After a year (2021) of rocketing crypto prices, technology stock dominance, and unprofitable IPOs (and SPACs) galore, bull market psychology finally fell back to earth.
Fund managers who happened to be overweight tech became famous overnight, only to see harsh reversals in 2022. Many are now underwater. If 2000 – 2002 is any useful allegory, there could be more pain to come.
The lesson in the memo?
Bull market psychology is a natural part of the cycle.
It will happen again as long as humans are the ones making the decisions.
“This time is different” continues to be the 4 most dangerous words in investing.
4—Conversation at Panmure House
This memo was actually a transcript of an interview and Q&A done with Howard Marks at an inaugural symposium on the subject of cognitive economics at Edinburgh Business School.
If that sounds like a lot to digest, the conversation went really into the weeds as well!
The interviewer, Patrick Schotanus, and Howard Marks went down the rabbit hole about some of the most controversial topics in finance, including the efficient market hypothesis and active versus passive investing.
These are very nuanced discussions, so I recommend reading the memo for yourself.
That said, it becomes clear that Marks has studied the market intensely over his 3+ decades of real world experience in managing money.
Simply, there are themes that have been prevalent in many memos of his.
The market has cycles. The economy swings like a pendulum, as do investor emotions (i.e. psychology). We can learn these lessons by respecting history and reading things like Marks’s book Mastering the Market Cycle.
Marks warns that there doesn’t seem to be a clear path to becoming a successful active investor today, especially with the wide access to financial information made possible by the internet.
He lands on two ideas for who can be successful:
- An investor who can see the future better than others
- An investor with superior qualitative analysis
These are just theories, coming from an investor who beat the market himself over decades.
But if the so-called “easy” period for value investing is over, then we should all take a cold, hard look at if active investing is really right for us.
5—I Beg to Differ
Investors often want to have their cake, and eat it too.
But investors trying to beat the stock market have an unavoidable reality to confront. Trying to beat the market is a zero-sum game. For every $1 that is made by beating the market, someone else on the other side of the trade has lost $1 by underperforming the market.
The only truly positive sum game in the market is made by passively holding an index fund, and participating in the growth of the overall economy.
Yet too many investors look for the mythical holy grail.
They want a strategy that beats the market, and never loses.
But to beat the market, you must have an opinion that’s different than the market’s. And that means taking a risk that if you’re wrong, you will be on the losing side.
It’s typical for a market-beating strategy to underperform the market at times.
Investors try to avoid this scenario, but it is part of the game.
Howard Marks thinks investors need to recognize this reality, and honestly assess whether they have the mental fortitude to accept it.
By definition—it’s not for everyone.
You have to be a second-level thinker. You have to have better judgment than the crowd’s. And you have to be, as Marks said, “temperamentally equipped to do these things.”
Tough pill to swallow for anyone working in this field.
6—The Illusion of Knowledge
This memo is about macro (or “macroeconomic”) forecasts. And how useless they are.
Howard Marks makes some convincing points on why macro forecasts are essentially impossible to be correct.
Just think about how many moving pieces there are in the economy.
The economy is made up of people, and people do things for all sorts of reasons.
Imagine you were trying to build a model to assess the effects of people receiving $300 of disposable income. Or how they will adjust their spending if manufacturer A raises its prices, or manufacturer B lowers them.
Take Apple as an example—you’d think that a rational human would buy the smartphone that’s so much cheaper than an iPhone, yet what do millions of people do every year instead?
And then let’s say you could even somehow model the behavior of 1 million people.
You’d have to then make many more similar forecasts correctly.
Say you had a pulse on what the economy was doing. Then you’d need to know its effect on future interest rates. Then how it would affect one industry versus another. Then the best performer in that industry based on your view of the future.
Even if you were able to get more than 50% of your forecasts right (a fantastic batting average!), you’d then need to be right multiple times in a row.
The probabilities of that are very low!
Then you have “black swan” events, which are wild and unexpected occurrences… where the past gives us NO help in predicting them…
You just have too many ways forecasts are wrong. Good luck investing with them.
Instead, be an investor who says “I don’t know.”
And invest with a margin of safety, knowing that the future is uncertain, and mitigating that risk by the way you invest.
7—What Really Matters?
As the title says, Howard Marks reviews some of his previous memos from 2022, and highlights some of the major themes he’s hit on again and again.
A few to remember:
- The trading mentality: leads to speculation. Buy an asset because you want what it produces
- Short-term events or performance: ignore the noise
- Volatility: it is not a good measure of risk
- Frequent trading: as much as you can, avoid touching your portfolio
Of the things that do matter, Marks recommends focusing on:
- Your performance over the next 5 or 10+ years
- Finding superior insight, which is needed for superior performance
- Look at investing as participating in the growth of businesses and economy
Howard Marks has seen a few fundamental changes in the investing industry – what he calls “sea changes.”
One was the accepted idea of tying risk with reward.
It may sound weird to think about for newer investors, but the idea that more risk is generally needed for more reward was not much acknowledged when Marks first started in his career.
Today’s investors have a new mindset: take appropriate risk for adequate reward.
That’s a new development.
Another sea change was 40 years of declining interest rates, starting from around 1982. This interest rate environment helped drive so much economic progress, in more ways than meets the eye.
Today, because of the Fed and inflation and many other economic factors, we might be seeing a reversal of that trend. Marks emphasizes that he isn’t making bets with investor capital on this idea.
But it could be something that the investing world is being slow to pick-up on.
As Marks said (talking about the declining interest rate period versus today):
“It should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.”
This might make interest rate “risk management” a decent idea for the average investor to consider moving forward.
Andrew has always believed that average investors have so much potential to build wealth, through the power of patience, a long-term mindset, and compound interest.