Howard Marks Has A Winning Streak Of Calling The Market. Here’s How He Does It.

Earlier this month, legendary investor Howard Marks wrote in a memo that “Once in a while – once or twice a decade, perhaps – markets go so high or so low that the argument for action is compelling and the probability of being right is high.” Or as Warren Buffett might say: it’s the fat pitch you wait for. And Marks knows more than a little about making big market predictions: the cofounder of Oaktree Capital Management has made five of them in 50 years, and they’ve all proved correct. Let’s take a look at those calls, and how you can make them too.

Marks has made two bearish calls.

The first of Marks’s bearish calls was back in 2000 before the dot-com bubble burst. Tech investors were buying young companies’ stocks at astronomical prices, often very speculatively priced as a multiple of current revenues because those firms hadn’t made any profit. And in many cases, there were no revenues to count either: prices were based on little more than a concept and hope. That bubble burst in early 2000 for, in Marks’ opinion, no other reason than that stock prices had become unsustainably high.

Then, between 2004 and 2007, Marks noted a flood of bizarre deals – think: low returns and high risk for investors – being brought to market. At the time, he’d had many conversations with Bruce Karsh, his cofounding partner at Oaktree, criticizing the state of the market for facilitating such deals. Oaktree wasn’t exposed to the subprime mortgages and mortgage-backed securities that were the main causes of the global financial crisis – Marks’s bearish conclusions about the market outlook were another instance when he accurately called the market.

The key here lies in understanding investor psychology, Marks says. You want to watch for moments when most folks are so optimistic that they think things can only get better. Remember that in extreme times, the secret to making money often lies in contrarianism, not conformity.

And he’s made three bullish ones.

In September 2008, as Lehman Brothers collapsed and the financial crisis unfolded, Marks penned a letter. He wrote that the markets were full of too much fear and too little greed, too much pessimism and too little optimism, and too much risk aversion and too little risk tolerance.

At that time, he boiled his thoughts down to a few takeaways: investor expectations were too low, asset prices were probably not excessive, and investors were unlikely to be disappointed. In other words, it was the epitome of a buying opportunity.

Marks wrote that if Oaktree’s fund managers invested and the financial world melted down, it wouldn’t actually matter what they had done. But if they didn’t invest and it didn’t melt down, Oaktree wouldn’t have done its job. So they bought into the falling market every month through to the end of the year.

Then, again in March 2012, poor stock market performance had led to investor disinterest, and that disinterest perpetuated the poor performance, creating one of the vicious cycles we see in markets from time to time. At that point, Marks wrote about thinking like a contrarian: that the extreme pessimism for stocks could mean it can’t get any worse. In that case, you could assume low stock prices would give way to future gains, not continued flatlining. And again, Marks’s fund bought stocks.

Finally, Marks made a call during the extreme pandemic uncertainty in March 2020. Here’s what he knew: there was a pandemic underway, the US stock market was down by a third, and the amount of cash in money market funds had increased substantially. Now, that didn’t tell him anything about the fundamentals, but the outlook for eventual market performance had improved. See, the more investors sold stocks, the less they had left to sell – and the more cash they’d have to use when they eventually became more optimistic. Again, Marks stepped in and bought stocks.

But even a powerhouse like Marks acknowledges that buying when markets are flooded with pessimism and fear isn’t easy. In fact, he said buying stocks in March 2020 was one of the biggest challenges of his career.

Here’s how you can make market calls like Marks.

You should avoid making general macro calls too often – five times in 50 years is about right. That said, you’ll need to make estimates about future earnings and asset values to pick stocks. Oaktree’s method here is to assume the future macro environment will resemble past norms, with a margin of error included in case the climate gets worse.

To take the temperature of the market, Marks says you have to look at an entire string of events and figure out what happened, whether a pattern has repeated, and what lessons could be learned from it.

You need to understand the market cycle: your best chance to nab a bargain will come from overly prevalent negative psychology, and the greatest opportunities to sell at too-high prices will arise from excessive optimism. Bear in mind, much of what happens in economies and markets doesn’t come from any mechanical processes, but from the to and fro of investors’ emotions. And remember that in extreme times, the secret to making money lies in contrarianism, not conformity – so you’ll need to get used to resisting emotional impulses.

You may have noticed that the first of Marks’ five calls was made back in 2000, and by that time, he’d already been working in the investment industry for more than 30 years. Of course, that doesn’t mean those first three decades were completely flat. Marks says it takes time in the field – and some scars – to develop the unemotional stance and contrarian approach needed to depart from the herd.

Oaktree doesn’t pride itself on trying to spot the market’s bottom: the lowest point before a recovery is essentially impossible to predict. Instead, it simply buys if a stock looks cheap, and buys more if it starts to look even cheaper.

And finally, Marks believes you should invest in line with your own risk appetite – so find the balance between aggressiveness and defensiveness that’s right for you.