Howard Marks explains how to avoid crashes by learning to recognize the signs of bull market excess
Oaktree Capital founder Howard Marks is a bold name on Wall Street, equally known for his company’s performance as well as lengthy investor letters that he periodically publishes free of charge on the Internet to reach as wide an audience as possible.
With stocks plummeting earlier this month, Marks — who built one of the most successful distressed debt funds in recent history with Oaktree — took to the financial press to offer some words of caution. A year earlier, Marks honestly warned investors that seemingly boundless market optimism was spiraling out of control.
In the months that followed, Marks once again proved correct, reminding his audience of why Warren Buffett once described his memoirs as a “must read” for anyone interested in the markets.
So, in keeping with his often counter-cyclical approach, Mark decided to explore the psychology behind bull markets at a time when stocks were standing on the edge of bear market territory.
In his latest book on investors, Bull Market Rhymes, Marks—who began his career in finance before bull markets and bear markets as having moved 20 percentage points in either direction—explained, that the “emotional core” of a bull market has nothing to do with the size of a bull market. movement, it is more about group psychology.
Old school, bear market
Before the pandemic relief hysteria spread, Marks argues that the latest real bull market was the internet boom of the late 1990s and early 2000s. Although stocks surged during the run-up to the Great Financial Crisis, the market in those days was only moving gradually, lacking the distinctive tone of unbridled optimism.
Marks said that bull markets are best described by how they feel, the psychology behind them, and the behavior that psychology leads to. The same is true for bear markets: “Does it really matter whether the S&P 500 is SPX
Decreased by 19.9% or 20%? My best old-school definition of a bear market: nerve exhaustion.”
To set the objective tone of his observation, Marx began with one of his favorite sayings, quoting Mark Twain: “History does not repeat itself, but it rhymes.”
With this in mind, Marks delved into what he described as the three stages of a bull market: During the first stage, a few forward-looking investors bet that things would get better. During the second period, more investors realized that fundamental improvement was already underway. And in the final stage, almost all investors believe that the last period of buttery returns will last forever.
One of the things that has distinguished the bull market associated with the pandemic away from the internet boom and other periods of hysterical optimism is that there has been basically no first stage, and very little second stage. Instead, “many investors went straight from hopeless in late March to highly optimistic later in the year.”
Super Stocks, Cryptocurrencies, SPACs
Marks added that emerging markets do not treat all stocks the same way. Instead, investor optimism typically gathers around a handful of “super stocks” — whether it’s the 1960s “Nifty Fifty”, or “FAAMGs” — a term for big tech stocks like Facebook Inc. FB,
Parent Meta Platforms Inc. and Google GOOG, a subsidiary of Alphabet Inc. ,
That underpinned a lot of market gains over the past decade (before driving stocks lower over the past few months).
This time around, the topic of “super-equities” was complicated by the rise of cryptocurrencies, which introduced a new wrinkle to an old dynamism by amplifying investor hysteria as millions chased the unprecedented returns enjoyed by the original crypto investors. The advent of the fee-free brokerage accounts heralded by Robinhood Markets Inc. HOOD,
Another innovation that distinguishes this market, Marks and others said.
While the 2020-2021 bull market had many unique characteristics, there were also features reminiscent of previous bull markets as well. Chief among these was the crushing of public offerings that included unprofitable companies. Relatively rare before the dotcom boom, this became increasingly common during the dotcom explosion and again recently as the SPAC boom offered investors what seemed like a “no-loss proposition” (in which investors were guaranteed to get a refund with interest if regulators failed to completion of a deal, or if investors do not like the deal they have chosen).
This idea is among the most dangerous in the investing world, Marks said, and it’s a reliable sign of hysteria.
Today, the average SPAC that completed the process over the past two years is trading at just $5.25 per share, compared to the standard SPAC offering price of $10. Sometime between then and now, investors have seen their rational fear of losses become fully absorbed by the fear of being lost; This is often the last – and most dangerous – phase of an obsession-led bull market. The primacy was reinforced by the “big idiot theory”: the idea that even if prices didn’t make sense, eventually someone would be willing to pay more.
Toward the end of his remark, Marx summed up his thinking with another popular proverb: “What a wise man does in the beginning, a fool does in the end.”