Howard Marks released his latest memo this week and Seth Klarman’s letter was leaked last week.
Marks’ Memo, titled “Political Reality Meets Economic Reality” covers just that. He spends the time on the second and third order consequences on two worrying trends in politics: tariffs and anti-capitalist sentiment.
Politicians perfected the offer of easy solutions to complex problems because they want soundbites that quickly get you to “yes.” Diving into second and third level consequences ruins their soundbite and puts votes at risk.
The memo is worth reading for Marks’s balanced take. I’ll add that the Appendix on “The Tax System Explained in Beer” is not to be missed.
While there are ways in which the system can be improved, I consider it problematic when people denounce capitalism without acknowledging its benefits. It’s ironic to think of politicians criticizing the capitalist system via platforms like Twitter and Facebook (accessed on their iPhones); at rallies reached via airlines and cars (perhaps employing ride-sharing services such as Uber); in meetings over a Starbucks coffee; and via cable news networks. All of these innovations that came out of a system that encourages people to take significant risks to start companies on the premise that they’ll reap the rewards of ownership if their businesses succeed.
I’m sure if they thought about it, the list of innovations these people wouldn’t want to live without — ranging from drugs to consumer products, to services, to technology — would be a long one. Which of those would we have today if not for the profit motives and the possibility of ending up with accumulated wealth? And in the absence of those expectations, to whom would we look for the innovations of the future? How’s the record of non-capitalist countries such as the U.S.S.R., Cuba, and Venezuela in this regard?
A great deal of America’s economic progress has resulted from people’s aspiration to make more and live better. Take that away and what do we have? The people at the bottom won’t have as many at the top to resent. But without the contributions of those who aim for the top, everyone will have less to enjoy… This is why I worry about the rise of negative sentiment toward capitalism and antipathy toward those who succeed under it.
Politicians, depending on their ideology, can pose simple questions that suggest simple solutions to the problems people face…
For many people, it’s easy to answer “yes.” The benefits from doing these things are obvious. Who would oppose them?
But it turns out they aren’t such easy questions, since economic reality shows them all to have downsides that just might exceed their upsides…
One of the key elements running through economics is its complexity: there are few decisions that face us that aren’t multivariate and that are free of second- and third-order consequences. Thus we shouldn’t take actions — like imposing tariffs — just because they offer potential benefits, without considering their costs. And we shouldn’t condemn things — like capitalism — solely because they’re imperfect, without taking into account their benefits.
Go read the rest of the memo here: Memo: Political Reality Meets Economic Reality
Klarman’s letter leaked last week and a copy was passed around online. You may still be able to find a copy with a Twitter search. Klarman covers similar concerns as Marks on the global economy and politics, which I won’t rehash. He starts off with the reminder that markets are unpredictable and what to do about it:
It’s always hard to know why the market does what it does. That’s part of the ever-interesting challenge we face in traversing the twists and turns of fluctuating prices and evolving fundamentals. On any given day, the sheer number of players, behaviors, economic factors, and business developments defy anyone’s ability to fully grasp what is going on and why. That’s why we develop and follow a game plan that does not purport to tell us what to do moment by moment, but rather is intended to help us successfully navigate the most challenging tumult. This is the essence of value investing.
At periods of maximum turbulence, stock and bond markets come to resemble commodities markets. Capital whips into stocks and out of bonds, or vice versa, as pension funds, mutual funds, hedge funds, algorithmic traders, and asset allocators rebalance their holdings. Our perpetual challenge in such markets is to rely on our acumen and analytical capabilities, while keeping our emotions under control and maintaining a long-term perspective.
Klarman points out that markets are highly levered, not only financially (low-quality leveraged loans and low-grade bond issues hit record levels the past two years) but psychologically causing complacency:
One factor propelling psychological leverage higher in recent years has been the relentless diminution of market volatility. Economist Hyman Minsky famously put forward the idea that stability itself could be destabilizing. Individuals, professional investors, and financiers are prone to project their own recent experiences into the future. So when adversity is absent, investors become complacent. They assume good times will continue and they grow careless about risk, perceiving it through rose colored lenses. When incurring greater risk starts to seem not only riskless but beneficial, they stretch even further.
And most people have never experienced a bond bear market before and history might not be a helpful guide either:
…many of today’s market participants have never experienced a bear market in bonds. The riskiness of their exposures may surprise them. And because marketplace conditions have evolved greatly over the last three decades, when we do eventually enter a fixed income bear market, neither historical correlations nor prior experience are likely to provide much guidance for how to successfully navigate this treacherous terrain.
Finally, he offered a baseball analogy for the proper mindset of a long term investor:
Consider the plight of a relief pitcher. Historically undervalued, unappreciated, often used interchangeably with other relievers, and, until recently, low on the major league pay scale. Required to be ready throughout most games at only a moment’s notice. And the role comes with the possibility of major psychological trauma. Few remember the slugger who grounds into a double play in the fourth inning, squandering a one-out, bases loaded opportunity. But everyone knows who gave up the gopher ball with the game tied in the bottom of the ninth to lose in a walk-off.
And that’s only the prelude. The really hard part is psychological, and comes in that pitcher’s next outing. The only logical, yet psychologically challenging, thing for the reliever to do is let it go and forget it happened, even if his teammates, manager, and fans seem possessed by an indelible and bitter memory that flashes before their eyes as he heads in to the mound from the bullpen.
In this way, a reliever has much in common with an investor. When you make an investment and the price drops, the key is to see the fall in price as not necessarily indicative of a past error or failure (no one, after all, can predict the daily meanderings of the markets), but as an opportunity. It’s not a doover – what’s done is done – but it is a fresh chance to make another good investment, potentially an even better one now that those shares are lower in price. As we’ve said before, the key in investing is to see the market’s fluctuations not as a source of feedback, a report card if you will, but as a potential driver of opportunity…
We have known many people who find the daily report card the market hands them a source of consternation and even anxiety. If the stock they recently purchased falls in price, they feel like they failed. Had they waited after all, they could buy more shares for the same capital invested. But in investing, it’s necessary to experience those price drops and see them as a source of further and greater opportunity and not as a problem. Similarly, price gains should not be experienced as a pat on the back from the market. They represent a diminution of opportunity to buy at the right price, though they do offer the potential to sell at a much fuller valuation.
We wish we had perfect market timing (as well as the ability to fly). The reality is that no one does or ever will. The key is to find a way to care about one’s investment results over time, but to not feel burdened by the daily fluctuations of Mr. Market. The only way to invest, after what you purchased has fallen in price, is to be that successful relief pitcher. Put yesterday’s outcome out of your mind, get back on the mound, and make the best decision you can today with all the information at hand.
- Worried Faces – Above the Market
- How to Invest for the Long-Term in a Turbulent Market – Behavioral Value Investor
- The Case Against Value Stocks – Validea
- Who Owns All the Stocks and Bonds? – A Wealth of Common Sense
- Origins of Greed and Fear – M. Housel
- The Single Greatest Error – Irrelevant Investor
- Getting Ahead By Being Inefficient – Farnam Street
- One Big Thing – Of Dollars and Data
- Opportunity Costs Just Went Up – S. Godin
- Populism + Weakening Economy + Limited Central Bank Power + Elections = Risky Markets and Risky Economies – R. Dalio
- How I Choose What to Read – D. Perell
- The 500 Year Long Science Experiment – The Atlantic