Howard Marks came out with a new memo to clarify the last memo he wrote. His latest is a good example of how people – the media – interpret what is said about the markets and reduce it to all or nothing decisions. It never is.
The all in (out) mentality reminds me of a gambler on tilt. They let their emotions drive their decision until they eventually bet everything and walk away from the table with nothing. And yet, investing gets reduced to this binary view too often (which probably has more to do with the misperception people have of investing in general).
The key word is “calibrate.” The amount you have invested, your allocation of capital among the various possibilities, and the riskiness of the things you own all should be calibrated along a continuum that runs from aggressive to defensive.
Investors’ actions should be governed by the relationship between each asset’s price and its intrinsic value. “It’s not what’s going on; it’s how it’s priced… When we’re getting value cheap, we should be aggressive; when we’re getting value expensive, we should pull back.”
Capital allocation – as a stock picker or an asset allocator – is like turning a dial that ranges from 25% to 75% based on changes in risk and opportunity. You’re never all out or all in. You’re partially in (out) all the time.
The hard part is figuring out where things stand in the market. Where are we in the cycle? The answer to that helps to decide whether to adjust the dial.
As I say regularly, “We may not know where we’re going, but we sure as heck ought to know where we stand.” Observations regarding valuation and investor behavior can’t tell you what’ll happen tomorrow, but they say a lot about where we stand today, and thus about the odds that will govern the intermediate term. They can tell you whether to be more aggressive or more defensive; they just can’t be expected to always be correct, and certainly not correct right away.
The person who said “there is no better or worse time” was on TV with me, giving me a chance to push back. What he meant, he said, was that the vast majority of people lack the ability to discern where we stand in this regard, so they might as well not try.
I agree that it’s hard. Up-and-down cycles are usually triggered by changes in fundamentals and pushed to their extremes by swings in emotion. Everyone is exposed to the same fundamental information and emotional influences, and if you respond to them in a typical fashion, your behavior will be typical: pro-cyclical and painfully wrong at the extremes. To do better – to succeed at being contrarian and anti-cyclical – you have to (a) have an understanding of cycles, which can be gained through either experience or studying history, and (b) be able to control your emotional reaction to external stimuli. Clearly this isn’t easy, and if average investors (i.e., the people who drive cycles to extremes) could do it, the extremes wouldn’t be as high and low as they are. But investors should still try. If they can’t be explicitly contrarian – doing the opposite at the extremes (which admittedly is hard) – how about just refusing to go along with the herd?
I believe this something we can all learn through experience. It takes time. But it also takes a willingness to almost always look wrong because the timing will never be perfect.
And that is why you’re never all in or all out. By always being partially in you never miss out on gains. You never feel the full brunt of the losses either. But it only works if you’re willing to forfeit some return in advance.
The memo is also a great example of revisiting the facts and changing your mind – specifically on crypto currency. It’s worth a read if you’re interested.
I don’t understand crypto-currency well enough to get involved in it. There seem to be way more questions (risks) than answers. But that’s typical of the “next big thing.”
So when that happens the spotlight sits on the unlimited potential, while the downside gets pushed aside. Much like the internet boom, the ideas behind all those failed companies eventually came to be. So it’s possible that 15 years from now the crypto fans can say, “I told you so.”
It’s also possible that cryptocurrency takes much longer to reach its potential than what’s currently reflected in the price.
So I’m passing. It won’t be the first, or last time, I miss the next “big thing”.
Marks Memo: Yet Again?
- The Four Fundamental Skills of All Investing – M. Housel
- Your Tolerance for Investment Risk Is Probably Not What You Think – M. Statman
- Why is Value Investing is So Difficult? – Behavioral Investment
- Equifax’s Instructions Are Confusing. Here’s What to Do Now. – R. Lieber, Part 2
- Identity Theft, Credit Reports, and You – Kalzumeus
- Ignorance Feeds Curiosity. Curiosity Cures Ignorance. – BloombergView
- Linear Thinking in a Nonlinear World – HBR
- Brain Machine Interface isn’t Sci-Fi Anymore – Wired
- ‘We’re the Only Plane in the Sky’ – Politico