Novel Investor

Compounding investing wisdom...

Happy Hour: Riding the Credit Cycle

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With rising interest rates, debt seems as good a candidate as any to cause the next downturn. How severe?

It depends on the rate and severity of interest rate hikes and inflation. It could be drawn out or sharp. My Magic 8-Ball doesn’t have the answer and neither do I.

None of this exists in a vacuum either. Interest rates, inflation, asset prices exist in a web of factors where changes in one have a multitude of possible effects on the others. And then you add humans to the mix. Spending a ton of energy trying to figure out what happens next seems like a wasted endeavor. But that’s just my take on it.

Besides, this post has more to do with where we are in the credit cycle, so we better understand the risks.

Howard Marks, in a 2001 memo, broke down the credit cycle like this: Continue Reading…

Howard Marks: The Perversity of Risk

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The “Illuminated” edition of The Most Important Thing by Howard Marks is filled with great commentary from other investors throughout the book.

Except, when you read it for the first time it can be a bit disruptive. It’s as if a random person is constantly adding their two cents while you’re in the middle of a conversation with the author.

Where the comments really become useful is when you go through the book a second time. Having the likes of Joel Greenblatt, Seth Klarman and others offer insights helps to tie things together.

And even Marks adds comments on his writing. Though, he tags his comments with themes.

The most important of those themes he labels “the riskiest things.” The not so obvious way to sum it up is the riskiest things turn out to be things that seem the least risky. Continue Reading…

Happy Hour: Ed Thorp’s Version of Mr. Market

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Barron’s interviewed Ed Thorp this week. Thorp’s curiosity led him down a path to finding ways to game inefficiencies in markets. He’s a math genius who wrote the book on winning blackjack. He parlayed that into a successful quant fund that earned around 19% a year for 20 years, then rolled that success into a second fund.

The Q&A session was short but had some good answers around the Kelly Criterion, whether market efficiencies still exist (he said yes), the value of time, and more. Okay, two highlights (with the links below).

The first is Thorp’s version of Mr. Market. I find it interesting how different people explain Graham’s parable. This is how a mathematical mind explains it in relation to owning an index fund. The second is on lessons for readers of his book A Man for All Markets. Continue Reading…

Mean Reversion in Markets

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Mean reversion is the one thing we can, eventually, rely on to align price with value. It also runs counter to the collective thinking in markets.

Mean reversion is the idea that things – growth rates, earnings, prices, returns – eventually move toward an average. It’s what you get when short-term expectations conflict with long-term reality.

History is littered with companies once considered great, that have since fallen by the wayside. And the companies that were written off for dead often exceed their lowly expectations by briefly performing well.

It turns out, few companies are immune to the cycle of creative destruction (it’s a feature, not a bug, of capitalism). Mean reversion is what results. Tobias Carlisle explains why in his book Deep Value: Continue Reading…

Happy Hour: Lucky Streak

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Morgan Housel is out with a great post on the relationship between luck and risk that you really should read.

Luck is the flip side of risk. You cannot understand one without appreciating the other.

If risk is what happens when you make good decisions but end up with a bad outcome, luck is what happens when you make bad or mediocre decisions but end up with a great outcome. They both happen because the world is too complex to allow 100% of your actions dictate 100% of your outcomes.

One of the biggest mistakes investors can make is confusing luck for skill and good decisions. When you’re dealing with probabilities there’s always a chance that an unlikely possibility makes you money. Continue Reading…

Lessons from Seth Klarman’s Margin of Safety

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Klarman on changing your mind

Seth Klarman’s Margin of Safety is a rare and elusive book that sells for a huge premium over its IPO original price. It’s a book about managing risk. And its namesake is the key to it all.

Klarman follows a value investing philosophy that originated with Ben Graham – buying something for less its worth.

What’s unique about Klarman’s book is the updated views relating to his own experiences prior to publishing in 1991. There are chapters dedicated to junk bonds, institutional investing and the short-term performance race, thrift conversions, looking for catalysts, and distressed/bankrupt securities. He also covers the basic value philosophy. Continue Reading…

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