Howard Marks: The key to superior investing: Insight, Not Formulas

There's a rule that there's a recession every eight or ten years. If you don't count that as a normal recession, we're in the 15th year or the 16th year. We're due for one tomorrow. I'm pretty sure there's not going to be one tomorrow. I would say, my approach is to say, I don't know. I can't tell you. But when I look around in the environment, I don't see terrible excesses in the economy. I don't see that consumption is overly enthusiastic. I don't see that inventories are building up too high. I don't see a large number of construction cranes in the sky suggesting overbuilding. It tells me things are kind of in the middle ground. And in the middle ground, there's no stellar conclusion to draw. There's nothing you can say about the condition of our economy strongly, which has a high probability of being right. So I say nothing. Got it. To all the viewers from the United States, Korea, and around the world, welcome to Global Money Talk by SunProTV. I'm your host, Dan Ha. Today, we're at the New York offices of Oaktree Capital Management for a very special conversation with Howard Marks. Howard really needs no introduction. But for those who don't know, I will say that Howard is someone that Warren Buffett pays attention to. Howard has influenced and inspired generations of investors, including me. It is my great honor and privilege to bring you this conversation with Howard Marks. Howard, thank you. Thank you, Dan. Thanks for that nice introduction. Very welcome. So I'd like to start with one of your recent memos, Mr. Market Miscalculates. In it, you wrote about how in the markets, meaningless statements are often given weight and how a given development can be interpreted positively or negatively, depending on the prevailing mood of the market, which reminded me of an Amos Tversky quote, people accept any explanation as long as it fits the facts. That said, price behavior can be a useful source of information at times. So could you please give a user's manual, if you will, on how to use price behavior as a source of information? Sure, Dan. That's a complex question, of course. And I think the basic rule in the investment world is that there are no easy answers. I think what you say is very important, quoting Tversky. People always say, well, why did that happen? And sometimes the answer is no good reason. There's randomness. There's irrationality. People say, well, he was a good man. Why did he die? Well, there may not be a correlation. It's a good company. Why did the stock go down? Well, who knows? Sometimes who knows is the right answer. But people, not just in the investment world, but in general, don't like going through life with the answer who knows. So as you say, or as Tversky says, they seek an explanation. Make sense of it. Well, sometimes you can't. I wrote a memo, and I'll say that a lot in the course of this interview, because I've written for 35 years, so I've written now on almost every topic in investing, a memo called What Does the Market Know? My general conclusion is the market doesn't know anything. The market is not some genius with a high IQ. The market is just the collection of the votes cast by all the people in it. So by definition, it's not any smarter. If you get a million people of average intelligence together, their conclusion is not any smarter than average. It's not like it accumulates to a greater total. Now, having said that, as you say, sometimes price movements are meaningful. So I think the answer is you can use as a signal to think about things, a signal to do some research. You see a stock is way up or way down. You might try to figure out if there's an obvious reason and try to figure out if the reaction of the stock price to the reason is excessive or insufficient. Maybe that will tell you there's something worth doing. But I have to stress, and I'll stress frequently in this conversation with you, that reaching these conclusions requires a very high level of expertise and experience and knowledge that most people don't have. So for the average person to look at a stock and it's up 20% this week and to say why is it up, is 20% an overreaction or an underreaction? Will it go up more and should I buy? The vast majority of people aren't equipped to make that decision. And if they try to do so, they're really deluding themselves. Understood. Also in that note, you wrote about how there are no immutable rules in investing that can be relied upon to produce the same results always. Yet investors do tend to make rules based on their experience mostly to protect themselves from repeating the same mistake. Never let your largest position become x percent of the portfolio or be greater. Next time when the x, y, z are true, buy the stock. Rules aren't perfect but they can help an investor stay disciplined. What are some of your rules that you'd like to share? Well I think there's an old saying, rules are made to be broken. You can have general policies but I think it's important to be ready to break them as necessary. I mean a great example is some people adopt a rule that if you buy a stock if it goes down x percent you should sell it. It's called the stop loss order. So let's say you say if I buy a stock and it goes down 10% I sell it. You have to think about what does that mean? It means that if you sell every stock that goes down 10% you can never lose 20% or 30% or 40%. But every once in a while you'll have a stock, you'll buy it, it'll go down 10%, you'll sell it and then it'll go up 100% from there and you'll miss all of those too. There is no rule that you can set to help you negotiate that. It's not down 10 or down 20. There is no automatic rule that will keep you safe but not result in you missing opportunities. I've always taken the approach that if you have a great success you should sell some. We say take a little off the table in order to capture some of the gain so that if it turns out to be fleeting you won't give it all up. But if you buy something that's up 30% and you sell some that means that if it goes up 60% that part you won't get a ride on. So it's not that the rule is wrong or right. The question is, is it right for you? Now the point is, like I said about the stop loss order, it prevents great losses but it also causes you to miss some successes. You have to decide which is more important to you. Based on your financial situation, your personality, those kinds of considerations. So my idea of taking a little off the table. If you buy something that goes up 30%, you sell some. Then it goes up another 30%, you sell some more, another 30%. Well, you would have made more money if you held on. But on the other hand, if it went up 30% and then back down you would have failed to tie up any of the profits. Which one of those two? You can't do both. You can't secure part of your profit and let it all ride. So every person has to work out for themselves what's right for them. You can't do this stuff perfectly. What is the definition of good for you? That's the question. That's an interesting point. You recently had a with your partner Bruce Karsh and the chess grandmaster Maurice Ashley. In that conversation, Bruce talked about the importance of being at peace with yourself as an investor, which I agree is hugely important. Can you tell us how one gets there? I think that ties into your point about what is right for you. It also ties into my college minor subject, which was Asian Studies. Asian Studies is a lot about contentment and being at peace, acceptance. There's no manual for achieving these things. But if you want to change something about your personality, that's what we're talking about here, it has to be intentional. You have to say, how can I achieve greater serenity? Importantly, one thing is that you have to not be a perfectionist. It's very hard to get investing just right. I used to have a friend and we joked a lot in our relationship and we decided one day to catalog all the ways you can be wrong. Number one is you buy and it goes down. Number two is you don't buy and it goes up. Number three is it goes up, you buy and it goes up and then it goes down. Number four is you buy and it goes down and you sell and then it goes up. Number five is it goes up and you sell and then it goes up more. There's an infinite number of ways to be wrong. There's only one way to be right, which is you buy, it goes up, you sell and it doesn't go up anymore. But you're not going to achieve that. So you have to achieve a level of serenity in your life, in all things, not just investing. But you have to accept that some of the things you buy are going to go down and some of the things you're going to buy will go up and you'll sell them and they'll go up more. And you can't make yourself nuts trying to do it exactly right because it's impossible. You know, one of the greatest quotes, and I think when I was a boy, John F. Kennedy was famous for using this quote, give us the courage to change what can be changed, the serenity to accept what can't be changed and the wisdom to know the difference. And I think that's important in all walks of life, including investing. You have to have the serenity to accept that you're going to strive very hard to get it right but you're not going to get it exactly right. And you have to be, if you make yourself crazy trying to do so, you're going to have an unhappy life. Got it. And as a follow-up to that, it seems important that the structure and the surroundings that an investor puts himself in is very important in achieving that peace. How have you structured Oaktree? What types of strategies are you pursuing? What types of strategies are you intentionally not pursuing? What are the tolerances for drawdowns and mistakes? How have you built the culture around that so that the investment decision makers at Oaktree can be at peace? Well, we're very fortunate, Dan, because we invest in something called credit. Credit means we lend people money and they enter into a contract with us and they'll pay us interest periodically and then they'll pay us our money back at a point in time. And so our outcomes are not wide open. Our outcomes are defined contractually. Most of the time people keep their promises and pay us as they promise and we get the return we expected. Once in a while they don't pay us and we have the rights of an unpaid creditor to pursue a settlement. And most of the time that works out okay. So when you are an investor in credit or a lender, your upside is limited. You get the promised return, but you don't get more most of the time and you don't have an NVIDIA or a Microsoft on your hands or an Amazon. But on the other hand, you have very few losers and rarely do we have big losers. So this fits my personality. It fits the organization. It fits my colleagues. It fits our clients. They come to us for that. So that's a very livable situation as opposed to being someone who concentrates on making ownership bets in startup companies where you can have a thousand to one payoff or a complete loss. And most of your investments will be unsuccessful. That's right for other people. It's not right for us. It's not what our clients come to us for. They may go to somebody else for that. But I found 46 years ago when I joined the bond department at Citibank, a form of investing that fits my personality, my DNA, my intellectual makeup. Now you say, how do we set the culture? I think the most important thing about the culture is to not have recriminations. I want everybody to make decisions that will be correct, but I accept that nobody can make only correct decisions. For all of us, it's a matter of the batting average. And the fact that somebody supports an investment that loses money, number one, it's not that unusual. Number two, it's understandable. Three, it doesn't mean they're a bad person or they were lazy. And that person should not get criticized. What if you were a pitcher in baseball and you got criticized every time you threw a ball or every time the other team got a base hit? We try not to have blaming or shaming. To understand what's human and what's achievable at the same time, if someone repeatedly makes mostly bad decisions over a long period of time, then we can draw the conclusion that that person's in the wrong job and maybe shouldn't work at Oak Tree. But if you want people to give you the benefit of their best reasoning, you can't criticize every mistake. Right, right. So somebody who follows your investment philosophy, who agrees with your investment approach, is it inherently better to apply your investment philosophy to bonds rather than stocks? Well, our philosophy, yes. Our philosophy, which is a large number of reasonable successes and a general absence of big failures. I mean, debt investments, that's what they're made for. They're ideal for that purpose. I wrote a memo called Fewer Losers, More Winners. And that's what it's all about. Everybody in your audience who sets out to be an investor should decide, number one, is their goal to be superior or will they accept an average result? An average result is quite good. In the U.S., the S&P 500 has gone up about 10% a year for the last 100 years, which means if you had a dollar 100 years ago, you'd have about 15,000 today. That's not bad, right? And that's average. Now, most of us don't get to live for 100 years and invest for 100 years, but still, if you invest at 10% a year, your money doubles every seven years. So if you can do that for 35 years, it'll double five times and a dollar would become $248,1632. Not bad. Will you be average or will you try to be above average, which introduces the possibility of being below average? And if you want to be above average, which I don't push for the amateur. The amateur generally, as I said in my answer to your first question, is not equipped to do above average. They should happily settle for average. And the great thing about being average is that you can achieve average results for sure through things like index funds and at a low cost and without risk of disappointment in terms of being below average. You can lose money, but you can't be below average. Anyway, if somebody says, no, no, I'm not going to settle for average. I want to be above average. I know I might fall short. Now that leads to the memo. Which route to superiority will you follow? Will you try to have more winners than the average investor or fewer losers or both? Now, it's hard to do both because the defensive mindset enables you to have fewer losers. The aggressive mindset is necessary to have more winners. It's hard to do both because it's hard to incorporate both the defensive mindset and the aggressive mindset. So you should say, what kind of person am I? Which is a better course of action for me? I'm comfortable with our approach because what it means is that when we're unsuccessful, we're a little unsuccessful. When we're successful, we're a little successful. I like that for myself and for my clients more than swinging for the fences and sometimes having abject failure. But everybody has to – if you see Nvidia and it was up four and a half times last year, the question is, are you going to kick yourself because you didn't have it? Well, human nature says you are. But you have to say to yourself, just a minute, didn't I say that I want to have fewer losers and that I'll live without catching all the winners? It's very hard to – given human nature where we have a great fear of missing out and we look at other people's successes and we feel terrible about it, it's bad for investing. There's a there is nothing so injurious to your mental well-being as to watch a friend get rich. Unfortunately, that's human nature. We have to try to beat that. One of my favorite stories from your memos is a story about your friend who wished he had bought all of Malibu for $300,000 as the Ringe family is said to have done back in 1892. To which you responded, well, you would have sold it when it got to $600,000. I think holding on to great long-term compounders in stock investing is very difficult. I think it's just as difficult as finding one. Now, it's difficult because the prudent thing to do is to rebalance. What I said before, take a little off the table. Sounds intelligent. Right. Therefore, and if so, if the prudent thing to do is to rebalance, then is profiting massively from great long-term compounders really just luck? I wouldn't say it's just luck, but it does require luck because you buy something and it doubles. You make a decision not to sell it. If it goes on from there to appreciate further, there is some luck involved. You can never say, oh, no, that was sure to happen. It was obviously an intelligent decision. At every point in the market, you look at the price of a stock or a bond or a piece of property and you say, is it fair, too high or too low? There's no scientific instrument for establishing these things. You make a judgment. The question is, are you lucky in your judgments? Lucky sounds like it was all by chance, rolling the dice. No, not necessarily. But still, we all make judgments every day about whether something is priced right or too high or too low. The word lucky may not be the right word, but do most of your decisions work out? We all know that when the decision works out, there's some combination of the fact that you made a good decision, but there's also some factor that you were lucky. Life turned out to be as you expected or maybe even a little better, and so you prospered. But look, in one of the memos I talked about Amazon that was selling at $90 in 1999 and $6 in 2001. This question is, if you bought it at $6, would you have sold it at $12? Lots of people would take a double. Would you have sold at $30 five times, $60 ten times? What about when it hit $600 and you're up a hundred times your money? Shouldn't you have sold – you used the word prudent before. Wouldn't it be prudent to sell some? Obviously, if you sell some, you can't let it all ride. Then I think when I wrote that memo, it was at $3,300. So if you sold some at six times, which was a hundred times your money, you missed the next five and a half times. So again, you're not going to get it all right. If you know somebody who bought Apple at $6 and still has it when it's $3,300 and never sold a share, you have to look at them and say, it was up 500 times and he didn't sell any. What if it had collapsed? So again, what is your mindset? What is your personality? How are you going to feel if something goes from $6 to $3,000 and back? For most of us mortals, we would sell some at $600 and some at $3,000 and then hope for the best. By the way, this goes to the difficulty of doing these things. If you buy something at $6 and it goes to $60 and you sell half your holding, make 10 times your money, do you say, I hope it goes up and I make more money? Or do you say, I hope it goes down, which proves that I was right to sell some? Again, human nature, the human condition, which is kind of screwed up. Financially, you can tell when something was a good decision, you see the outcome. Humanly, the description of a good decision can be very challenging. Got it. Shifting gears a bit, if we don't count the 2020 COVID recession, which lasted for two months as a real recession, then the U.S. economy is in its longest ever expansion by a wide margin. Now, if we count it as a real recession, obviously then that's a different story. How do you treat the 2020 recession? Was it a real recession, therefore we're simply in a normal economic cycle? Or was it merely a disruption, therefore we're way in overtime? Well, it's a great question, Dan. You asked me before, what are my rules? And I said, rules are made to be broken. There's a rule that there's a recession every eight or 10 years. If you don't count that as a normal recession, we're in the 15th year or the 16th year. We're due for one tomorrow. I'm pretty sure there's not going to be one tomorrow. But you don't know. Nobody can say, was it a recession? Is this a normal experience? Are we due for one immediately? Or did it restart the clock and will it be 2028 or 2030? Nobody can say. And to rely on applying those rules of eight or 10 years mindlessly is obviously folly. I would say, my approach is to say, I don't know. I can't tell you. But when I look around in the environment, I don't see terrible excesses in the economy. I don't see that consumption is overly enthusiastic. I don't see that inventories are building up too high. I don't see a large number of construction cranes in the sky suggesting overbuilding. When I look in the newspaper, I see some good news and some bad news, some good news and some bad news. And one day they say, maybe we're going to have inflation rekindling, and one day they say we're going to have a recession soon. It tells me things are kind of in the middle ground. And in the middle ground, there's no stellar conclusion to draw. There's nothing you can say about the condition of our economy strongly, which has a high probability of being right. So I say nothing. Euphoric markets tend to have what I call culprits, where the euphoric behavior typically begins. Well, I think the way I would say that is euphoria needs something to coalesce around. And I'm going to guess that your answer to my question, do you see any of these culprits? I'm going to guess the answer based on what you just said is probably no, that you don't see any. In the last couple of decades, the great excesses have not been in the economy. They've been in the financial markets. In the 99-2000 period, we had a bubble in tech stocks, too much optimism. In 08, we had a bubble around housing and housing-related debt. But of course, even though we didn't have great excesses in the real economy, we had some doozy recessions because damage to the financial sector from the investment excesses correcting pulled them down. But yes, you're right. At the present time, I don't see that culprit, which would be... And by the way, I don't think that the stock market is crazy high. It's a little high, but it's not crazy high. And I don't think that the credit market is crazy either, just a little too unworried at this time. There are some things that a natural contrarian like me would worry about, but not so great as to be paralyzing. Can you share a couple? Well, it's just what I said. I mean, here we are in the third quarter of 24. If you go back two years, the world was very pessimistic, which meant that the rewards for making investments were very high because people felt so low and things were priced reasonably as a result. Now most people are pretty optimistic. The stock market has rallied for almost two years, and the aversion to extending credit has weakened so that the reward for bearing risk in the credit market has declined. So I like to buy when everybody's pessimistic and there's no optimism priced in. Today, most people are fairly optimistic, not crazy, and so there's little pessimism priced in. I like to buy when there's a lot of pessimism priced in, and that's not the case today. So I think that you can invest today, but there's nothing to get that excited about. I get excited when people are jumping out of Yeah. You think about investing in terms of odds. In my experience, most people think about investing in terms of being right. Did you always think this way in terms of odds, or did this evolve for you over time? That's a great question. I don't know if I've ever been asked that question before. I think it's a matter of maturing. I joined the investment business in 69, switched to actually managing money in 78 in Citibank's bond department. Sometime in that 78 to let's say 88 period, I don't think I ever thought in terms of yes, no, but I think that's when I strengthened my probabilistic focus. You start to realize that most questions aren't yes, no, but a matter of probabilities. 1963, there was a World's Fair in Flushing, New York, which is where I lived, in Queens. IBM had a pavilion there. They had an interesting thing. They had two sheets of plexiglass with a series of rods connecting them and opening at the top. They poured in a bunch of balls at the top, and the balls went like this. They bounced off the rods, and by the time they got to the bottom, they were piled up in this shape. I was 17. That was my first exposure to probability. Most things happen as you expect. Less things happen in ways you don't expect. Once in a while, something happens that you thought never could happen, what we call the tales. That's the way I think about life. You have to really sharpen your focus on that. In one of the memos, I told the story of, I think it was the Super Bowl in 2016. I'm not too good on football dates, but Carolina Panthers were playing the Denver Broncos, and they had a former football player on. He didn't go to the University of Chicago. He didn't have a PhD in investing, but they said to him, who do you think is going to win? He said something very smart. He said, eight out of 10, Carolina wins. This could be one of the two. Most people don't add that latter point. Most people hear, oh, eight out of 10, Carolina wins. Well, I'm not even going to watch a game. I know how it's going to win. Sometimes that happens. You have to get away from black and white thinking. I keep saying throughout this interview, Dan, in investing and in life, when you're dealing with future events, you never know how it's going to turn out. You have to recognize that, and you'll be a happier person and more effective. Right. Well, we'll have to leave it there, but thank you very much. It's a pleasure, and I wish you much luck with your new show. Thank you very much. Okay. Bye-bye.