Like the sun, market cycles will forever go up and down

A simple question, when we expect the sun to rise in the morning, reach the highest point in the sky by midday and set in the evening almost at the same time, are we really forecasting or just expecting a galaxy pattern to repeat itself?

Of course the latter is true. For your information, the same phenomenon reigns powerfully inside financial markets.

To remind us of this fact today, we dig a few points from Howard Marks’ (chairman/co-founder of the $122 billion Oaktree funds) recent memo titled: seven worst words in the world, to give a little detail on this wonderful subject of cycles.

One, cycles are “same differently”. Howard notes that details of market cycles (such as their timing, amplitude and speed of fluctuations) often differ from one to the next, as do their particular causes and effects.

He adds that in investing, it’s not uncommon to have a sense for what’s going to happen but not know when. To illustrate this point, he reminded the world of his famous warning in 2007 – “Race to bottom” memo penned in February of the same year – which he wrote 19 months before the Global Financial Crisis set in.

He thus cautions that it’s still better to “turn cautious when the situation becomes precarious” than keep going and suffer losses. Perhaps Mark Twain defined this point best when he said; “History doesn’t repeat itself, but it does rhyme.”

Two. Understanding cycles is key to successful investing. On this point, Howard points out that “the themes that provide warning signals in every boom/bust are the general ones: that excessive optimism is a dangerous thing, the risk aversion is an essential ingredient for the market to be safe; and that overlay generous capital markets ultimately lead to unwise financing, and thus to danger for participants.”

To profit, he advises monitoring when the elements mentioned above make for unwise behaviour on the part of market participants, elevated prices and high risk, and when the opposite is true.

His idea is “cut risk when these things render the market precarious but turn aggressive when the reverse is true.” This is the essence of cyclical investing.

Thirdly, cycles are a reflection of human nature. Speaking on this he says: “Like any other auction, when potential buyers are scarce and don’t have much money or are reluctant to part with the money they have, the things on sale will go begging and the prices paid will be low.

But when there are many would-be buyers and they have a lot of money and are eager to put it to work, the bidding will be heated and the prices paid will be high.”

In other words, humans tend to be imprudent when cash is plenty and prudent when it’s in short supply.

I must admit Howard’s memo was quite refreshing. Reading it reminded me of a famous royal philosopher who spoke of the existence of cycles eons ago.

In one of his reflections (Ecclesiastes 3: 15), he says, “whatever is has already been, and what will be has been before.” To end this, I urge all serious investors to find the memo and fish for more insights.