Friday, June 7, 2013

Book Review: Billionaire Howard Marks' 'The Most Important Thing Illuminated'

If Warren Buffett, Christopher Davis, Joel Greenblatt and Seth Klarman recommend a book, it might—just might—be worth reading. It certainly got my attention.

Warren Buffett calls Howard Marks’ The Most Important Thing Illuminated “that rarity, a useful book.” And as a researcher with a library of a couple hundred books myself, I couldn’t agree more.

For those unfamiliar with Howard Marks, he is the Chairman and cofounder of Oaktree Capital Management, an investment firm with $77 billion under management. The Most Important Thing Illuminated, published in 2013, is an update to Marks’ original, published in 2011, though in Illuminated Marks has help. Greenblatt, managing partner of Gotham Capital and author of The Little Book That Beats the Market, offers his own commentary throughout the pages, as do Christopher Davis, portfolio manager of the Davis Large Cap Value fund, and Seth Klarman, president of The Baupost Group and a well-respected value investor. Marks keeps good company.
I had high expectations when I picked up The Most Important Thing Illuminated, and I wasn’t disappointed. This isn’t yet another “how to invest” book or a tired rehashing of received investment “wisdom” that looks more like something found in a fortune cookie and which rarely seems to hold up in practice.
Instead, Marks gives us the insightful thoughts of a man who struggles with his own investing decisions on a daily basis. There are no shortcuts, formulas or easy tricks. But there is a wealth of experience and thoughtful contemplation from a real “in the trenches” investor who has been doing this a long time.
Marks starts the book with a chapter on “second-level thinking,” and I consider this one of the most valuable lessons in the entire book. Having a good understanding of this chapter alone will put you head and shoulders above most of your peers.
Mechanical trading rules work really well…right up until the point that they don’t. And why don’t they work consistently over time? As Marks explains,

The reasons are simple. No rule always works. The environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable. An investment approach may work for a while, but eventually the actions it calls for will change the environment, meaning a new approach is needed. And if others emulate an approach, that will blunt its effectiveness.
Investing, like economics, is more art than science. And that means it can get a little messy.
“Messy” is not a technical term, but it is accurate and descriptive hear. Markets are driven by people and by ever-changing real-world events. Trying to cram this into a mechanical trading model or a black box is a recipe for disaster. And frankly, it’s mentally lazy and reflects an unwillingness (or inability!) to grasp complexity.
This brings me to Marks’ points about second-level thinking. What exactly is “second-level thinking.” Perhaps it is best explained by example:
  • “First-level thinking says, ‘It’s a good company let’s buy the stock.’ Second-level thinking says, ‘It’s a good company, but everyone thinks it’s a great company, and it’s not. So the stock’s overrated and overpriced; let’s sell.’”
  • “First-level thinking says, “The outlook calls for low growth and rising inflation. Let’s dump our stocks.’ Second level thinking says, ‘The outlook stinks, but everyone else is selling in panic. Buy!’”
  • “First-level thinking says, ‘I think the company’s earnings will fall; sell.’ Second-level thinking says, ‘I think the company’s earnings will fall less than people expect, and the pleasant surprise will lift the stock; buy.’”
Call it contrarian thinking, applied game theory or just being clever, but this is the mindset that is required to be a successful investor over time. It’s also a skill that few investors have or have the mental discipline to use.
It’s not easy going against the grain and taking views that are contrary to the consensus. But then, no one ever said that investing should be easy.
Market Technicals and Psychology
As a value investor, Marks is not a fan of technical analysis (i.e. charting) but he does stress the importance of understanding what he calls “market technicals,” or non-fundamental factors that affect the supply and demand for a security. Failing to understand these can lure an investor who looks at value alone.
What are some examples? Marks lists two specifically: the forced selling that takes place when a market crash trips margin calls, which forces leveraged investors to sell at any price, and the cash inflows that go to mutual funds that are usually invested irrespective of price. To these I would add short squeezes, secondary stock price offerings that dilute shareholders, and buyout offers.
These technical factors are often closely related to market psychology. And as Marks writes, “The discipline that is most important Is not accounting or economics, but psychology…

Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.
Need an example? Think of Apple’s performance over the past few years. Apple was the “must own” stock of the 2010s. Everyone owned it—individual investors, mutual fund managers, hedge fund managers…you name the investor, and chances are good that Apple made up a good-sized chunk of their portfolio.
There were cases of focused hedge funds having 20-30% of their portfolio in Apple. Even now, after Apple’s massive slide, the stock accounts for nearly 15% of the Technology Select SPDR, one of the most popular ETFs for investing in the tech sector. Apple’s position in the ETF is bigger than Google’s and IBM’s combined.
It’s not a figure of speech to say that there was no one left to buy Apple. No matter how great a company is, there is a limit to how high a percentage of investors’ portfolios it could comprise.
And we all know what followed. Apple’s share price fell by over 40%, and may or may not be finished falling.
A pure value investor wouldn’t have seen the risk in Apple. Based on popular metrics such as price/earnings or price/sales, Apple wasn’t particularly expensive. It actually looked pretty cheap compared to the broader market.
But if you had taken market technical and investor psychology into account, you would have known to be wary. You almost certainly wouldn’t have timed the top perfectly, but you would have known that caution was warranted.

Wednesday, June 5, 2013

As We Approach the End of Monetary Easing, Howard Marks Thinks Investors Should Be Cautious

According to Marks, we have not had a "free market" in money for a long time. The easy money policy of the Federal Reserve has to end. The only question is when.

Marks thinks the "when" is going to be in the fairly foreseeable future.

The end of the easing is obviously going to result in higher interest rates, since the easing is the reason that rates are artificially low today.

He thinks that today is a time for caution for investors because there is no way to know how the economy will do once the stimulus is removed. That is dangerous when it is combined with the fact that low interest rates have already boosted asset prices.

Monday, May 27, 2013

Howard Marks' Full Presentation On "Investing In Uncertain Times"

In the following presentation, given by Howard Marks - the world's largest distressed debt investor - he warns of the perils of "investing in uncertain times." As Reuters notes, he fears the "unsound practices" from before the financial crisis are creeping back into credit markets, with private equity firms bidding increasingly high prices for companies. Marks points out the ease with which lowly rated companies were issuing debt this year, how companies were paying out record dividends to their shareholders and the increasingly high debt-to-equity multiples private equity firms were paying for companies amid a resurgence in deals. "We have a world in which nobody is thinking bullish. Everybody's worried and yet people are acting bullish," and predicts a looming "shake-out" in the hedge fund industry as he asks rhetorically, "today there are 8,000 hedge funds. Are there really 40,000 exceptional people (working for hedge funds)?" In conclusion, Oaktree Capital's founder warns that investors, in their search for returns, were becoming overly confident while the economic background was still gloomy.

Wednesday, May 22, 2013

Howard Marks Gains 133% on Eagle Sell, Four Reduced in First Quarter

Oaktree Capital's Howard Marks , the genius memo writer preferred by other billionaire Gurus and Wall Street investors, sold only one holding as of quarter ending March 31, 2013. Investor Guru Marks made a gain of 133% on his sell out of the shipping company Eagle Bulk Shipping Inc. ( EGLE ). He also reduced four other positions, making solid gains there as well. Here are the details of his first quarter 2013 sells:

Sold Out: Eagle Bulk Shipping Inc. ( EGLE ) - Shipping & Ports

Howard Marks sold out his position with EGLE, as of March 31, 2013. He sold a little more than 1.5 million shares at an average price of $2.30 per share, for a gain of 133%; the previous quarter he gained 112.7%, after four rocky quarters.

This trade impacts his portfolio by -0.09%.

The current share price is $5.36 compared to past valuations:

Reduced: Charter Communications Inc. ( CHTR ) - Pay TV

Howard Marks reduced his CHTR position by 83.54%, as of March 31, 2013. He sold more than 10 million shares at an average price of $85 per share, for a gain of 34.1%. His average price on around 19.7 million shares bought is $33.86 per share for a 237% gain. Howard Marks owns 2 million shares after the trade.

This trade impacts his portfolio by -31.16%.

The current share price is $114.00.

Reduced: Delphi Automotive PLC ( DLPH ) - Auto Parts

Howard Marks also reduced his DLPH position by 37.51%, as of March 31, 2013. He sold 2,400,728 shares at an average price of $40.39 per share, for a gain of 21.4%. His average price on around 14 million shares bought is $28.99 per share for a 69% gain. Marks holds 4 million shares after the trade.

This trade impacts his portfolio by -3.71%.

The current share price is $49.05.
Reduced: CIT Group Inc. ( CIT ) - Specialty Finance

Howard Marks reduced his CIT position by 89.26%, as of March 31, 2013. He sold a little more than 3.37 million shares at an average price of $42.08 per share, for a gain of 6.6%. His average price on around 8.9 million shares bought is $42.08 per share for a 25% gain. Marks holds 405,979 shares after the trade.

This trade impacts his portfolio by -5.27%.

The current share price is $44.84. 
Reduced: General Motors Co. ( GMPRB ) - Auto Manufacturers

Howard Marks also reduced his General Motors Co. Preferred Shares position by 70.06%, as of March 31, 2013. He sold shares at an average price of $43.75 per share. Marks owns 427,400 shares after the trade.

This trade impacts his portfolio by -1.75%.

Chairman of Oaktree Capital since its formation in 1995, Howard Marks has a global reach. His portfolio lists 88 stocks, seven of them new, with a total value of $4.9 billion, and a quarter-over-quarter turnover of 5%. With around $78 billion in assets under management, Oaktree Capital invests in less efficient markets and alternative investments, looking to a variety of strategies, including corporate debt, convertible securities, distressed debt, control investing, real estate and emerging markets in the Asia Pacific region, Latin America, Eastern Europe, the Middle East, Africa and Russia. As of March 2013, Howard Marks has a net worth of $1.65 billion.

Monday, May 13, 2013

Where to Find Yield in a Low-Rate World: Pro

Howard Marks, Oaktree Capital, explains why high-yield bonds are less vulnerable to rising interest rates than other classes of fixed income, with Oscar Schafer, Rivulet Capital chairman

Tuesday, April 30, 2013

Market Rally: Get In or Get Out?

As the market continues to rally, how should you invest your money? John Calamos, Calamos Investments and Howard Marks, Oaktree Capital, discuss

Sunday, March 31, 2013

Howard Marks Letter "The Outlook for Equities" March 2013


Friday, March 15, 2013

Howard Marks: "It Isn't Just A Windfall, It's A Warning Sign"

Despite the all-knowing Alan Greenspan confirming there is no irrational exuberance currently, Oaktree Capital's Howard Marks is less convinced. Though he is not bearish, he lays out rather succinctly the current pros and cons for equities - based on the various 'valuation' arguments, discusses the folly of the equity risk premia, and highlights the dangers of extrapolation and what history can teach us... "appreciation at a rate in excess of the cash flow growth accelerates into the present some appreciation that otherwise might have happened in the future... it isn't just a windfall but also a warning sign."
Via Oaktree Capital's Howard Marks,
The problem with basing a pro-equities argument on the yield comparison is that most of equities’ current attraction on that basis comes from the lowness of interest rates. Just about everyone knows (a) interest rates are artificially low because of central banks’ efforts at stimulus and (b) rates will be considerably higher at some point in the intermediate term. In that case, rising rates would render stocks less attractive.
The Other Pros and Cons of Equities
"There are many ways to view valuation, and many elements in the current debate over equities. Here are a few of them (I?ll start by reiterating the above for the sake of completeness):

  • The differential between the S&P earnings yield and the risk-free rate or the yields on bonds – and their ratio – makes stocks look extremely cheap. PRO
  • The attractiveness of these relative valuation parameters is highly dependent on interest rates staying low. CON (or LESS PRO)
  • Relative to normal post-WWII p/e ratios, stock prices are average to slightly low as a multiple of projected earnings for the year ahead. PRO
  • Robert Schiller?s cycle-adjusted p/e ratios are gaining increased attention, and they suggest full rather than fair valuations. CON
  • Arguably earnings growth in the years ahead will be slower than that which prevailed in the decades following WWII. Thus the post-war valuation norms are too high under the changed circumstances and should be discounted. CON
  • The outlook for earnings is restrained by the questionable macro environment, including the challenges in restarting growth and the dire prognosis for the federal deficit. These problems may not be easily solved. CON
  • Among the things keeping earnings high – and thus making stocks seem attractive – are some of the highest profit margins in history. If profit margins were to move toward normal levels, this would bring down earnings, either taking stock prices down with them or lifting p/e ratios and thus reducing stocks? attractiveness. CON
  • Corporate cash hoards are high, implying some combination of safety, potential for stock buybacks, and possible dividend increases. These are all good for shareholders. PRO
  • Investor attitudes toward stocks remain tepid (see below). PRO
  • However, with the S&P 500 up 16% last year and 10% so far this year, it can?t be argued that stocks have been overlooked and or that attitudes towards them are still mired in the doldrums. CON"
What History Can Teach Us...
"In the mid-1970s I was fortunate to happen upon one of the first of the time-worn pearls of wisdom that contributed so much to my education as an investor. It described the three stages of a bull market:

  • the first, when a few forward-looking people begin to believe things will get better,
  • the second, when most investors realize improvement is actually underway, and
  • the third, when everyone?s sure things will get better forever.
In “The Tide Goes Out,” written in March 2008, several months before the lows of the financial crisis, I applied the same thinking to the converse – the three stages of a bear market:

  • the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won?t always be rosy,
  • the second, when most investors recognize things are deteriorating, and
  • the third, when everyone?s convinced things can only get worse.
Hindsight always makes it clear what was going on at a particular point in time. It?s a snap now to say the second quarter of 2007 marked the third stage of a bull market: no one could think of a way to lose money. And in the fourth quarter of 2008 (for credit) and the first quarter of 2009 (for equities), we were certainly in the third stage of a bear market: most people thought the financial system was about to collapse, and securities that had halved in price could do nothing but halve again."
And On The Dangers of Extrapolation...
"To me, the answer is simple: the better returns have been, the less likely they are – all other things being equal – to be good in the future. Generally speaking, I view an asset as having a certain quantum of return potential over its lifetime. The foundation for its return comes from its ability to produce cash flow. To that base number we should add further return potential if the asset is undervalued and thus can be expected to appreciate to fair value, and we should reduce our view of its return potential if it is overvalued and thus can be expected to decline to fair value.
In other words, appreciation at a rate in excess of the cash flow growth accelerates into the present some appreciation that otherwise might have happened in the future. Or to paraphrase Warren Buffett, “when people forget that corporate profits are unlikely to grow faster than 6% per year, they tend to get into trouble.” I doubt he intended anything special about 6%, but rather a reminder that when assets appreciate faster than the rate at which their value grows, it isn't just a windfall but also a warning sign."

Thursday, February 28, 2013

Howard Marks Letter "High Yield Bonds Today" February 2013