Anyone who has studied financial history, or even held an investment for a period of time, will know that markets tend to move in cycles. One moment they are surging, the next they are falling. Still, knowing that cyclicality exists and taking advantage of it are two different things. Indeed, many experts think that trying to time the market is so difficult that any attempt to do so is doomed to failure.
Famed hedge-fund manager Howard Marks disagrees. In this book, he argues that cycles not only exist, but are predictable and exploitable.According to Marks there are two main factors driving financial cyclicality. One is investor expectations, which tend to swing back and forth between optimism and risk-taking on the one hand, and pessimism and risk-aversion on the other. The other is the business cycle that drives the real economy. This is driven by firms' investment in future production, the amount of money that banks are willing to lend (and the terms on which they are willing to do so) as well as consumer spending. Both forces are closely related, and both drive movements in the financial cycle and reverse them.
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To take an example, optimism about the prospects for commercial real estate in the 1970s and 1980s, and for residential housing between 2002 and 2006, encouraged banks to lend money to developers and homeowners, thus further raising demand. When the euphoria cooled, banks cut off further credit, making refinancing impossible, while a glut of new property entered the market built on anticipation of demand that never materialised. In both cases, the winners were what Marks calls the "third owners" not the original speculators or the banks, but those who bought the distressed loans and real estate at rock-bottom prices.
Marks suggests that the best way to benefit from cyclicality is to adopt a contrarian stance, avoiding those assets seen as "hot" in favour of those that are being shunned by investors. While he accepts that this stance is not fool-proof, since bubbles can get larger before they burst, this generally shifts the odds of success in your favour, which is the best that a strategy can offer in a world of uncertainty.
Marks's isn't the only book to tackle market cycles, and the first few chapters of the book take a little time to get going. But few people have Marks's experience or expertise and his focus on the real-world consequences (and causes) of market euphoria makes his book more rounded and nuanced than other books that deal with this topic.
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