Howard Marks - Risk Means More Things Can Happen Than Will Happen

Feb 25, 2024

This note comes from the transcript of a Howard Marks interview, talked about investing and market cycle. By far, the interview contains some of the most mind-opening ideas about clear thinking I have ever listened to.

What is happening in the world right now signals a downturn in the economy. You can’t predict, but you can prepare. These thoughts and ideas from Howard Marks will somewhat be useful for us.

Below are some of the most important quotes:

“Risk means more things can happen than will happen.”
“Mujō” literally means “the turning of the wheel of the law” – in other words, the operation of life. The essence is impermanence because the wheel does turn. It also means the unpredictability of the future. These were really formative for me, and they have unconsciously informed everything I’ve done. I personally think that in the investment business – and also in life – you are better off if you realize that life is always going to change on you, there will always be new things coming down the pike, and that you can’t control it. What we have to do is live with it.
You should know that when we’re low in the upcycle, that’s a time to be aggressive, put a lot of money to work, and buy more aggressive things, and when the cycle has gone on for a long time and we’re elevated, that’s the time to take some money off the table and behave more cautiously.
To teach yourself to be unemotional is to counter human nature, and by definition, it can’t be easy.
If you are as emotional as others, you will probably succumb to the same errors.
“Not everything that can be counted counts and not everything that counts can be counted.”
We have to view the future not as an event which is predetermined and predictable or determined already, but as a range of possibilities, as a probability distribution.
The future is a distribution of possibilities, and if we’re really smart, we know what the possibilities are, and we may have an idea of which are more likely and less likely, but we still don’t know what’s going to happen, and I think we have to behave that way. Now, some things we know more, some things we know less. We shouldn’t get confused. But the most important single thing is to not have the same degree of conviction about all of our opinions.
But Kaufman said two kinds of people lose a lot of money: The people who know nothing and the people who know everything. Very few of us know nothing, but it’s really important not to assume we know everything.
Taleb uses a concept called “alternative histories,” the other things that reasonably, probably could have happened, but didn’t. When you look at a historical event, you have to ask yourself if that outcome was inevitable, in which case it demonstrates a truth, or if it was subject to randomness and other things could have happened just as well.
I wouldn’t necessarily say that dumb money can become smart money, but I would say that one of the ways to avoid being dumb money is to not act as if you know things you don’t know. Maybe by the time I get done giving the quote, I’ll be able to remember who said it, but somebody very wise said – Mark Twain, that’s it – “It’s not what you don’t know that gets you into trouble. It’s what you know for certain that just ain’t true.”
The market operates so as to confound rule-makers.
“If I could ask only one question regarding each investment I had under consideration, it would be simple: How much optimism is factored into the price?”
So clearly, buying good things and avoiding bad things can’t be the secret to success in investing. It has to be the price you pay. It’s not what you buy, it’s what you pay.
The key is paying a low price relative to something called intrinsic value. If you pay a high price relative to the value, you’re unlikely to do well and you probably have to get lucky to have a good return, but if you pay a low price relative to the intrinsic value, then the odds – like my book says – are on your side. So we want low price to value. How do you get low price to value? The answer is low optimism.
You mean looking for low overall optimism?

Right. In short, the things that everybody feels good about are likely to be the things that are high-priced, and the things that everybody feels bad about are likely to be low-priced, so if you could find a stock where nobody thinks this company could ever have a good day, maybe there’s a chance that it could produce some favorable surprises and make you a lot of money. If there’s a company like the Nifty 50 back in ’68, where everybody assumed – literally, Tim – nothing bad could ever happen to these stocks, then clearly, there has to be so much optimism in the price that there can never be a favorable surprise. We make money from favorable surprises, and if the positive conviction is so high, then by definition, there can never be a favorable surprise. So I think this is a number one concept.

We should never say “never,” “always,” “has to,” or “can’t.” These expressions are far too absolute to be winners in a world beset by uncertainty and randomness. When you use those words, you tend to get into big trouble.
“I’m going to tell you about the three stages of the bull market. In the first stage, just a few incredibly insightful people understand that there could be improvement. In the second stage, most people recognize that improvement is actually taking place. In the third stage, everybody and his brother believes that things will only get better forever.
A lot of people have moved into higher-risk investments in order to get the returns they want because right now, safe investments – treasuries, high-grade bonds, cash, and money markets – offer so little. So people have been forced to move out the risk curve and take more risk, and that makes the world a riskier place for you and me. I borrowed a phrase from my late father-in-law, who said that those people could be described as handcuff volunteers. They’re doing things not because they want to, but because they have to. But the effect on the market is the same. When people move to riskier actions, it makes the market riskier for everyone.
So when I say “with caution,” I mean with more caution than usual. I think this is a time for more caution than usual, and that’s what I would tell those people.
So I think that the outlook is not so bad and the prices are not so high that you have to practice maximum defensiveness, go to cash, and suffer a 1 percent return on cash, but I think the outlook is not so good and prices are not so low that this is a time for aggressiveness, and I wouldn’t be aggressive.
I think one way that I help myself make these decisions – and it might be helpful to your listeners – is I constantly remind myself and others that as an investor, there are really two key risks that we face every day. Now, the first one is obvious and everybody knows about it. It’s the risk of losing money. What’s the second? It’s not so obvious. It’s a little more subtle. It’s the risk of missing opportunity.
When reminded of the twin risks, most people would say, “I think that’s right. The truth is, I don’t want to lose a lot of money, but on the other hand, I don’t want to miss all the opportunities, so I’m going to compromise. I’m going to balance the two. I’m going to do something in the middle.” That makes sense. Other than daredevils and scaredy-cats, everybody should do something in the middle. Exactly where in the middle is debatable and should be tailored to their own psyche and financial position.
So the interesting question is “What about today?” Today, should you be in your normal balance between the twin risks or should you be different? Should you be in a higher-risk position because so many things yield so little or should you be in a lower-risk position because there are so many uncertainties? And I actually agree with the latter. So fully invested – and being cautious does not mean being in cash – and with everything you want to do in the investment business, there are higher- and lower-risk ways to do it, and I think today is a time for the lower-risk ways.
Being human, we are our own worst enemy. Everything that goes on in the world and the market conspires to make people buy when things are going well and prices are high and sell when things are going badly and prices are low, and fighting that is the number one theme of the book, and it’s the number one theme of success.