Booked: Mastering the Market Cycle

A little while ago, I read a book by the title of “Mastering the Market Cycle” written by Howard Marks.

Howard Marks is an investor and writer, who began his career at Citibank. Eventually, he’d start up his own Capital Management firm, Oaktree Capital Management.

Interestingly, Oaktree focuses on what’s known as Distressed Securities, and is one of the largest global asset management firms in this space. Distressed Securities focus on companies who are in serious trouble, possibly facing bankruptcy – so they trade at deep discounts.

Companies like Oaktree take on these companies after careful review and analysis to zero-in on good companies with poorly structured debt and sickly balance sheets; looking for value with good companies who need restructuring. A bit of a sidetrack, but Howard Marks discusses it a bit in his book and it’s a rather interesting specialty.

On to the book itself! Marks discusses the typical lifecycle of markets, fundamentals of those cycles driven by economic variables, and the larger swings we see in real life, driven by investor psyche and more.

He discusses the underlying upward trend we see driven by macroeconomic growth of a country. This might be 2-3%. However, we never see this consistent percentage, but rather higher returns and lower returns; peaks and troughs.

Above image from Intelligent Economist

Around this upward trend, people and external factors such as changes in regulation, taxation, innovation, etc. create the peaks and troughs around this 2-3% growth. We actually experience years of 10% and more, or far far less, possibly negative returns (recessions).

Peaks are created by exuberance, promise of economic expansion, favourable policy, and a desire for more consumption through higher spending. In these good times, lenders relax debt covenant provisions making it easier for people and companies to attain leverage, also known as credit because lenders feel confident in the economy’s trajectory.

Troughs are created by fear. Droughts in business opportunities that starve capital of effective ways to generate adequate return and lenders increase scrutiny on lending which leads to reduced availability of credit.

There was an example, if I recall correctly, it was in Marks’ book but I don’t have it with me as I write this.

It went something like this:

If you go into a retail store and buy a shirt on credit card, you are not paying them. There’s no exchange of physical cash, nor is it a debit to your savings account. They are allowing you to take the shirt on the promise (credit) of being paid by the creditor, typically a bank (which seems pretty well guaranteed).

The bank then assumes the counter party risk of you not being able to pay (and would charge you 20% interest if you can’t). If you walk out with that shirt and subsequently cannot pay the credit card balance, the bank needs to charge you interest – if you don’t have the assets to pay, the bank eventually needs to write-off the loan and take a loss.

Overly simple example, but the basic mechanics are there.

Okay, so picture this on a more grand and global scale, imagine all the credit floating around out there these days; we’re still in good economic times, although the cycle is long in the tooth.

Imagine things take a turn, and lenders become fearful – they reduce ones ability to borrow through credit, interest rates rise, etc. as lenders fear borrowers will not have the capacity to pay them back.

People cannot purchase as much, since they cannot borrow against the future, and they have to dump more of their after-tax income to service their debts as interest rates rise (which is a problem here in Canada. Houses are leveraged to the hilt here.)

While I enjoy the subject matter, I struggled a bit with the writing style. A bit dry for my liking, but there’s good information in the book for beginners. Pick it up at your local library for a spin!

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