Howard Marks Part-1: We

cannot predict future, but we

can prepare
It is not only our ability to predict but predicting better than the
others that matters the most, says the noted investor thinker
Jitendra Kumar Gupta
    

Howard Marks, co-founder of the US-based Oaktree Capital, is considered to be

one of the most influential investment thinkers. Warren Buffett once said about
him: “When I see memos from Howard Marks in my mail, they're the first thing I
open and read.”

Often dubbed as goldmines for the curious minds, Howard Marks’ memos are
among the most read investor letters globally. We went through several of his
memos between January and June this year, particularly in the backdrop of the
current crisis, to enhance our understanding and develop a framework to deal with
the uncertainty.
 We will cover several of these lessons and frameworks, handpicked from these
memos, over the next few days.

Key takeaway-1: We cannot predict, But we can prepare 

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We cannot predict… 

Howard Marks, in his client memos and books, has repeatedly spoken about our
inability to predict the future or know what the future holds.

In his book, “Mastering the Market Cycle”, Marks writes: “As I’ve made clear,
I don’t believe in forecasting. Very few people can know enough about what the
future holds for it to add to their returns, and the record of most forecasters — in
terms of both predicting events better than others and having better investment
performance than others as a result — is quite lacklustre. A few people become
famous in each period for singular, spectacular successes, but usually their next
correct forecast doesn’t come for many years.”

Forecasting is not only difficult but considered as an extremely rare ability, which
is often a result of randomness and luck. In his recent memo titled “Uncertainty”,
he once again touches on the subject, particularly in the context of Covid-19.

What makes the task difficult?  

Multiple factors working at the same time — “For investors, the future is

determined by thousands of factors, such as the internal workings of economies,
the participants’ psyches, exogenous events, governmental action, weather and
other forms of randomness. Thus the problem is enormously multi-variate,” says
Howard Marks.
The element of randomness: Referring to Covid-19 and the sequence of events
triggered by the pandemic, he suggests, “No one can succeed in predicting things
that are heavily influenced by randomness and otherwise inconsistent”.

Economics is not a precise science: Unlike physics or any other subject that

involves a precise science, economics and other related activities are not precise
science — that is the biggest handicap while indulging in prediction.

Unreliable inferences: Economists and investors often indulge in drawing

inferences from the past or developing patterns in the mind with reference to the
past. However, while they could be helpful, Marks believes they are not reliable
and thus impair our ability to predict.

Inviting unnecessary competition: It is not just the prediction, we as investors are

inviting unnecessary competition. When we indulge in predictions, we are directly
and indirectly competing with those who do not know that they do not know. Such
competition is neither healthy nor worthwhile.
It is not only our ability to predict but predicting better than the others that matters
the most.

In his memo, Marks suggests: “First of all, forecasting is a competitive arena. The
argument for the difficulty of out-forecasting others is similar to the argument for
market efficiency (and thus the limitations of active management). Thousands of
others are trying, too, and they’re not ‘empty suits’. Many of them are educated,
intelligent, numerate, hard-working, highly motivated and able to access vast
amounts of data and computing power. So by definition it shouldn’t be easy to be
better than the average.”

A mere halo effect 

If predicting future is difficult, what about the forecasters and their ability to
predict? Howard Marks quotes Warren Buffett, who once said, “Forecasts usually
tell us more of the forecaster than of the future”.

The factors enlisted above make it clear that our ability to predict is limited. Marks
writes that people who are indulging in this business are nothing but guessing or
speculating on something that most of them have no ability to predict. The
outcome of such an exercise is similar to the result of tossing a coin.

In his 2009 memo “The Long View”, Howard Marks has explained this human
tendency with an excellent analogy or a story.

“There’s an old story about a group of blind men walking down the road in India
who come upon an elephant. Each one touches a different part of the elephant —
the trunk, the leg, the tail or the ear — and comes up with a different explanation
of what he’d encountered, based on the small part to which he was exposed. We
are those blind men. Even if we have a good understanding of the events we
witness, we don’t easily gain the overall view needed to put them together. Up to
the time we see the whole in action, our knowledge is limited to the parts we’ve
touched.”
…But we can prepare 

Without predicting what the future holds in store, investors can still act in a
sensible manner and benefit.

While explaining how to live with the cycles in his 2001 memo, Howard Marks
had suggested, “No one knew when the tech bubble would burst, and no one knew
what the extent of the correction could be or how long it would last. But it wasn't
impossible to get a sense that the market was euphoric and investors were behaving
in an unquestioning, giddy manner. That was all it would have taken to avoid a
great deal of the carnage. So I'm not trying to give the impression that coping with
cycles is easy. But I do think it's a necessary effort. We may never know where
we're going, or when the tide will turn, but we had better have a good idea where
we are”.

In his latest June 2020 memo, titled “Uncertainty II”, Howard Marks extends these
important points.

He stresses the point that instead of predicting the future, the focus could be on
what we already know and what is knowable.

“In 2001, I wrote a memo titled ‘You cannot predict. You can prepare’. At the first
glance that (title) seems like an oxymoron. How can we prepare for something we
cannot predict?” he says.

“We can do so by recognising that they will inevitably occur, and by making our
portfolios more cautious when economic developments and investor behaviour
render markets more vulnerable to damage from untoward events.”

In his May 2020 memo, Howard Marks says: “Many years ago, my friend Ric
Kayne pointed out that ‘95% of all the financial history happens within two
standard deviations of normal, and everything interesting happens outside two
standard deviations’. Arguably, bubbles and crashes fall outside of the two
standard deviations, but they are the events that create and eliminate greatest
fortunes.”

To sum it up, Howard Marks suggests that investors can not only prepare for these
pandemic like events, which lie at the extreme end of a bell curve, but also take
advantage of those situations through portfolio adjustments. However, the key is to
shift our attention from “where we are heading in the future and what we do not
know or not knowable” to “where we are in the given cycle and what we know and
are knowable”.