A common theme that underlies Howard Marks (Trades, Portfolio)’ commentary on intelligent risk analysis is the fallacy underlying the phrase “this time, it’s different,” adopted by far too many investors to sustain their belief that favorable market conditions will continue indefinitely. Indeed, Marks argues that failure to adequately challenge this mindset, so prevalent during bull markets, is an indication of how many investors fail to adequately factor in a qualitative element of risk in their investment decisions.
In his 2019 memo to clients, Marks revisited the concept of risk assessment within the context of the conventional wisdom that holds the current decade-long bull market still has legs.
For purposes of informed risk assessment, Marks didn’t contend the “this time, it’s different” proposition is demonstrably false; only that its validity may be predicated on some shaky or tenuous assumptions. As Marks noted, many of the current prognostications about the direction of the market rest on a number of underlying premises, most notable of which are the unwavering belief in the permanence of the “Goldilocks” economic environment; namely, two unquestioned assumptions that:
“Economic growth won’t be so strong that it brings on excessively high inflation, or so weak that it ends in recession.”
“Inflation won’t be so low that the economy stagnates, or so high that it leads to burdensome increases in the cost of living and requires contractionary interest-rate increases to cool it off.”
Marks posed a question with regard to many of the sanguine predictions or theories currently offered by analysts and investors alike in support of their belief in continued market vitality:
“What do all the theories propounded above have in common? That’s easy: they’re optimistic. Each one provides an explanation of why things should go well in the future, in ways that didn’t always go well in the past.”
Marks argued that all the “this time, it’s different” theories, suggesting the current bullishness sentiment is warranted, blinds investors to genuine risks resulting from overvaluation and price mismatches among asset classes, that many inadvertently or deliberately ignore:
“Everything else being equal, these things result in asset prices that are high relative to intrinsic values, and their presence exposes us to the risk that they’ll abate, taking asset prices down with them.”
Marks described how investors’ perceptions of their market losses and gains in times of plenty are prone to extremes and differ markedly from these same assessments in our everyday lives:
“That’s one of the crazy things: in the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless.’ The pendulum careens from one extreme to the other, spending almost no time at ‘the happy medium’ and rather little in the range of reasonableness.”
Marks notes those who incorporate “the four words” (i.e., this time, it’s different) as the determinative basis for their investment decisions, are sometimes blithely unaware of the losses they will sustain by not being more circumspect in their outlook for the market:
“Widespread attaching of ‘the four words’ to bullish propositions suggests that the environment is being perceived as flawless. When and if that swings to hopeless, the result is pain for investors.”
In his 2019 memo, Marks again, characteristically admitted that he doesn’t know what will occur; all of the financial and economic assumptions that are necessary for continued prosperity very well may come to fruition. Nonetheless, he argued that investors should be aware that, frequently, it would take a remarkable series of events transpiring in tandem for all these necessary conditions to occur simultaneously.
Finally, Marks reminded value investors that patience, humility and skepticism about the conventional wisdom can provide rewards:
“The best investments often are made in times of fear and desperation. That’s rarely possible when investors are willing to blithely dismiss the limitations of the past with the words ‘this time it’s different.’ I would remind those investors of a quote usually attributed to Mark Twain: ‘History doesn’t repeat itself, but it does rhyme.’