Oaktree Capital founder Howard Marks is a bold name on Wall Street, as well known for his company’s performance as he is for his extensive letters to investors that he periodically posts free online to reach the widest possible audience.
As shares plunged earlier this month, Marks, who created one of the most successful distressed debt funds in modern history with Oaktree, turned to the financial press to offer a few words of caution. A year earlier, Marks presciently warned investors that the market’s seemingly limitless optimism had gotten out of hand.
In the intervening months, Marks once again proved himself correct, reminding his audience why Warren Buffett once described his memos as “required reading” for anyone interested in the markets.
So, in keeping with his often countercyclical approach, Mark decided to explore the psychology behind bull markets at a time when stocks were teetering on bear market territory.
In his latest missive to investors, titled “Bull Market Rhymes,” Marks, who began his career in finance before bull and bear markets were defined as a 20 percentage point move in either direction, explained that the “emotional essence” The bull market has less to do with the magnitude of the movement and more to do with crowd psychology.
Old school bear market
Before the pandemic relief hysteria took hold, Marks argues that the most recent true bull market was the dot-com boom of the late 1990s and early 2000s. to the Great Financial Crisis, the market of those days moved only gradually and lacked the distinctive tone of unbridled optimism.
Bull markets “are best described by what they feel like, the psychology behind them, and the behavior that psychology leads to,” Marks said. The same goes for bear markets: “Does it really matter if the S&P 500 SPX,
Has it dropped 19.9% or 20%? I prefer the old-school definition of a bear market: stressful.”
To set the thematic tone of his note, Marks began with one of his favorite sayings, paraphrased from Mark Twain: “History does not repeat itself, but it does rhyme.”
With this in mind, Marks delved into what he described as the three stages of a bull market: During the first phase, a handful of forward-thinking investors bet things will get better. During the second, more investors realize that the underlying upturn is really underway. And in the final stage, virtually all investors believe that the recent period of frothy returns will continue forever.
One thing that set the pandemic-related bull market apart from the dot-com boom and other periods of hysterical optimism was that there was essentially no first leg, and very little second. Instead, many investors “went straight from hopeless at the end of March to very bullish later in the year.”
Super Stocks, Cryptocurrencies, SPAC
Bull markets don’t treat all stocks the same, Marks added. Instead, investor optimism typically coalesces around a handful of “super stocks,” whether they be the “Nifty Fifty” of the 1960s or the “FAAMG,” a term for mega-cap tech stocks like Facebook Inc. FB,
parent company Meta Platforms Inc. and Alphabet Inc.’s Google GOOG,
that fueled much of the market’s gains over the past decade (before driving stocks lower in recent months).
This time around, the “super stocks” theme was complicated by the advent of cryptocurrencies, which introduced a new facet to the old dynamic by magnifying investor hysteria as millions chased the near-record returns enjoyed by cryptocurrencies. original crypto investors. The advent of zero fee brokerage accounts introduced by Robinhood Markets Inc. HOOD,
and others was another innovation that set this market apart, Marks said.
While the 2020-2021 bull market had many unique features, there were also features that were reminiscent of previous bull markets. Chief among them was the multitude of public offerings involving unprofitable companies. A relative rarity before the dot-com boom, it became increasingly common both during the dot-com boom and more recently when the SPAC boom presented investors with what looked like a “no-loss proposition” (since it was guaranteed that investors would get their money). return of the money with interest if the organizers failed to consummate a deal, or if the investors did not like the deal they chose).
That notion is among the most dangerous in the investment universe and is a reliable sign that hysteria has taken hold, Marks said.
Today, the average SPAC that has completed the process over the past two years is trading at just $5.25 per share, compared to the standard SPAC offering price of $10. At some point between then and now, investors found that their rational fear of loss was completely subsumed by the fear of missing out; this is usually the final, and most dangerous, stage of the mania-driven bull market. Its primacy is further cemented by the “biggest fool theory”: the notion that even if the prices don’t make sense, someone will eventually be willing to pay more.
Towards the end of his note, Marks summed up his thinking with another popular adage: “what the wise do first, the fool does last.”