Sunday, 16th October 2011

Howard Marks Investing Ideas, part 4

Written by George Traganidas Topics: Stock Investing, Wealth Building

The “know” and “don’t know” schools

The “I know” school people believe they can discern what the future holds, and in their world investing is a simple matter:

  • First you decide what the economy is going to do in the period under consideration.
  • Then you figure out what the impact will be on interest rates.
  • From this you infer how the securities markets will perform.
  • You choose the industries that will do best in that environment.
  • You make judgments about how the industries’ companies will fare in terms of profits.
  • Based on all of this information, you pick stocks that are bound to appreciate.

End of story. Of course, the usefulness of this approach depends entirely on people’s ability to make these decisions correctly. What if you’re wrong about the economy? What if you’re right about the economy but wrong about its impact on a company’s profits? Or what if you’re right about profits but the valuation parameters contract, and thus the price? The bottom line is that the members of this school think these things are knowable. Lots of people are perpetually and constitutionally optimistic about both the long-term future for stocks and their ability to make these judgments correctly.

The “I don’t know” school in short,

  • Feel it’s impossible for anyone to know much about a vast number of things.
  • Consider it especially difficult to outperform by guessing right about the direction of the economy and the markets.
  • Spend our time trying to know more than the next person about specific micro situations.
  • Think more about what can go wrong than about what can go right.

In contrast to the “I know” school, people in this group are more cautious and feel a strong need for downside protection.

Classic Investment Mistakes

  • Borrowing short to buy long
  • Confusing paper profits with real gains
  • Being seduced by loss limitation
  • Misjudging liquidity
  • Ignoring the impact of others
  • Underestimating correlation

Fire Sale Process

  • Take on short-term capital
  • Invest it in longer-term or illiquid assets
  • Experience price declines and writedowns that eliminate your resolve to hold, unsettle your suppliers of capital and/or jeopardise your capital adequacy
  • Receive a margin call or capital withdrawal notice
  • Need to raise cash on a day of market chaos
  • Be forced to sell into an inhospitable market regardless of price

Take advantage of opportunities in a collapsing market

  • Have a firm well-reasoned estimate of an asset’s intrinsic value
  • Recognise when the asset’s price falls below its value and buy
  • Average down if the price goes lower
  • Be right about the value


“There can be few fields of human endeavour in which history counts for so little as in the world of finance.” John Kenneth Galbraith

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” John Kenneth Galbraith

“The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.” Warren Buffett

“People get into trouble when they forget that in the long run, stocks won’t appreciate faster than the growth in the corporate profits.” Warren Buffett

“It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.” Amos Tversky

“Markets can remain irrational longer than you can remain solvent.” John Maynard Keynes

“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” John Maynard Keynes

“A speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware.” John Maynard Keynes

“Nobody goes to that restaurant anymore; it’s too crowded.” Yogi Berra

“Most of financial history has taken place within two standard deviations, but everything interesting has occurred outside of two standard deviations.” Ric Kayne

“In economics things happen slower than you expected they would, but when they finally do, they happen faster than you imagined they could.” Larry Summers

“Improbable things happen all the time, and things that are supposed to happen often fail to do so.” Bruce Newberg

“Those who cannot remember the past are condemned to repeat it.” George Santayana

“Risk means more things can happen than will happen.” Peter Berstein

“What the wise man does in the beginning, the fool does in the end.”

“The six-foot tall man who drowned crossing the stream that was five feet deep on average.”

“The more you bet, the more you win when you win” Las Vegas maxim (… and the more you lose when you lose.)

“It’s essential to remember that the fact that something’s probable doesn’t mean it’ll happen, and the fact that something happened doesn’t mean it wasn’t improbable.”

“I have given up on trying to get people to do what I tell them to do; they do what I pay them to do.”

“He knows the price of everything but the value of nothing.”

“In times of crisis, all correlations go to one.”

“Experience is what you got when you didn’t get what you wanted.”

“Being too far ahead of your time is indistinguishable from being wrong.”

“History doesn’t repeat itself, but is does rhyme.”

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

“…understanding the difference between certainty and likelihood can make all the difference.”

“Investing isn’t supposed to be easy. Anyone who finds it easy is stupid.”

Follow the practical way,

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