05 Nov Another Howard Marks’ Memo – It’s Not Easy

On second level thinking

There is nothing reliable to be learned about making money. If there were, study would be intense and everyone with a positive IQ would be rich. – John Kenneth Galbraith

Anyone who thinks it’s easy to make money from markets must be a first level thinker.
First-level thinking says:”It’s a good company; let’s buy the stock.” Second level thinker says: “It’s a good company but everyone thinks it’s a great company, and it’s not. So the stock is over-rated and over-priced. Let’s sell”

First level thinking is simplistic and superficial. First level thinkers see what’s on the surface, react to it simplistically and buy or sell on the basis of their reactions. They don’t understand their setting as a marketplace where asset prices reflect and depend on the expectations of the participants. They ignore the part that others play in how prices change. And they fail to understand the implications of all this for the route to success.

The herd is wrong about risk as often as it is about return. When everyone believes that something is risky; their unwillingness to buy usually reduces its price to the point where it’s not risky at all. This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them.

The riskiest thing in the world is the widespread belief that there’s no risk.

The problem that befalls most people (the first level thinkers) is that they fail to distinguish between fundamental risk and investment risk. What has to be remembered is the defining role of price. Regardless of whether the fundamental outlook is positive or negative, the level of investment risk is determined largely by the relationship between the price of an asset and its intrinsic value.

On diversification

It’s normal to have some laggards in a portfolio that’s truly well-diversified.

Paper: It’s not easy