Cycle positioning is the process of deciding on the risk posture of your portfolio in response to your judgement regarding the principle cycles, and asset selection is the process of deciding which markets, market niche and specific securities or assets to overweight and underweight.

There are the two main tools in portfolio management. It may be an over-simplification, but I think everything investors do falls under one or the other of these headings.

Cycle positioning primarily consists of choosing between aggressiveness and defensiveness: increasing and decreasing exposure to market movements.

The recipe for success here consists of:

(a). Thoughtful analysis of where the market stands in its cycle.

(b). A resulting increase in aggressiveness or defensiveness.

(c). Being proved right.

These things can be summed up as “skill” or “alpha” at cycle positioning. Of course, “c”-being proved right-isn’t a matter fully within anyone’s control, in particular because of the degree to which it is subject to randomness. So being proved right won’t happen every time, even to skillful investor who reasons things out well.

Don’t try to time the market

One thing that even Warren Buffett doesn’t do is to try to time the stock market, although he does have a very strong view on the price levels appropriate to individual shares. A majority of investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process.

“So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or stock market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money,”

Stock prices may appear random, but there are repeating price cycles, which are predominantly driven by the participation of large financial institutions. Large institutional buying plays out in four distinct phases:

  1. Accumulation
  2. Markup
  3. Distribution
  4. Markdown                   

Howard Marks on Cycles

Dealing with downturns

Oaktree didn’t predict the mortgage crisis and it wasn’t mentioned in any Marks memo. But when it came they were ready. The key is to prepare for different scenarios. Marks then talked in more depth about his views on market prediction than I’ve heard him do on other occasions. He broke it out like this:

-Some events can be predicted with high accuracy.

-Some events can be predicted with some accuracy.

-Some events can be extremely unpredictable.

Not all opinions are equally valuable. You have to factor in how accurate you can be predicting that future scenario. We have to view the future not as a predetermined event but think of it in terms of range of outcomes.

Marks on cycles

A few times during the interview he went into cycles, the economic cycle being the subject of his new book “Mastering the Market Cycle.” Cycles can be different in many ways: speed of onset, duration, ramification, length, course, timing and others.

But some things are similar. A cycle is nearly over when the psychology of market participants is elevated. When bull markets get old you are further into the cycle and generally prices are high. These sort of “tells” are universal and don’t allow you to time exactly, but you should know the cycle is old and you need to start being cautious.

Recommended reading

Grant’s Interest Rate Observer

Fooled by Randomness

A Short History of Financial Euphoria

Source: Howard Marks new book “Mastering the Market Cycle: Getting the Odds on Your Side”

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