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Move Forward, But with Caution: Lessons from Howard Marks on How to Deal with Bull Markets

Recent advances in neuroscience and physiology have shown that when we take risk, including financial risk, we do a lot more than just think about it.

We prepare for it physically. Our bodies, expecting action, switch on an emergency network of physiological circuitry, and the resulting surge in electrical and chemical activity feeds back on the brain, affecting the way it thinks. In this way, the body and the brain string together as a single entity, united in the face of challenge.

Normally, this fusion of body and brain provides us with the fast reactions and gut feelings we need for successful risk-taking. But under some circumstances, these chemical surges can overwhelm us. And when this happens to investors, they come to suffer an irrational exuberance (or pessimism) that can destabilize the financial markets and subsequently wreak havoc on investors’ wealth creation process.

Consider bull markets. When rising stock prices start to validate investors’ belief, the profits they make translate into a lot more than mere greed. They bring on powerful feelings of euphoria and supremacy.

It is at this point that investors feel the bonds of worldly life slip from their shoulders and they begin to flex their muscles like a newborn superhero.

In such situations, assessment of risk is replaced by verdicts of certainty (like “Nifty is quickly headed towards 20,000 points” or “This time it’s different” thinking). Most investors just know what is going to happen with the stock market in general, and their stock prices in particular. And it is such a time in the financial markets’ journey that requires someone like the legendary investor Howard Marks to write one of his most cautionary memos to clients of his fund Oaktree Capital.

As Marks mentions in his latest memo, there have been several times he has written cautionary memos in past. But he confesses at the very start of this memo, “Some of the memos I’m happiest about having written came at times when bullish trends went too far, risk aversion disappeared and bubbles inflated.”

He wrote one such memo on the first day of 2000 (, when the dotcom bubble was near its peak. The other was in February 2007 (The Race to the Bottom), just when last major crisis was nearing its peak.

Now, he writes this in his latest memo –

I’m convinced “they” are at it again – engaging in willing risk-taking, funding risky deals and creating risky market conditions – it’s time for yet another cautionary memo. Too soon? I hope so; we’d rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains. (We all want there to be bargains, but no one’s eager to endure the price declines that create them.) Since we never know when risky behavior will bring on a market correction, I’m going to issue a warning today rather than wait until one is upon us.

Marks then shares a list of the elements that typically form the foundation for a bull market, boom or bubble (quotes in italics are mine) –

A benign environment (exists) good results lull investors into complacency, as they get used to having their positive expectations rewarded. Gains in the recent past encourage the heated pursuit of further gains in the future (rather than suggest that past gains might have borrowed from future gains).

A grain of truth (exists) the story supporting a boom isn’t created out of whole cloth; it generally coalesces around something real. The seed usually isn’t imaginary, just eventually overblown.

Early success (yes, seen all around) the gains enjoyed by the “wise man in the beginning” – the first to seize upon the grain of truth – tends to attract “the fool in the end” who jumps in too late.

More money than ideas (yes, yes, yes) when capital is in oversupply, it is inevitable that risk aversion dries up, gullibility expands, and investment standards are relaxed.

Willing suspension of disbelief (doesn’t seem as of now, but we’re almost getting there) the quest for gain overcomes prudence and deference to history. Everyone concludes “this time it’s different.” No story is too good to be true.

Rejection of valuation norms (exists) all we hear is, “the asset is so great: there’s no price too high.” Buying into a fad regardless of price is the absolute hallmark of a bubble.

The pursuit of the new (yes, youngsters are getting richer faster) old timers fare worst in a boom, with the gains going disproportionately to those who are untrammeled by knowledge of the past and thus able to buy into an entirely new future.

The virtuous circle (exists) no one can see any end to the potential of the underlying truth or how high it can push the prices of related assets. It’s broadly accepted that trees can grow to the sky: “It can only go up. Nothing can stop it.” Certainly, no one can picture things taking a turn for the worse.

Fear of missing out (can see all around) when all the above becomes widespread, optimism prevails and no one can imagine a glitch. That causes most people to conclude that the greatest potential error lies in failing to participate in the current market darling.

The healthy part about the current times Marks mentions is that, while many of the things listed above are in play today, some of the usual ingredients are missing.

Unlike what we last saw in the 2007 boom period, many investors today are conscious of the uncertainties listed above, and also recognize that prospective returns are quite skimpy. Many also accept that things are unlikely to go well forever.

But the big problem we have on hand is that most of us cannot think of what might cause trouble anytime soon. This leads Marks to write –

…it’s precisely when people can’t see what it is that could make things turn down that risk is highest, since they tend not to price in risks they can’t see. With the negative catalyst so elusive and the return on cash at punitive levels, people worry more about being underinvested or bearing too little risk (and thus earning too low a return in good markets) than they do about losing money.

“How difficult could this get?” you may start to wonder when you read that even a legend like Marks is doubting whether he’s early to sound the caution bells. But who said investing was easy?

As Morgan Housel wrote in one of his recent posts –

Investing is not easy. Why? Because most of matters can’t be easily defined as black or white. It’s a vague, shifting shade of grey.

No analyst or fund manager on television will ever tell you this – that investing is not easy, even for them. No superstar investor on social media will do it either.

Of course, the rules of success in investing are simple and have been laid down clearly for decades now, first by Mr. Graham, then by Mr. Fisher, and then refined by Mr. Buffett and Mr. Munger. But the not easy part is taking these lessons seriously and practicing them over long periods of time, especially in today’s times when too much information and too much noise crowds these lessons out of an investors’ brain. And when too many people are seeking instant gratification.

So, What to Do Now?
Chess legend Garry Kasparov advises this in the introduction of his book How Life Imitates Chess

The stock market and the gridiron and the battlefield aren’t as tidy as the chessboard. But in all of them, a single simple rule holds true: make good decisions and you’ll succeed; make bad ones and you’ll fail.

Make good decisions. Yes, that’s the best advice. Always make good decisions…whether times are good or whether they are bad. Certain or uncertain. Also, while making decisions, caution must always be the keyword for a sensible investor.

In fact, Mr. Marks has re-rung the cautious bell like he does in most of his memos. In his latest one, he mentions about continuing to follow his 2012 mantra –

“move forward, but with caution” – and, given today’s conditions, with even more caution than in the recent past.

The last part of his memo is particularly enlightening because here he offers us on a platter all he may have learned about dealing with bull markets in his decades of investment experience. Here’s that part verbatim –

…the keys to avoiding the classic mistakes (in such market conditions are) –

  • awareness of history,
  • belief in cycles rather than unabated, unidirectional trends,
  • skepticism regarding the free lunch, and
  • insistence on low purchase prices that provide lots of room for error.

Adherence to these things – all parts of the canon of defensive investing – invariably will cause you to miss the most exciting part of bull markets, when trends reach irrational extremes and prices go from fair to excessive. But they’ll also make you a long-term survivor. I can’t help thinking that’s a prerequisite for investment success.

The checklist for market sanity and safety is simple, and the answers will tell you what to do:

  • Are prospective returns adequate?
  • Are investors appropriately risk-averse?
  • Are they applying skepticism and discipline?
  • Are they demanding sufficient risk premiums?
  • Are valuations reasonable relative to historic standards?
  • Are deal structures fair to investors?
  • Are investors declining any of the new deals?
  • Are there limits on faith in the future?

The basic proposition is simple: Investors make the most and the safest money when they do things other people don’t want to do. But when investors are unworried and glad to make risky investments (or worried but investing anyway, because the low-risk alternatives are unappealing), asset prices will be high, risk premiums will be low, and markets will be risky. That’s what happens when there’s too much money and too little fear.

I’ll close with a final “ditto,” from “The Race to the Bottom” of just over ten years ago:

If you refuse to fall into line in carefree markets like today’s, it’s likely that, for a while, you’ll (a) lag in terms of return and (b) look like an old fogey. But neither of those is much of a price to pay if it means keeping your head (and capital) when others eventually lose theirs. In my experience, times of laxness have always been followed eventually by corrections in which penalties are imposed. It may not happen this time, but I’ll take that risk.

What Am I Doing Now?
I don’t claim to be among the smartest investors out there, so knowing what I’m doing now shouldn’t matter to you much. But, just for its fun element, here is what I’m doing with my savings and investments now –

  • First, I am not selling (or looking to sell) my high-quality investments just because their valuations have reached a high level. In fact, I don’t intend to sell such stocks ever, till I need to meet a financial goal or till the underlying businesses give me reasons to sell them.
  • Second, if I’m finding value in certain pockets of the market, I am investing instead of waiting for even perfect values.
  • Third, I am completely off the temptation of buying “chor” (crooked) companies and managements. I don’t buy into this theory of searching for value in garbage quality stuff just because there’s nothing available of the high-quality stuff. I remind myself of what Thomas Phelps wrote in his book 100 to 1 in the Stock Market – “Remember that a man who will steal for you, will steal from you.”
  • Fourth, I understand and highly appreciate this fact that being a part-time investor who is not dependent on the stock market for his living puts me under no obligation to act at all times. When I have nothing to do in the markets, I do nothing. I love this flexibility and put it to complete use.
  • Fifth, I understand that I am not entitled to “always high prices” from my stocks. And thus, I keep my bulls**t indicator on high alert when I see someone pitching me even higher prices. I have never bought blindly on tips, and I maintain such a stance however attractive the proposition looks like. As a wise man said, “Tips are just that. Tips. Following blindly is setting you up for epic ruin.” This is especially true in markets like these.
  • Sixth, to act on my increased caution with every surge in prices, I am allocating a smaller portion of my incremental savings to equities (the rest goes to liquid funds etc.).
  • Seventh (and I’ll end here for it’s my lucky number), I am spending less and less time thinking and looking at the stock market and my stocks, and more time reading, doing nothing, and fooling around with my family. That keeps me away from all or any madness that others deeply involved in stocks may be bearing now.

To repeat, all this that I am doing should not be a big deal for you.

But what Mr. Marks says, I think, should be.

Remember history and learn from it. Ask questions. Believe in cycles. Be skeptical. Insist on low purchase prices that provide lots of room for error.

You have my best wishes.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.


  1. R K Chandrashekar says:

    Dear Vishal and Anshul
    Full ‘ marks’ for this timely initiative.
    Everyone seems to like bull markets, though lot more wealth is created in bear markets😊.
    Here we are in UK on a 2 months laid back holiday amongst kith and kin. Stocks are last on my mind, though mutual funds are on auto pilot-SIP. I saw the wonderful work you did for children. Keep doing the good work. Stay blessed.

  2. Thanks Vishal

  3. Nikhil Menon says:

    Hi Vishal – Great article as always! I was wondering since you mentioned that “a part-time investor who is not dependent on the stock market for his living” I am curious as to how you maintain your lifestyle and support your family. For people like us in the rat-race it would be helpful advice. Past savings? Other investments? Lower costs? Your business earnings (blog only?) and so on.

    I hope you don’t find this intrusive. It would be educational for us all.


  1. […] I chanced upon Safal Niveshak’s article on Howard’s memo. At the end of his article, he touched on seven things that he is currently doing now on his […]

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