Summer S.'s Key Ideas from Mastering the Market Cycle
by Howard Marks

A: Recovery from an excessively depressed lower extreme, toward the midpoint.

B: The continued swing past the midpoint, toward an upper extreme or high.

C: The attainment of a high.

D: The downward correction from the high back toward the midpoint.

E: A continuation of the downward movement past the midpoint, toward the new low.

F: The reaching of a low.

G: Recovery from the low back toward the midpoint.

Keep in mind that:

• Excessive optimism is dangerous.
• Risk aversion is an essential ingredient for the market to be safe.

The output of an economy is the product of hours worked and output per hour. Thus the long term growth of the economy is determined by fundamental factors like birth rate and the rate of gain in productivity.

Long term trends have given the economy and stock market a strong uptrend over several decades:

• Macro Environment
• Corporate Growth
• The Borrowing Mentality
• Popularization of Investing
• Investor Psychology

Central bankers have dual responsibilities that are in opposition to each other:

• Limit Inflation: which requires restraining the growth of the economy.
• Support Employment: which calls for stimulating economic growth.

Governments

When governments want to stimulate their country’s economy, they can:

• Cut Taxes
• Increase Government Spending
• Distribute Stimulus Checks

When governments want to slow their country’s economy, they can:

• Increase Taxes
• Decrease Government Spending

The mood swings of the securities markets resemble the swing of a pendulum. They swing between the following:

• Between euphoria and depression
• Between celebrating positive developments and obsessing over negatives
• Between overpriced and under-priced
• Between greed and fear
• Between optimism and pessimism
• Between risk tolerance and risk aversion
• Between urgency to buy and panic to sell

• Investing is basically “bearing risk in pursuit of profit.”
• The ability to understand, assess, and deal with risk is the mark of the superior investor and an essential requirement for investment success.
• The way investors are collectively viewing risk, and behaving in regard to it, is of overwhelming importance in shaping the investment environment in which we find ourselves. 
• The state of the environment is key in determining how we should behave with regard to risk at that point. 
• The rational investor is diligent, sceptical, and appropriately risk-averse at all times.

Superior investing doesn’t come from buying high-quality assets, but from buying when the deal is good, the price is low, the potential return is substantial, and the risk is limited. These conditions are much more the case when the credit markets are in the less euphoric, more stringent part of their cycle.

• Capital: all the money used to finance a business.
• Credit: the portion of a company’s capital that is made up of debt rather than equity.

If the market were a disciplined calculator of value-based exclusively on company fundamentals, the price of a security wouldn’t fluctuate much more than the issuer’s current earnings and the outlook for earnings in the future.

Three stages of a bull market:

• A few forward-looking people begin to believe things will get better.
• Most investors realize improvement is taking place.
• Everyone concludes things will get better forever.

Three stages of a bear market:

• A few thoughtful investors recognize that, despite the prevailing bullishness, things won’t always be rosy.
• Most investors realize things are deteriorating.
• Everyone is convinced things can only get worse.

The investor’s goal is to position capital so as to benefit from future development. The Key to accomplishing this goal is:

• To know where the pendulum of psychology and the cycle in valuation stand in their swings.
• To refuse to buy when too positive psychology and the willingness to assign too high valuations causes prices to soar to peak levels.
• To buy when downcast psychology and the desertion of valuation standards cause panicky investors to create bargains by selling despite the low prices that result.

There are three ingredients for success:

• Aggressiveness
• Timing
• Skill

If you have enough aggressiveness at the right time, you don’t need that much skill. Good timing in investing can come from diligently assessing where we are in a cycle, and then doing the right thing as a result.

There are six main components (or three pairings) to the formula for investment success:

• Pair 1: Cycle Positioning and Asset Selection
• Pair 2: Aggressiveness and Defensiveness
• Pair 3: Skill and Luck