Howard Marks, Oaktree Capital — 2022-06-23
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Memos from Howard Marks 2022-06-23T07:00:00.0000000Z" pubdate title="Time posted: >6/23/2022 7:00:00 AM (UTC)">Jun 23, 2022
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I recently was asked by Patrick Schotanus of Edinburgh Business School to participate in their inaugural symposium on the subject of cognitive economics. The symposium took place at Panmure House, the final residence of the great economist Adam Smith, and the theme was the Market Mind Hypothesis (MMH), which Patrick developed. I spent an hour recording a video interview with him, which on May 24 was shown at the symposium and followed by a live question-and-answer session. We then used software to create a transcript of the taped interview. I've edited it only to make my remarks more intelligible and less painful to read (without changing their message); any serious additions are shown in brackets.
While little of my content is totally new (in fact, you might recognize some thoughts that I went on to incorporate in Bull Market Rhymes ), it seems only right to share it with Oaktree's clients because it's never all been presented in one place before. I hope you'll find something worthwhile in the conversation.
Patrick Schotanus: Hello, Howard. Thank you first of all for participating in our symposium by way of this fireside interview, in which we'll discuss some of your memos as well as other reflections that you've shared with investors over the years. For the benefit of our multidisciplinary audience, I'll introduce some of these questions with some explanatory background, especially from a cognitive angle. So I'd like to start with a few questions by MMH team members. The first one is from James Clunie:
You often write about the concept of the pendulum. More recently, in a podcast , you applied it to international affairs. While the pendulum appears at first glance to be a mechanical model, importantly, you have also applied it to human psychology, especially mood swings. These fit much more with a spontaneous "market mind," which you have also referred to, for example, in your memo You Can't Predict. You Can Prepare . Consequently, the question is, in what way and to what extent is the pendulum mechanical? For example, would it be correct to say that while the pendulum implies mean reversion, the latter is not a mechanical process and is thus difficult to predict?
HM: Thanks for that question, Patrick. I'm very pleased to be discussing these topics with you. As you know, they're something I'm fixated on, and it's great to have someone to talk with about them. I think the pendulum is a good example of many of the things we're going to discuss today. It's an idea. It's a concept. The idea is that it's something that swings back and forth. Something that oscillates, something that fluctuates around a midpoint. That's the whole concept.
It's certainly not mechanical. In physics, I think the pendulum has certain qualities, and as a result, its behavior can be predicted. But in the things I'm talking about, no. As you know, my last book, in 2018, was called Mastering the Market Cycle , and I talked a lot in there about the pendulum. I got a note from Nick Train of Lindsell Train in London, saying something like, "I disagree with you, Howard: this isn't a pendulum. Its movement is not regular, it's not predictable, the speed of the fluctuations varies, and their extent varies." And I said, "Nick, let's have lunch." So, when I next got to London, we sat down and I explained to him that there are multiple definitions of a pendulum. One definition says it's mechanical and thus predictable, and governed by the laws of physics. And another definition says that it's a swing."
In your question to me, Patrick, you used the term "mood swing," and I think understanding it as a mood swing is much more useful for our purposes. As this discussion progresses this morning, I think the main thrust is going to be that these things are not scientific and thus not consistent and repeatable.
PS: Russell Napier, another member, has a related question also covering the mechanical angle. Mainstream economics, also known as mechanical economics, which partners the unlikely bedfellows of Neoclassical and Neo-Keynesian economics, views and treats the market as some automaton, in a way, that can be centrally engineered, planned, and steered. If instead we view the market as embodying our collective extended mind, acknowledging its warts and all, which obviously is our thesis, which two episodes in your career would be best suited to study the market mind?
HM: Russell's question about the two episodes, contained in your last sentence, would limit me too much. So, if you don't mind, I'm going to go way beyond that, because I think my answer to this question is central to our whole discussion today.
Your first few words, when you discussed what Russell said, refer to the economy as mechanical, and I think that isn't helpful. Applying the word "mechanical" (again, as with the first question) suggests that it's governed by the rules of physics, the laws of nature, that it's a science, that it performs the same each time, that it's repeatable, studiable and extrapolable. And I think these are all wrong.
And in fact, I aggressively remind people that I'm not an economist, but also that economics is called the "dismal science." And I'm not sure it's a science at all, but if it is, it's certainly dismal, in the sense that it's not like physics, where if you do A, you always get B. Sometimes you get C or sometimes nothing at all. Richard Feynman, the great physicist, once said, "Physics would be much harder if electrons had feelings." You walk into a room, you throw the light switch, and the light goes on. It always goes on, because every time you throw the switch, the electrons flow from the switch to the light. They never forget to flow; they never decide to flow in a different direction; they never flow from the light to the switch. They never go on strike or complain that they're underpaid.
So, the point is that economics is not a science, in my opinion. You know, science is all about causality and predictability, and if A happens, then B is sure to happen. Well, that's certainly not true in economics. If A happens, B might tend to happen most of the time. That doesn't make it a science.
Now let's talk about using these concepts to refer to investing, not economics. I have a presentation that I give, called The Human Side of Investing, or the Difference between Theory and Practice . It was inspired by a quote from a great philosopher. You may know him (or maybe not, since you're mostly not Americans): Yogi Berra. Yogi was a great catcher for the New York Yankees baseball team in the 1950s – a highly skilled baseball player, but more famous today for the things he said, or maybe he didn't say them. (One of the things Yogi said is, "I never said half the things I said.")
But anyway, he once said, supposedly, that "In theory there's no difference between theory and practice, but in practice there is." And to me, that's the essence of this answer to you. It's the essence of my work, and in my opinion, it should be the essence of your work and that of your colleagues at this conference.
What we learn in school, in my opinion, and what we should learn in school, is how things are supposed to work. That goes for the economy, and that goes for the markets. However, the teachers might also help by adding, ". . . but it doesn't always work that way. That's a framework; that's a thought model. It cer