Howard Marks on Contrarianism: Excerpt From His Book

Today with permission we're posting up thoughts from Oaktree Capital's chairman and founder Howard Marks from his book: The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor.


Contrarianism

"Accepting the broad concept of contrarianism is one thing; putting into practice is another.  On one hand, we never know how far the pendulum will swing, when it will reverse, and how far it will then go in the opposite direction.

On the other hand, we can be sure that, once it reaches an extreme position, the market eventually will swing back toward the midpoint (or beyond).  Investors who believed that the pendulum would move in one direction forever -- or, having reached an extreme, would stay there -- are inevitably disappointed.

On the third hand, however, because of the variability of the many factors that influence markets, no tool -- not even contrarianism -- can be relied on completely.

Contrarianism isn't an approach that will make you money all of the time.  Much of the time there aren't great market excesses to bet against.

Joel Greenblatt: I've put it this way: just because no one else will jump in front of a Mack truck barreling down the highway, doesn't mean that you should!

- Even when an excess does develop, it's important to remember that "overpriced" is incredibly different from "going down tomorrow."

- Markets can be over- or underpriced and stay that way -- or become more so -- for years.

- It can be extremely painful when the trend is going against you.

Seth Klarman: This is where it is particularly important to remember the teachings of Graham and Dodd.  If you look to the markets for a report card, owning a stock that declines every day will make you feel like a failure.  But if you remember that you own a fractional interest in a business and that every day you are able to buy in at a great discount to underlying value, you might just be able to maintain a cheerful disposition.  This is exactly how Warren Buffett describes bargain hunting amid the ravages of the 1973 to 1974 bear market.

- It can appear at times that "everyone" has reached the conclusion that the herd is wrong.  What I mean is that contrarianism itself can appear to have become too popular, and thus contrarianism can be mistaken for herd behavior.

- Finally, it's not enough to bet against the crowd.  Given the difficulties associated with contrarianism just mentioned, the potentially profitable recognition of divergences from consensus thinking must be based on reason and analysis.  You must do things not just because they're the opposite of what the crowd is doing, but because you know why the crowd is wrong.  Only then will you be able to hold firmly to your views and perhaps buy more as your positions take on the appearance of mistakes and as losses accrue rather than gains."


Excerpted from Howard Marks' book: The Most Important Thing Illuminated (you can get a e-book/Kindle version here). Copyright (c) 2012 Howard Marks.  Used by arrangement with Columbia University Press.


P.S. - if you missed it earlier, we posted another excerpt from Marks book too.

Excerpt From Howard Marks' Book: The Most Important Thing Illuminated

Today we have a special treat for readers as we've been granted permission to publish an excerpt from the book written by Oaktree Capital's Chairman, Howard Marks.

Marks' book, The Most Important Thing Illuminated (or Kindle e-book version here) features a section on combating negative influences, which we've excerpted below:

"People who might be perfectly happy with their lot in isolation become miserable when they see others do better.  In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.

Howard Marks: Emotion and ego: A lot of the drive in investing is competitive.  High returns can be unsatisfying if others do better, while low returns are often enough if others do worse.  The tendency to compare results is one of the most invidious.  The emphasis on relative returns over absolute returns shows how psychology can distort the process.

I know of a nonprofit institution whose endowment earned 16 percent a year from June 1994 to June 1999, but since its peers averaged 23 percent, the people involved with the endowment were dejected.

Seth Klarman: Even the best investors judge themselves on the basis of return.  It would be hard to evaluate yourself on risk, since risk cannot be measured.  Apparently, the risk-averse managers of this endowment were disappointed with their relative returns even though their risk-adjusted performance was likely excellent, as borne out by their performance over the following three years.  This highlights just how hard it is to maintain conviction over the long run when short-term performance is considered poor.

Without growth stocks, technology stocks, buyouts and venture capital, the endowment was entirely out of step for half a decade.  But then the tech stocks collapsed, and from June 2000 to June 2003 the institution earned 3 percent a year while most endowments suffered losses.  The stakeholders were thrilled.

There's something wrong with this picture.  How can people be unhappy making 16 percent a year and happy making 3 percent?  The answer lies in the tendency to compare ourselves to others and the deleterious impact this can have on what should be a constructive, analytical process.

Joel Greenblatt: This is incredibly important.  Most institutional and individual investors benchmark their returns, and therefore most end up chasing the crowd: accent on the wrong sylLABle."

Excerpted from, The Most Important Thing Illuminated by Howard Marks.  Copyright (c) 2012 Howard Marks.  Used by arrangement with Columbia University Press.  You can also get the Kindle e-book version here.


His book is definitely a must-read so check it out.  And if you missed it, we also posted up Marks' recent commentary on contrarian signals.