Howard Marks explains how to avoid a crash by learning to recognize the signs of a bull glut

Oaktree founder Howard Marks is a big name on Wall Street, known for his company’s track record and the lengthy investor letters he regularly posts for free online to reach the widest possible audience.

Earlier this month, Marks, who built one of the most successful distressed debt funds in modern history with Oaktree, issued some warnings in the financial press as the stock market tumbled. A year ago, Marks presciently warned investors that the market’s seemingly boundless optimism was out of control.

In the months that followed, Marks was proven right again, reminding his audience why Warren Buffett had described his memo as a “must read” for anyone interested in the markets.

So, in keeping with his often countercyclical approach, Mark decided to explore the psychology behind a bull market when stocks are on the brink of a bear market.

in his latest investor lettertitled “Bull Rhymes” — who began his career in finance before bull and bear markets were defined as moving 20 percent in either direction — explained that the “emotional nature” of bull markets is not as similar to that of a bull market. The magnitude of the movement has more to do with mass psychology.

Old school, bear market

Before the pandemic relief hysteria, Marks argued that the last real bull market was the dot-com boom of the late 1990s and early 2000s. Despite the stock market rally on the eve of the financial crisis, it was a slow-moving market that lacked unbridled optimism.

A bull market is “best described in terms of how it feels, the psychology behind it, and the behavior that it leads to,” Marks said. The same goes for bear markets: “S&P 500 SPX,
Is it down 19.9% ​​or 20%? I prefer the old-school definition of a bear market: nerve-wracking. ”

To set the thematic tone for his notes, Marks began with one of his favorite lines, quoting Mark Twain: “History doesn’t repeat itself, but it rhymes.”

With that in mind, Marks digs into what he calls the three phases of a bull market: In the first phase, a handful of forward-looking investors are betting that things will get better. In the second phase, more investors realize that potential improvements are actually underway. In the final stage, almost all investors believed that the recent period of frothy returns would last forever.

One of the things that separates the pandemic-related bull market from the dot-com bubble and other periods of hysterical optimism is that there is basically no first phase and very little second. Instead, many investors “turned straight from despair at the end of March to high optimism later in the year”.

Super Stocks, Cryptocurrencies, SPACs

Bull markets don’t treat all stocks equally, Marks added. Instead, investor optimism has typically focused on a handful of “superstocks” — whether they were “Nifty Fifty” or “FAAMGs” in the 1960s — a term for big tech stocks like Facebook Inc. FB,
Google GOOG of parent companies Meta Platforms Inc. and Alphabet Inc.,
This has driven most of the market’s gains over the past decade (before leading stocks fell over the past few months).

This time, the “superstock” theme is complicated by the advent of cryptocurrencies, which have fueled investor hysteria as millions chase the near-unprecedented returns enjoyed by original cryptocurrency investors, giving Old dynamics bring new wrinkles. Robinhood Markets Inc. HOOD ushered in the emergence of zero-fee brokerage accounts,
And other products are another innovation that sets this market apart, Marks said.

While the 2020-2021 bull market has many unique characteristics, there are also some that are reminiscent of previous bull markets. Chief among them are public offerings involving unprofitable companies. Relatively rare before the dot-com bubble, this has become more common during and more recently, as the SPAC boom offered investors a seemingly “no-loss offer” (as investors were guaranteed to get their the investor fails to complete the transaction, or if the investor does not like the transaction of their choice, a refund with interest).

That kind of thinking is one of the most dangerous in the investing world, and a sure sign that hysteria has taken hold, Marks said.

Today, the average SPAC transaction price that has gone through this process over the past few years is just $5.25 per share, compared to the $10 IPO price for a standard SPAC. Between then and now, investors have seen their rational fear of loss completely overshadowed by the fear of missing out; this is often the last — and most dangerous — phase of a fanatical-driven bull market. The “greater fool theory” further cements its primacy: Even if the price doesn’t make sense, there will eventually be someone willing to pay more.

At the end of his note, Max summed up his thoughts with another popular adage: “What the wise do in the beginning, the fool in the end”.