During this stage, investors are more likely to take on risk and engage in speculative behavior, as they believe that the market will continue to rise. Howard: Sure. One of the most important chapters in the book is on the credit cycle. Most people don't think about the credit cycle very much. Of course, those of us who deal in lending do more so. The credit cycle is really very important and it is one of the fastest moving cycles. Very important and very volatile. What credit cycle is mostly about is about the availability of credit and the terms. Sometimes the credit window is too wide open, too many people wanna lend money, and when they compete to make the loans the loan goes to the person who will take the lowest quality and the least yield. That's a dangerous condition. I call it the race to the bottom. At other times the credit window closes, credit is not available or it's only available on very high cost and very tight terms, that's the great time to be an investor. Real estate has emotional up-cycles and down-cycles just like any other asset, but what makes it interesting and unique is the significant time lag involved in bringing new supply to market. Unlike issuing new debt or equity, it takes years in real estate between “let’s do it” and “the deal is done”, due to the difficulties in finding land, getting approvals, design, construction, etc. Small swings in the economy lead to big swings in profits, bigger swings in markets, and changes in the credit window. The credit window can go from “wide open” to “slammed shut” in an instant. Small changes in fundamentals can trigger big shifts in markets, with a turn in investor sentiment providing the catalyst. Howard Marks, CFA, a co-founder of Oaktree Capital Management and a pioneer of distressed debt investing, has made his career by stepping in to provide capital when the credit window slams shut.

Alan: Okay. Next question, this actually dovetails on a comment I think you talked a bit about in your first answer about the market cycle. The question is about what you're observing right now in the high-yield bond market and how that impacts your expectations for let's say the next year or two. What I wanted to add to that was I think one of the things you mention in your book is sort of signs that the market might be getting a bit ahead of itself or a bit frothy. One of the things you talk about is the quality of bond issuance and the high-yield markets, and the distress debt arena and that recently we've seen, and I think the Federal Reserve commented on this frankly a few months ago, that the quality of issuance has really slipped. Covenants have gotten weaker. Credit quality's gotten weaker. I'm curious about your perspective on that, as it pertains to the market cycle and, perhaps to answer the question, how that shapes your view of the next year or two? But on the other hand, when the market goes down and fundamentals are negative and prices are retreating and people feel worse and worse and worse, that's when they should be buying, but that's when they're getting more and more depressed. So you have to be a contrarian, and one of the ... Contrarianism takes many forms, but I think the most important form of contrarianism is refusing to succumb to the same emotions that are driving the market. We are all, including me, we are all subjected to the same influences. We all read the same news. Well, some of us only read from the left, and some only from the right, but there aren't an infinite number of media outlets. We all hear the same facts, or alternative facts. We all see the market going up or down the same. We all make money or lose money at a given point in time. Mastering the Market Cycle: Getting the Odds on Your Side" by Howard Marks is a must-read for any investor who wants to gain a deeper understanding of the cyclical nature of financial markets. The ability to understand, assess, and deal with risk is the mark of the superior investor and an essential requirement for investment success.

9. The Credit Cycle

The bubble stage of the market is characterized by a period of irrational exuberance and overvaluation. The other thing that I talk about in the book, cycle positioning, which is trying to have more in the market when the market is low in its cycle and about to perform well, and take some chips off the table when it's high in the cycle and not so attractive, again, this is embroidering around the edges. Try to do better, because of course, if you don't do better than average, you're not going to make a living for long in our business, but still, the fundamental secret to investment success is long-term compounding. Initiating projects in boom times can be a source of risk, buying them in weak times can be very profitable. So when you put together the quantitative measures of evaluation and the qualitative indicators of behavior, I thought that the results called for caution. Now, of course, a little bit of the bloom is off the rose. So I summed this all up in a memo, September 26th of last year. The book was coming out October 2nd. I wanted the memo out before the book, and of course the memo, eventually, if you wait long enough, you're gonna have good timing. So that September 26th memo was good timing, as the market started to turn down on October 4th, but if you read that memo, I think you'll see the reasons for my caution.

Basically this is a specialized part of the credit cycle, described in the last chapter, that Marks has particular expertise in. 11. The Real Estate Cycle Marks has a well-earned reputation for prescience and patience.A decade ago, he and his Oaktree partnerBruce Karsh made a hugely successful beton distressed corporate debt during the financial crisis. While most asset managers suffered from investor withdrawals, Oaktree was raising money.

Cycles aren’t just a series of events that happen one after another. They are a chain of events linked by causality, where each causes the next, and is caused by what came before. Because the primary driver of ups and downs is overreaction in a positive or negative direction, which is based on human psychology, there will be no beginning or end to cycles. Now, in answer to your question, I don't believe in macro forecasts. That's number one. It is one of the views that I hold most strongly. I heard you mention a comparison in the introduction to a guy from Omaha, and it would be a daunting comparison. And I certainly don't put myself in his class. He told me that for a piece of information to be desirable, it has to satisfy two criteria. It has to be important, and it has to be knowable. The macro is certainly important. The macro drives the markets these days and does so to a much greater extent than ever in the past, and so yes, important. But in my opinion, not knowable. The crash stage of the market is characterized by a period of rapid decline and increased investor panic. How does he know which investments will accrue value? Well, he doesn’t. Though some guesses are more likely to be correct than others, an investor never truly knows what the outcome of an investment will be. All he can do is discipline himself in the art of making educated guesses.