Howard Marks: AI, Value Investing, Market Cycles, Investor Psychology

SPEAKER_1 (0:00)

The last time you were on campus, life was different. We were not talking about Claude or Gemini or AI. The words private credit were in the air, but not the way they are today.

The memos that you asked us to read is striking, because taken together, they outline a philosophy and really a complete sort of philosophy, but which is still relevant for today, which is really the test of an enduring system. Fewer losers, more winners ask whether great records are built primarily by avoiding disasters or by finding exceptional upside, making money by not losing it. What really matters remind us that many of the things investors obsess over, which we hear about all the time in mythology and in an ex post sense, short-term forecast, trading activity, relying on volatility as a complete measure. These are distractions from what compounds value across time and finally taking the temperature, ultimately suggest that rare moments that really matter are ones when investor psychology pushes markets to the extreme. So get us started. Help us think about how these, this investment philosophy gives us a good background against which we can think about today's environment, where the Fed is holding policy rates between 350 and 375, CPI is running relatively, relatively tamedly, although we'll see what happens when the numbers get updated. Credit spreads might be pricing some of the stress.

What's the temperature of today's market?

Howard Marks (1:39)

Well, you know, the market has run into some trouble in the last maybe two months.

Here's what happens. The market gets ahead of steam based on optimism. It gallops ahead on further good news.

One or two negatives come in, but the market finds it very easy to reject those and exclude them from their thinking. Part of it is because the general trend is still positive, but part of it is because of something called cognitive dissonance. And cognitive dissonance is something that you should all familiarize yourself with. And it is basically the human brain's ability to reject the information, which is at odds with its predisposition.

And if you want a good book on the subject, which my son, Andrew Marks, Penn, class of 2009, recommended to me a couple of years ago, it's mistakes were made by not, but not by me. And of course, that's the way we all think. And it was written by a woman named Carol Tavris. Good book. And so the market is riding on optimism, rising continuously. The good news is incorporated and causes price to go higher, bad news is ignored.

And then at some point in time, for some reason or no reason, kind of a critical mass of negativity arises, and it overcomes this predisposition to be optimistic. By the way, I believe that there is predisposition to be optimistic, not pessimistic, optimistic. Why is that?

Because you have to be optimistic to be an investor. What is investing? You take your money, you give it to somebody else in the hope you'll get back more later. So if you think about it, it has to be built on optimism. But sometime, enough critical mass of bad news gels, I use the idea confluence, to knock this process off stride.

So what we really had was, it started around the middle of last year. There were a couple of bankruptcies in the credit markets, first brands and something called Tri-Color. And the market had everything had been going swimmingly. We didn't have any prominent bankruptcies for a long time because the economic conditions were very good. And then finally, suddenly we had these two. And not only were they bankrupt, but it appeared that they were fraudulent. Possibly, the lawyers say possibly fraudulent.

And then the market kind of recoiled. Well, maybe I should go back one further. April 1st, President Trump announced second, announced some massive tariffs, much more than had been expected, and put them on. And then a week later paused them, and then put some more on and took some off. And the market had a negative reaction. The market actually went down 15 percent in the days surrounding the tariff announcements. Then we had the first brands in tri-color around September, I think it was, maybe August.

Then people started to wonder about private credit. Had it been extended to freely, poor standards. Jamie Dimon of JP Morgan says a lot of things best. He said, when you see one cockroach, there are probably more.

People started to say, well, maybe there's something wrong here. But then this year, number one, we had the, around February 1st, OpenAI and Anthropic announced new models for coding, which really looked like they're going to put all the coders out of jobs. And maybe if machines could write code, what do you need software companies for? So maybe they'd call all, put all the software companies into trouble. And a lot of software companies had raised a lot of money in the credit markets when they were taken over. It became a darling of the takeover business. So there was a lot of software debt out there. Now all of a sudden, maybe the whole industry is going to crash. And one thing you have to bear in mind, I'm sorry that these answers go on so long, but I can't help it. But you have to bear in mind that, as I say, in real life, things fluctuate between pretty good and not so hot. But in the minds of investors, they go from flawless to hopeless. And psychology swings to the extreme. First they like them too much, then they hate them too much. And you don't want to be caught on the wrong side of that, or you don't want to be part of that movement. So they go from everything's fine with software to nothing's good with software. Well, the truth is always in between. And then, of course, we had the commencement of the attacks on Iran. And nobody knows how that's going to end or what the result of that is going to be. And now it looks like it has serious implications for the energy markets and consequently maybe for the economy.