On Pigs, Cobwebs And Howard Marks – ValueWalk Premium
Howard Marks

On Pigs, Cobwebs And Howard Marks

I can guarantee a few things about Howard Marks’ new book, Mastering the Market Cycle. You will enjoy the thoughtful writing in clear language, and you will learn one great, and I believe correct, idea about the operation of markets.

Q3 hedge fund letters, conference, scoops etc

“But you will not master the market cycle. Nobody can.”

What you can do, as part of a broader program of self-education in economics, finance, and investing, is to understand better why market prices seem to run in cycles, and market psychology swings between euphoria and despair with more or less predictable regularity. This book should be a part of that self-education strategy.

Ultimately, however, Mastering the Market Cycle is disappointing because it relies on repetition, rather than intellectual exploration, to teach one big idea: Market cycles are best understood as extremes of risk perception, not of price. When everybody thinks there is no risk in the market and that all will work out well, sell. When almost everybody thinks the market is almost infinitely risky and that nothing will work out well, buy.

That’s it. The idea is repeated as a general principle and specifically for high-yield debt (the asset class in which Marks, the founder of Oaktree Capital, made his first and best-known fortune), distressed debt, equities, and real estate. Sell when others are indifferent to risk; buy when there’s blood in the streets, said Nathan Mayer Rothschild (1777-1836). So says Howard Marks as well.

How long does it take to raise a pig?

Since my views on Mastering the Market Cycle can be expressed in relatively little space, I’m using the greater space allowed me in these pages to explore ideas about why business and market cycles exist at all. The current fashion is to blame human behavior, which we’ll all admit is imperfect. Marks writes, “The tendency of people to go to excess will never end. And thus, since those excesses eventually have to correct, neither will the occurrence of cycles.” In this vein, behavioral economics and behavioral finance are today’s hot topics, using irrationality to explain what the economist’s traditional assumption of rationality cannot.

Or can it? There’s an old and entertaining trope in economics called “cobweb theory,” named after the shape of a diagram showing the progression of prices in agriculture. Exhibit 1 is a simple example:

Exhibit 1

Cobweb theory: Changes in the price of an agricultural product over time

Howard Marks


The cobweb in Exhibit 1 results from farmers facing uncertainty about future outcomes, in this case the future price of a pig. Under such circumstances, “mispricing” the pig, with over- and undershooting of both the price and the number of pigs produced, is perfectly rational. It results from having incomplete information about the future value of the pig. This concept originates with the early 20th century agricultural economist Mordecai Ezekiel.1

First, the farmer faces a price signal (high prices) telling him to raise more pigs, so he does so. But it takes a long time to raise a pig. Meanwhile, other farmers, receiving the same signal, have also increased their pig production. By the time the pig is ready for market, there are too many pigs and the price falls. In the next round, farmers interpret the new low price of pigs as a signal to cut back on production. This causes an eventual price increase and a pig shortage. And so on ad infinitum.

Read the full article Laurence B. Siegel, Advisor Perspectives

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