9 February 2016

In this week’s episode Preston and Stig discusses the book “The Most Important Thing” written by billionaire Howard Marks. Whenever Howard Marks was meeting with investment clients, he often found himself mentioning that one factor, was “The Most Important Thing”. As a result of this continual guidance, Marks wrote this book. Each chapter of the book is devoted to fully understanding a new investment concept that might be the most important thing about the stock, and in the final chapter he explains how to use them all at the same time.
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  • How Preston’s short position of junk bonds is performing.
  • How any asset is attractive at the right price, and how no asset is attractive at the wrong price.
  • Why value investors should be attentive to credit cycles.
  • How all financial markets are swinging like a pendulum and how to profit from it.
  • Why value investing is like tennis for beginners.


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Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Intro  00:41

Broadcasting from Bel Air, Maryland, this is The Investor’s Podcast. They’ll read the books and summarize the lessons. They’ll test the waters and tell you when it’s cold. They’ll give you actionable investing strategies. Your hosts, Preston Pysh and Stig Brodersen!

Preston Pysh  01:04

Hey, how’s everybody doing out there? This is Preston Pysh. I’m your host for The Investor’s Podcast. And as usual, I’m accompanied by my co-host Stig Brodersen out in Denmark.

Today we’ve got a book written by by billionaire Howard Marks. And for anybody in the investing community, particularly the value investing community, Howard Marks is a very famous name, and somebody that a lot of people follow quite closely. The name of his book is “The Most Important Thing: Uncommon Sense for the Thoughtful Investor.”

Warren Buffett has endorsed this. I see his short endorsement on the front of it. It says this is that rarity, a useful book. So he has a bunch of people that have endorsed this: Seth Klarman, John Bogle, Joel Greenblatt, all the big names have endorsed this book. And for the most part, I thought it was a good book. I wouldn’t say that this is hands down the best investing book that a person should read. But I think that it’s something that’s very important and it gives very sound advice. I think it’s a very good refresher for maybe people that have read the “Intelligent Investor” and some of the books that are a little bit more complicated. I think that this is a great book to just listen to on like your Audible device, or I wouldn’t necessarily say you have to get the hardcopy.

A lot of investing books, you kind of need to get the hardcopy because there’s math in it or there’s charts or equations and things like that. This wasn’t one of those kinds of books. This book was more one that you could just put on and listen to and it’s just giving you good sound advice and things to think about to mitigate your risk is the best way I could describe this.

So, Stig, did you have any opening comments or your thoughts of the book as far as whether you liked it, didn’t like it, or whatnot?

Stig Brodersen  02:49

Yeah, I think I’m probably in the same place where you are. I think it was a great book, a good book, and perhaps not great. It’s more like a philosophical book. I don’t know if we can use that word for an investment book, but it was kind of like this is how you should look at investing. If you do that, you have some principles for at least not losing all your money and then probably also to make a decent return. It was more than that kind of a book, I’d say.

Preston Pysh  03:14

Yeah. And we’ll go through chapter by chapter to just kind of give people the highlights of the book so you can kind of see what we’re referring to, but in general, very good book. I like that they went pretty fast. How long did it take to listen to on Audible?

Stig Brodersen  03:27

Like five or six hours? Something like that. And some of the books as you said before, Preston, have a lot of numbers and so on. Sometimes you have to listen to it. I definitely didn’t have to do that for this book. It was easy breezy with this book.

Preston Pysh  03:39

It was easy to listen to and it wasn’t that long. It was pretty short. So real fast. I’ll give you a background on Howard Marks. So Howard Marks was born in 1946. His net worth is close to $2 billion right now. He was born and raised in Queens, New York. So all the people from Queens out there, that was where Howard Marks was originally from. He went to the Wharton School of Business for his undergrad, and then he went to the Chicago Booth School of Business for his master’s. After that, he worked for the Citi group in 1969 as an equity research analyst. So he was in the stocks starting out. Then by 1985, he went into high yield bonds and convertible securities.

I think a lot of people in the industry when you’re working in fixed income, that’s the more sought after role because you’re dealing with very large quantities of money when you’re dealing with fixed income, so bonds and things like that. So after that, in 1995, he left with five other partners, and when they opened up their Oaktree Capital Management Company. And just to kind of get through some numbers on the performance of Oaktree, which has been around since 1995. They’ve averaged 19% returns since that timeframe. So, they’ve done well extraordinarily well compared to other investors out there. Well, at the time of writing, I should say his company, his company was managing $80 billion, because that’s what’s written in his book here. And this book came out what was it, 2011? I believe, yeah. 2011 was when this book was published.


So let’s go ahead and dive into the book. All right, so here we go to chapter one, “Second-level thinking.” I like this discussion. And what he’s talking about what second-level thinking is he says, “Most people that are in the market are just level one thinkers.” And what he means by that is, let’s say that you have a company that their net income went up for the quarter. So the level one thinker would hear that the profit went up, and they’d immediately want to go out and buy more of that stock because the profits improving. And Marks tries to caution people and give people an idea of how complex things can be whenever you’re looking at something like that.

So let’s just dig deeper and talk about second-level thinking. So a second-level thinker would say, “Yeah, the profit went up, but how did they do that? How did they get their net income to go higher? And was their revenue in lockstep with previous gains, if you will?” So what you would do is you’d go in and you’d look at the income statement and say, “Yeah, well, their net income went up, but they pulled all these assets off their balance sheet and sold them. And that increased their income statement. And when we look at the income statement, you can see that the revenues have been contracting for the last, you know, five quarters or seven quarters. So they’ve got an issue with sales and generating revenue. And they’re offsetting that by pulling things off their balance sheet.”

And that’s just the tip of the iceberg for second-level thinking. I mean, most people that are in investing would hear that conversation that I just threw out there and be like, yeah, that’s pretty basic stuff. So that might even be classified as level one thinking.


So then he goes into even more discussion and I liked the way that he laid this out in the book because what he’s talking about is 100% true, and the amateur or the level one thinker might be doing in order to buy, he’s doing the exact opposite. And he’s selling in those circumstances because he feels like he has more knowledge and a more robust background to understand what’s happening.

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Stig Brodersen  07:12

I think his main advice was that for you, as an investor, you have to ask yourself, “Am I a level one thinker or a second-level thinker?” That’s the question need to ask yourself. And if you’re not a second-level thinker, well, then you probably shouldn’t be in the stockpile in the first place. Or at least you shouldn’t be buying individual stocks.

So another example was just a generic example. He was saying, “Okay, a company reports nice earnings. So the level one thinker might be saying, ‘This is nice. I need to buy that company.’ And the second level thinker is saying, ‘Hmm, perhaps if so many people know that and like that, then it’s probably overvalued.’” So it’s just another small, neat example of how to think on different levels. And what he’s saying is that if you don’t think as a second-level thinker, how can you be smarter than the other people. You need to be smarter than all the people to beat other people in the market. That was his simple premise for this chapter.

Preston Pysh  08:04

All right, so everyone’s gonna like the second chapter in his book, and it’s all about the efficient market hypothesis. Warren Buffett has a fantastic example he brings this up and Howard Marks brings this up in the book, where he talks about coin flippers. And I know anyone who’s read about Warren Buffett, they’ve probably heard this example. But if there are people out in the audience that haven’t, I’m gonna just explain it to you from that vantage point, so you understand what we’re talking about.

So Warren Buffett has this example that he likes to use where he says, “If you lined up a million people, and they all had to flip a coin. After the first coin flip, half of them would be out and then half of them would still be in because they had called the correct heads or tails. And if you continue to do that time and time again, you know, after 10 times in a row, you might have let’s just call it 100 people left out of the group that you originally started with that had correctly forecasted every single coin toss in a row without any mistakes.”

And he said, “Whenever you have that these people, these 10 people that would have, you know, correctly called they’re their coin toss, they would most likely be going out and writing books and telling the world how good they are at coin flipping and what they did in order to call the coin flip appropriately.”


He said, “Most likely the same people would be bragging to the opposite sex on how well they were able to forecast their coin flipping and, and whatnot.” And he just goes off, and it’s kind of a fun conversation. But what he’s getting at is the chance of somebody just always being right whenever you’re dealing with a large sample set. And so when you think about that, from an investing standpoint, you can have people that have been doing well in the market for 10 years, just because maybe they’re one of those people that are in the small portion of the sample set.

But what Buffett then does is he kind of turns this conversation on its head and he said, “That is true, that exists just based on statistics, that rule of this law and everything exists.” He says, “But the one thing that they’re not accounting for is what happens if everybody who was flipping the coin was from the same hometown. And they all had the same teacher that taught them something. There would probably be something to that, that makes it not a normal distribution anymore.”

And what he’s getting at is, he says, “All these people that have done extremely well in the market, they pretty much came out of the Graham value investing background, and employ the same principles,” which, you know, Warren Buffett, Howard Marks. All these guys are employing these value investing principles taught by Benjamin Graham. So that’s where he’s like, that’s what makes it different. And that’s one of the arguments that he uses whenever he’s typically debating this efficient market hypothesis stuff.


One of the examples that Howard Marks uses in the book, he says, he’s talking about Yahoo when it was valued at $237 in 2000, but by 2001, it had plummeted to just $11. And so he says, “Therefore, the market was wrong in at least one of these instances.” And I totally agree with that. So my personal view of how I see the efficient market hypothesis. I look at it a lot like weather patterns. I know that’s a strange example but let me explain.

So whenever you talk about efficiency and the thesis for the efficient market hypothesis, I think has a lot of validity to it except for at the very end of it. So the thesis and I’m going to generalize this is that at any given point in time, the market is appropriately priced. I somewhat agree with that statement.

Now, where I think it comes off the rails is whenever they say, “And therefore you cannot profit from the market if it’s always 100% efficient.” That’s where I disagree with it. And let me explain why. So if we were going to try to project a forecast of what’s going to be like in, let’s just call it my old hometown, Pittsburgh, Pennsylvania. What’s the weather gonna be like tomorrow in Pittsburgh, Pennsylvania? I’m pretty sure you could project and predict what that’s going to be like, very close. Not exactly. You can’t say the temperature is going to be 32.356 degrees, you can maybe say, “Hy, the temperature is going to be approximately 32 degrees at nine o’clock in the morning.” Okay, that’s a future forecast. And what you’re doing is you’re looking at models and you’re looking at pressures within the system of all those molecules and out and there are tons of things happening.


Now am I going to say that the weather pattern is inefficient and that it’s not operating? No. It’s operating at an optimal environment where the pressures are between highs and lows and everything is coexisting in their optimized at any given snapshot in time. They are perfectly organized, based on the fundamentals and the pressures that exist. If you had to stop time, they are perfectly organized, but that doesn’t mean that you can’t project and see where things are going with a reasonable amount of probability.

That’s why I disagree with the efficient market hypothesis because I see financial markets operate in a very similar manner. There are pressures that exist. There’s capital that’s flowing from one asset class to another. And when you can see the velocity of how that money’s flowing from one asset class to another, you can make reasonable projections. So that’s my opinion. It’s kind of a strange opinion. I don’t know if other people out there would agree with it. I’m sure if I told that to a college professor like Stig, they’d probably roll their eyes and say it is perfect and you cannot profit. But let’s hear Stig’s opinion.

Stig Brodersen  13:35

I’m definitely one of those professors that don’t believe in the efficient market hypothesis. And I’m sure a few who listened to the show before we definitely discussed that quite a few times. I’m happy we had this discussion, Preston, because it kind of sounds like we feel that the stock might be overvalued, which we do. I mean, don’t get us wrong or anything, but it might seem like the market is always irrational. It’s not. I definitely agree with Preston that to some extent, it’s somewhat efficient. I mean, there’s a reason why it’s priced as it is. And there’s a reason why Berkshire is priced at $300 billion and not$ 80 million, right? It’s not a complete coincidence.

But you just need to understand that there’s something called the long run. And in the long run, the market is very, very efficient. And then we have the short run. And then a lot of hiccups that just happened in the market. Just one more thing is that we also often talking about individual stock picks. So you might have an inefficient market, and you have tens and thousands of stock issues, but you just might have one or five stocks that are heavily overpriced or underpriced. And that still means that it might sound like it’s extremely inefficient, but it still might be somewhat efficient. So I’m happy we had this discussion, Preston.

Preston Pysh  14:43

Let me provide a real-world example because this was literally in the news last night, and just so everyone knows, it’s 29th of January 2016. So last night, Amazon, after the market closed, came out and Amazon said that their revenues and then they had a decent profit that they listed, but the revenues are starting to drop off and starting to level out. I don’t remember when we had this conversation, maybe it was six months ago, maybe not even that long ago. I think maybe it was with James O’Shaughnessy, we were talking about Amazon, I can’t remember who the guest was.

But we were there talking about Amazon. And one of the comments that I had made was, hey, I understand how it’s being traded, it’s being traded off of a multiple of the revenue. So whatever the revenue is, is pretty much where the market cap is being traded at. And to me, that kind of makes a lot of sense, because a lot of people would make the argument that Amazon could quickly change their algorithms and pulling a 10% profit margin if they wanted to, but they’re not.


So my argument at that point in time, I said, “Yeah, it’s growing. It’s been growing like a weed, but you can kind of see that the revenues are starting to slow down a little bit.” I mean, it’s still growing very fast. Don’t get me wrong, folks. It’s growing fast. But you can start to see the revenue starting to slow down and I said on the show, I believe this is how the conversation went. And I said, “Once those revenues start to pull back and they start to plateau, and you’re dealing with a, I mean, this company is getting huge, massive, and growth at that level is a whole lot harder than whenever they were a couple hundred million dollars. I promise you that.”

So you’re starting to see that with this last report that came out that the revenues are starting to taper off and they’re starting to plateau. And when that happens, you know, my projection, my opinion was that the stock is going to get punished. Now, I didn’t have a timeframe when I thought that could happen. I could be next month, it could be in a year. I didn’t know the timing of when that happened.

But what I was doing by having that conversation is identifying the risk of why I don’t own Amazon. I think it’s a great company. Don’t get me wrong, I love the company. I use it all the time. But I found that at that point in time in that discussion, I was not going to take a position because of that inherent risk. So this goes to this efficient market hypothesis. The efficient market hypothesis would say it’s impossible to project what’s going to happen to the stock and you cannot profit from that. And this isn’t a profit but protection of principle discussion.

But whenever I was looking at those, I see that as a lot of risks, it has a lot of downsides, in my opinion, as things would change and revenues are starting to plateau out. Sure enough, as that news came out last night, the thing was down like 7%, as soon as the news came in the aftermarket, so it was down like 7%, as soon as the news came out. And who knows what’s going to happen now moving forward. It could rebound, it could go down even further, I don’t know. But I do know that I think there’s a lot of risk in the price whenever it’s being traded at that multiple because I think they have issues bringing in that kind of margin, I do, and sustain their competitive advantage.

Stig Brodersen  17:45

One of the thesis about the efficient market hypothesis is that we all have access to the same information and that information is priced into the current stock price. And I just think that the idea is wrong because the premise is that you need to be able to predict the unpredictable before we can beat the market, which is somewhat true if you think that everyone has the same amount of knowledge. But again, here we are. And even Preston, my business partner, we talk about all the time, we don’t have the same knowledge about Amazon. So how can I expect that everyone in the world is able to trade Amazon? Millions and millions of people all have the same knowledge and therefore price Amazon the same way? I just think that if you think about the thesis behind why the market should be efficient at all times, I just think it’s wrong. So that was my point here.

Preston Pysh  18:33

Okay, so in chapters three, and four, I’m going to kind of combine is chapter three is titled “Value.” And then chapter four is titled “The relationship between price and value.” Marks takes the exact same stance as Warren Buffett, and what he’s talking about is you got, as the investor has to figure out what the value of the business is. Rhen you’re obviously using some type of discount cash flow analysis or some type of valuation metric to determine which you think the intrinsic value of the businesses. And then when he talks about is the relationship between this price that is being traded for on the market and the actual value that you determine it to be.

I think that this discussion for anybody that may be joining the podcast and hasn’t listened to some of the earlier episodes, or you’ve gone to the Buffett’s Books and watched any of our videos there, we go into a lot of detail describing different approaches to value stocks. So if you’re listening to this for the first time, and you don’t know how to do any of that, or you’d like to learn how to do it, go to our website, BuffettsBooks.com. It’s 100% free of over 10 hours of video content that teaches you this kind of stuff. So with that, I’m probably just going to move on because his comments were very similar to Warren Buffett’s, and the main thing which he gets into chapter five, which is understanding risk.

What he’s talking about he is about one of your biggest risks is the price that you’re paying and making sure that you have a margin of safety built into the price that you pay. So if you determine that a stock is worth $100. Okay, you are not going to go and pay something that is, you know, $140 for something that you think is worth $100. And that conversation is so important because I think a lot of people don’t realize is every time that you pay a premium over something that you think it’s worth, let’s say you paid $140 for something that you thought was worth $100, you’re paying that 40% premium. You’ve already handicap your returns into the future, you’ve already determined with a lot of probability that your returns are going to be significantly lower than what they would have been if you were able to buy it at $100.

And so I think a lot of people don’t think about that. I think most people don’t even understand the conversation. But the faster that people can realize and understand what he’s talking about in that section, the faster I think they’re going to kind of protect their downside and perform quite well in the markets because they’re going to be minimizing their risk.

Stig Brodersen  20:56

Yeah, I like this discussion about how any asset is attractive at the right price and how an asset is not attractive at the wrong price. And just a recurring sample, Preston, I know that you have been looking at shorting junk bonds. And that’s not because junk bonds per se always should be shorted “because it sounds like junk sounds like a bad asset, we should short that.” No, you’re looking at what’s the value? And what’s the price? and you simply need to compare those two all the time. Like, I would assume that you would go long om junk bonds if you could buy it, like even horrible junk bonds for one cent, right? But you can’t do that. So they’re priced high. So that’s why you’re shorting them. So I think that’s something that we need to understand with Howard Marks is that, again, any asset is attractive at the right price and wrong if it’s priced too high.

Preston Pysh  21:41

Yeah. And I think that that’s a fantastic comment, where you’re talking about, “Hey, a lot of people say I won’t buy that I refuse to buy that.” Well, if the price was a penny, would you buy it? And so you always have to have this conversation of there can be a right price regardless of how much risk is associated with something. And I think that that’s one of the key points that Howard Marks talks about in this book. And I’m glad that he did because that’s a conversation that a lot of people typically don’t have.

Now, relating this back to Benjamin Graham’s book “Security Analysis,” he talks about this idea as well. And one of the key things that he wants people to understand is that you always, always look at protecting your downside risk before considering the yield.

So let’s say that you could buy something at a severe discount, cheap price, and you could get a 30% yield on it, if you know, let’s just talk fixed income. That would be expected to do a 30% yield, assuming that the principal would be paid back at the end. He says, before you just go out and chase that yield, you have to have a very thorough and deep understanding of what your chance of default is. And that needs to be your first consideration as opposed to the yield. A lot of people put the cart before the horse and they’re just like, “I could make 30%,” and then they don’t even think about what the probability of default is on that purchase.

Stig Brodersen  23:04

And just in continuation, I want to address one quick point. That’s one of the things in the book where he’s talking about being ahead of your time and being wrong. And those two things can be very difficult to separate sometimes, like, just because you probably from an investment, it might still be a bad investment, you might still have evaluated the risk wrong. And even though that you lose money on an investment, like the calculation that you’re making, the assessment you’re making might still be correct. That’s the problem with stock investing. It’s not like if I were to discuss football with Preston, and I would say, “Hey, I think that the Steelers will win this weekend.” And what Preston would probably say, “That’s not me.” And we will figure out like really, fast like whether or not I was right or wrong. It is not like that whenever you’re doing a bit in the stock market. Like when does this end? It’s not like the end of the football game, like when are you right or when are you wrong? And that’s this is a philosophical discussion that Howard Marks has in this book. And I think that’s important, especially times like this, like when the market is dropping. You think, “Hey, I might have done something wrong.” And well, perhaps you have, but it’s the whole idea of how you’re just ahead of your time or are you indeed wrong whenever you are assessing your decision.

Preston Pysh  24:14

I wanted to provide a quick update because I told people that I would do this with that high yield bond short position that I was putting on. So I put that on at the beginning of December since December here, we’re almost two months later at the end of January, and I say it’s up 3% to 5% since I put that on. So compared to the stock market, from where I put this on, I think the stock market’s down what 10% to 15% since I put that on. That position has beaten the stock market so far. Let me emphasize so far, it has beaten the stock market by about I’d say close to 15%, which is great. That’s an awesome place. So far, that’s worked out pretty well. I’m continuing to hold it and we’ll see where things go from here but I just wanted to provide an update for people on it.

Just so people know, I’d much rather recommend a cash position than to do something like this. I think that, if you would have been in cash, whenever I put this on, you would have beat the market by like, call it 10%. So I just want to emphasize that. Let’s go ahead and keep moving with the book, though.


So the next section that we’re going to talk about, and he gets into this whole discussion of risk, which Stig and I just kind of covered in chapter seven, but then he goes into chapter eight. And he talks about being attentive to cycles. And I loved this conversation. This is something that you typically don’t hear a lot of value investors talk about. So I really liked the fact that he brought this up in the book.

What he’s talking about is the credit cycle. He’s saying, you need to have an understanding of where you’re at in the credit cycle because if you don’t have that situational awareness of where you’re sitting in time, in reference to where the cycle is at, you’re just kind of setting yourself up for failure. And I totally agree with that statement in this section. I was happy to see this.

So he even lays out some basic principles of determining where you’re at in the credit cycle and kind of having an idea when maybe the market is getting a little overpriced and risky. I think that’s probably the best word to use is he’s giving you tools in the book to identify whether he thinks that the credit cycle is starting to assume a lot of risk at where it’s at.

And so one of the examples that he uses is whenever high yield bonds, and you got to remember he did some time as a high yield bond and junk bond trader. So he understands this quite well. He says, “When high yield bonds start to elevate in yield and the yield starts to take off, you’re probably entering kind of a period where you’re at the end of a short term business cycle or a credit cycle, whatever you want to refer to it as.”

So and that’s what we’re seeing in the market right now. That’s why I put on them the short for high yield bonds. So you’re seeing that one critical variable. He also talks about some other variables. He talks about profit margins for companies going down. We’re seeing that happen. He lays out a few others. I don’t know if Stig remembers all the ones that he lays out in the book but the conversation is refreshing because most value investors don’t talk about this and they just completely ignore it altogether.

Stig Brodersen  27:11

People should definitely watch the Ray Dalio which we shamelessly advertised. It’s a free video though. We advertised it like hundreds of times in the podcast because Ray Dalio does that even better, I want to say and also like it’s animated, and then I also thought that Preston was going to be happy about having chapter eight about cycles included in the value investing book. That was me, my two thoughts.

Preston Pysh  27:33

I was listening to it. I was like, “Oh, this is awesome. Finally, somebody from the value investing community is pointing this stuff out.” And you know, here’s what I think a lot of people fail to recognize with Warren Buffett specifically, is, although Buffett doesn’t talk about it, he puts it into practice, and he does this. And you can see that he does it by just looking at his balance sheet and looking at the way that he invests. If you look at Berkshire Hathaway’s balance sheet in the last year, you can see his common stock holding is decreasing. Now it’s not decreasing at a rapid pace because he’s a guy who holds because he’s got enormous capital gains that he pays if he sold.

So like he’s not going to sell Coke, he makes more on the dividend than he does, you know, with his original purchase price. So why in the world would he sell that? He’s not going to sell it. But if you look at his balance sheet, you can see that his common stock position has decreased by, this is off the top of my head and I hadn’t looked for a while, but I’d say $10 billion to $15 billion over the past year. So he’s decreased that position by about 10%. You look at his cash position, his cash position is like almost 70 to $80 billion, or something crazy like that. He’s increasing and his cash position just keeps growing.

So for people to think that Warren Buffett isn’t being attentive to credit cycles, I tell you that I totally disagree with you. I think he’s putting this stuff into practice, but the only difference is, Howard Marks is writing about it, Warren Buffett doesn’t write about it because I don’t think that Warren Buffett wants people to go out there and try to quote-unquote, time the market even though that’s not what I would call it. I would say he’s managing his risks appropriately through proper asset allocation as time progresses in the credit cycle. That’s how I would describe it. And for me, I was excited to see Howard Marks do this.


So then in chapter nine, Marx talks about, the title of that chapter is “Awareness of the pendulum.” So what he’s saying is that all these things go in cycles, whether you’re talking about commodities, fixed income, you name it currencies, they swing like a pendulum. And so when you’ve got something that’s swinging in one direction, you have to have awareness of where you’re at in that swing. Are you out at the left limit? Are you out at the right limit? Are you at center mass with accelerating to the other side? And that’s what I love this analogy. I love this discussion because when we look at current market conditions, let’s talk about where that pendulum is at right now.

Okay, oil. I know we talked about it all the time. But if you think that oil has a lot more to lose, I don’t think that it has a whole lot more to lose. Okay, I think that this thing’s getting ready to be pegged out at the limit. Heck, it might have already been pegged. We’re seeing the price got down to like $26. It’s already come back up to like, $33. I’m still holding tight. But I but when I think about this analogy of where the pendulum is at, this thing is way out there. It’s out at its limit. It’s getting ready to come back the other way. And I think for anybody that doesn’t agree with that, I think that you’re maybe missing a big opportunity here in the long run. I will emphasize it. I still haven’t taken a position. That doesn’t mean that I’m not watching this very closely and might be missing it. Stig is obviously in so maybe he’s the smart guy. I don’t know.

Stig Brodersen  30:42

Well, I’m $7 more heavy than they were like a week ago. I don’t know if you can put it like that. Yeah, but I like the analogy he had about the pendulum. I have never heard about that before. And the thing it’s nice. We had James O’Shaughnessy on, whom Preston talked about earlier here in the podcast, and well he didn’t use the same analogy but he said the same thing as whenever he was backtesting, it might look like well, we had a few drawbacks here and there. And then we had a bull market, whatever. But in the long term, it looks fine. He’s also saying that when you’re in the middle of it, you know, things can flip so fast. And if you have this short term horizon, it can be bad, because you don’t know when it will flip. And when we’re talking about the oil price, we don’t know when it will flip. But we can always say like, which direction is going to like the big swing? Is that going up? Or is it going down? And it’s probably going up. So that’s the point from this chapter.

Preston Pysh  31:32

The other one that I want to talk about is the currency of the US dollar. I think that the US dollar is just I mean, at epic levels, as far as its strength, and I think that it has nowhere to go but down at this point. Now, I’m holding a lot of dollars and waiting for that opportunity to put that to use in other sectors. But I recognize the fact that when we’re looking at and thinking about this from a pendulum’s standpoint, this thing is pegged out at its limit, it’s getting ready to swing the other way.

And I think that the catalyst for that happening is the Fed, saying that they’re going to do more quantitative easing through negative interest rates or whatever. They’re gonna have to do some major adjustment here to offset this strong dollar because it’s killing emerging markets. And so as that continues to happen, I think the Feds are going to have to change their policy, that’s going to cause the pendulum to start swinging in the opposite direction. And that’s whenever I’m going to change, you know, the way I’m seeing things, but when we look at it, those are the two big things that I’m seeing right now that are definitely limitations with where the pendulums at.


All right, so I was expecting this episode to be kind of short, and it’s going a little long. And so what I’m gonna stop doing is just going chapter by chapter and I want to talk about three main points that I had for the rest of the book that I felt were important. And then, Stig, I’m sure has some other points that he’s going to want to talk about and then we’ll just kind of wrap it up.

So one of the things that he talks about later in the book, I’d say this is like in the last quarter of the book, he talks about the probability distribution. And I like this discussion because what he’s talking about is at any given point in time, there’s this array of potential outcomes. And I think that that’s something that a lot of investors don’t think about whenever they’re buying an individual stock or an index or whatever. So let me just talk about this from current market conditions.

So when we look at the S&P 500, my opinion is that the s&p 500 is going to continue to get pushed down in the long term. Okay, that’s my opinion. So if I was gonna say a probability of that happening, I’d say, you know, I have a 75% confidence that the S&P 500 is going to continue to get punished throughout 2016. That’s my opinion. So that’s what it would be like, do you ever see these weather forecasts where they do a hurricane that’s tracked to hit landfall, and when it’s five days from hitting landfall, they’ve got this kind of path, and it’s like this array of options of where it could go. You got a left limit, you got the right limit and you got the most probable direction for the travel. And when this thing’s way out there, and it’s got a ways to go and there are many days before the storm will hit landfall. The array is wide and the potential for it hitting something here a stateside, it might be from the tip of Florida clear up to like, you know South Carolina or something. It’s got this wide path that it could hit.

And I think about that graphically in my head as I’m thinking about this array of things that could happen in financial markets. So like my example, the S&P 500, you know, the Fed could come out literally next week, okay? The Federal Reserve could just change their minds, change everything and say, We’re gonna launch massive quantitative easing, you know, next week.” And if they did that the market, in my opinion, the market would go wild. Now, who knows if it would, but my opinion is the market would go wild if something like that happens. And so that is a potential that is something that could happen.


I think people when they’re thinking about risk, and they’re thinking about the probability distribution of what could happen, a lot of people don’t consider what bad things could happen. They only account for what good things could happen to their investment. So they’ll take that position. Let’s say you take a short position in the S&P 500. Okay, it could go down, it could go exactly what your expectation is, or you could have something crazy that happens like the Fed coming out and changing their policy. And then it starts going in a different direction. And so people have to be prepared, and think through all those different options and understand what that distribution might look like because, for people that don’t understand that distribution, they’re not accounting for risk appropriately. And that’s what he’s talking about in the book. I love that conversation.

Stig Brodersen  35:35

So one of the high points that I want to talk about is this idea if you want a specific asset class or specific stock in your portfolio. And this is one of the things that Marks talks about and saying how that is the wrong way of looking at investing. So you would have even advisors saying to you, “Well, you should always have 20% in bonds or your age in bonds, or whatever he’s saying.” And that likely is an investment perspective, especially if you’re an active investor. That just doesn’t make any sense at all. Like you would buy the best possible assets, you will buy them when they’re cheap. And you will not, perhaps you would sell them when they are overpriced.

Now, there might be a lot of different reasons why you would do that. And we talked about Warren Buffett’s investment in Coke before. He has to pay a lot of capital gains, but the intuition is still the same. And this goes back to the thing we’re talking about being attractive at the right price and not being attractive at the wrong price.

So just for you guys out there, if you ever hear about the optimal portfolio in terms of you should always have 30% in domestic stocks or 70% international stocks, that just doesn’t make any sense. At least that’s one of the points in the books and I definitely agree with that. Also, because what will typically happen is that you will not get a sufficient return.


And this was another thing about risks and what he’s saying is that you will often hear investors saying I need to take on more risk to increase my return because there’s this idea that the more risk you take, the higher the return will be. But if you think about that, it doesn’t make that much sense, because if you can just take on more risk to achieve a higher return, by definition, that wouldn’t be risky. So that was one of those small quirks I liked about the book that this philosophical approach to when you hear a statement, why that statement would be wrong, and how to think about investment. I definitely like this one he had about how to assess risk and how you shouldn’t be predetermined of what you want to own. It’s always dependent on the current market conditions.

Preston Pysh  37:33

So one of the conversations that I liked in the book as well as this idea of defensive player versus an aggressive player. And the example that he uses is tennis, which I liked because I think about this all the time whenever I try to play tennis because I’m a total amateur on the tennis courts, and I’ve always had the opinion… It’s probably rooted in my idea of investing that whenever I play other people that are amateurs or you know, moderately good, my approach was always to play very defensive and just keep the ball in play and let them make the mistake.

And it’s interesting to hear Howard Marks talk about this analogy of tennis whenever he’s talking about investing. He says, “A professional player, they can hit those winners and those hard shots, they can blast it down the line, they could put it back in the corner, and they can do it with insane accuracy and consistency, but the amateur person that goes out there and plays, they can’t do that at all. They’re going to miss it, why they’re going to hit it long, they’re going to hit it into the net. And so if you’re an amateur and you’re not this, this person is just like highly trained and just very skilled, your chances of winning are so much higher. If you just take the risk-free play of just keeping the ball in play, just hit the shot, keep it in play and force the other person to have the air.” And I totally agree with that.

And he said, “You have to know where you’re at. You have to know your own capabilities and your own skill sets and know your limitations, in order to do that, because the person who doesn’t know that they’re gonna hit the ball along because they just want to hit it hard, they’re going to make that mistake time and time again. And they’re going to lose the match overall because they’re just not aware of their own limitations.” And so when you think about that, from an investing standpoint, you are the only person that knows how much you know. And so if you are just over-aggressive, and you’re out there buying individual stock picks, and you can’t even tell a person, you know what some of the lines on an income statement are on a balance sheet, you’re probably not being realistic with what your actual knowledge is and what your capabilities are. And when that happens, his opinion is you’re going to lose the match. And so he said, his philosophy at his capital investment company has always been to just keep the ball in play and keep it simple. I totally agree. I think that that is such sound advice and good advice for people to follow.

Stig Brodersen  39:54

I’m so happy Preston that you brought this point up. That was the last point I want to talk about in this book. That was nice and I just think that it’s interesting because whenever I started looking to value investing, and obviously, I read about Warren Buffett and I heard about some of his investments and how he made his analysis and like, in away. I was very impressed but I was also very depressed because I was thinking how can I ever be smart enough to make the same investment decisions like Warren Buffett? He just seems complex to me. And still does. Like thinking like Warren Buffett, even though I do what I can, I am probably okay with me never being at that level.

So I’m not thinking about his personal saying, like hitting the winners. I’m not thinking about playing tennis like, man, the first name that came to mind was like, Andre Agassi. I’m old. Roger Federer. Yeah, sorry about that, guys. So you might not be like the very best at what you’re doing, but as long as you’re not making horrible mistakes, you’re probably going to be fine. And what he’s saying is that the outstanding investment careers, they’re typical, very short, not super investors like Warren Buffett, obviously. But investments in careers don’t end because they don’t have enough winners, particularly because there are too many losers. And that’s something I think a lot about, like rule number one, is really, again, not to lose money. think about the risk that way, you know, spend 9% of the time thinking about how not to lose money. And then with the remaining 10% of your time, think about how can I pick the best stocks?

Preston Pysh  41:26

All right, guys, that’s all we have for you. The name of the book was “The Most Important Thing.” We liked the book was very good. If you’d like to listen to this book for free, 100% free, go to our website, theinvestorspodcast.com and if you go to any of the show notes pages, you’re going to see at the bottom that we have a link for a thing called audible.com. It’s through Amazon, it’s an Amazon service. So all the books that they have on Amazon are in an audio format. Audible is the service that Amazon has. The application that you install on your smartphone that Amazon has. So if you want to download that Audible book, “The Most Important Thing” by billionaire Howard Marks, you can go use that link, and you can download it for free and listen to it. But you got to use our link in order to get the benefit of having the first book for free. So that’s what we recommend. That’s how I listened to this book. And it was very useful. I liked it. And that’s just a service that we have on our website for all of our listeners.


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Outro  44:55

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