Diversification is Not a Magic Elixir
Diversification is not a magic elixir.
These are the words mentioned by Howard Marks, co-chairman of Oaktree Capital Management, and one of those widely regarded in the investing community, in his latest podcast.
The link to this 34 minutes podcast is given here, but I regurgitate / provide a quick summary on what he thinks about the current investment environment below.
A. Change and technology are much more a part of life than in the past
Howard started off in his podcast that the world today is significantly different than the world 40-50 years ago. In the past, the world didn’t felt like it was evolving so fast. However, now, anything and almost everything can be disrupted.
There are several implications to this, particularly that we have to give much more thought to how a particular industry or business will potentially be disrupted. This will affect the timeframe which we hold onto stocks or even our thesis on why we buy them in the first place.
Another implication is that there are no longer safe, once considered blue-chip stocks anymore. Hence, we have to constantly refine our way of thinking and see how disruption will affect industries and businesses.
B. Diversification is much more than buying lots of companies in your portfolio
If you buy 100 companies, but all get their supplies from a particular company say China or India, that is not diversifying. Diversifying is to protect yourself from what you don’t know. Howard is of the view that if you have a favourite stock, and you are sufficiently well covered on the downside, you can actually put all your money in it. Diversification is more about trading downside risk in exchange for upside potential.
C. Current market cycle is not as low as in the year 2000
Understanding cycles is really important in investing because people live their lives through pattern recognition. Cycles are comprised of excesses and corrections as long as people are involved in the markets.
Howard mentioned that this is a very unusual cycle because the correction in March 2020 was not due to excess in the economy. He mentioned that this is a one-off event and not a typical cycle.
Usually, the stock market follows an economy. When an economy is doing well, stock prices rise. Conversely, when an economy is not doing so well, stock prices taper.
He further mentions that a lot of people are saying that the current market cycle is a bubble, however, he doesn’t think so because the economic outlook for most economies is still positive. The P/E ratio of the S&P 500 today is approximately 21 times, whereas in the year 2000, the P/E ratio of the S&P 500 is approximately 32 times and that is then a bubble.
D. Cryptocurrency and bitcoin
Howard used to be a sceptic on cryptocurrency and bitcoin, given that there is no intrinsic value to such “assets”. If there are no intrinsic value, how do you then assign a price on it?
However, the pandemic, which allowed him to spend lots of time with his son, changed his mindset.
His son made him conclude that he was a knee-jerk sceptic, just because he has seen a lot of financial innovation that failed. Howard also admitted that he did not see the supply and demand side of things. There are lots of things in life that have no intrinsic value but still have a lot of value, eg. Art and Paintings.
Hence, for cryptocurrency and bitcoin, supply may be limited while demand may be high and hence, people can accord value to it. Even though we may not see the value of it, doesn’t mean others doesn’t see the value of it.
What are some other useful insights that you have learned from Howard Marks? Feel free to share with us in the comments box below!
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