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Circle Of Competence Issue #1

'Latest Thinking,' Howard Marks' latest memo, was a gem. I love reading his well-written and in-depth commentary on current market conditions and would recommend them to anyone aspiring to learn more about financial markets. Here are a few key points that I took away from the latest edition.

Marks lays out both the bullish as well as bearish case for equities and sums up his approach to the market by writing, "move forward, but with caution."

Pros of current market conditions:

- The current recovery is one of the longest in history, spanning 103 months since 2009

- Tax cuts in the short term will return money to tax payers, allowing greater potential savings/investment rates

- Low inflation leads one to think that central bankers won't rush to raise interest rates quickly but rather slowly and gradually

- Unemployment at 4.1%

Cons of current market conditions:

- Generationally low interest rates are more likely to rise in coming years, but we do not know by how much

- Valuation ratios are historically rich (Buffett ratio of Market Cap to GDP, private equity transaction multiples, real estate capitalization ratios)

- Thus if investors are investing at current market multiples, there has to be a bullish view that "this time is different" and there is more yet to come in the underlying fundamental expansion and market multiple expansion

- Most investors have FOMO and do not want to miss out on what has been duly noted to be the'market melt-up'

(Chart provided by

So, in Marks' words, move forward, but with caution. His latest memo was written January 23rd, merely days before the latest market volatility which resulted in the SPY ETF (S&P 500 ETF) dropping from a high of 286 to current levels of 265, nearly an 8% decline. Are we entering a bearish correction or simply has the short volatility trade become overcrowded and traders are rushing to the exits? Time will tell, but for long-term investors, the proper action seems to be proceeding with caution and demanding value in each purchase decision.


Embrace volatility - it is what allows long-term investors to acquire equities below their intrinsic value. As Buffett once wrote, if a company is worth twice what it is selling for in the equity markets and it declines by 10%, 20%, or 50%, does this make the investment more risky? No! On the contrary, it is the time at which hardened investors with conviction need to "back the truck up."

My last comment will be on what I like to dub the Buffett Balance Sheet Watch. Here are the past 5 years of cash on hand at Berkshire Hathaway, his holding company:

2012 - $46.9B

2013 - $48.1B

2014 - $63.2B

2015 - $71.7B

2016 - $86.3B

2017 3Q - $108B

See a trend here? Buffett demands value, and he won't deploy large swaths of shareholder capital at the current sub-par forward returns offered in the markets. But look for him to sharpen his pencil and break out the calculator as markets correct and valuation multiples shrink.

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