Howard Marks co-founded Oaktree Capital and has written the Oaktree memos since 1990. They're long, candid letters that cost nothing to read, and Buffett has said he reads them first when they arrive. Keep them in your reading rotation for good. Marks distilled them into two books, The Most Important Thing (2011) and Mastering the Market Cycle (2018). He's the philosopher of risk and cycles. Fisher and the compounders look mostly at the business, while Marks looks mostly at the market's mood and the price it produces. That makes his school the natural bridge into Phase 7's macro machine.
What is second-level thinking?
His most portable idea is the gap between first- and second-level thinking. First-level thinking is simple and shared: "This is a good company, so buy the stock." Second-level thinking is deeper and harder, and it has to be contrarian and correct at once: "This is a good company, but everyone knows it. The price already embeds a rosy future and expectations are too high, so it's an overpriced stock. Sell." Or the reverse in a panic: "This is an ugly, hated business, but it's priced for bankruptcy and the fear is overdone. It's a bargain. Buy."
His core claim is that to beat the market you have to think differently from the consensus and be more right than it. You need both halves. Being contrarian and wrong is just being wrong expensively. Agreeing with the consensus can never beat it, because the consensus is already in the price.
Second-level thinking is the reverse DCF turned into a habit of mind. Always ask what's already priced in, and take a position only when your view of the future differs, defensibly, from the one the market implies.
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How does Marks think about risk?
Like Klarman, Marks rejects the academic habit of equating risk with volatility. For him risk is the probability and consequence of permanent capital loss. It's an ex ante condition that's largely invisible and mostly a function of price. The same asset is risky when it's overpriced and safe when it's cheap, so risk is created by the prices investors pay, and not by shaky businesses.
His most important and counter-intuitive teaching is that risk is highest exactly when it feels lowest. At the top of a bull market prices are extended and skepticism has died. Everyone is confident. Risk is at its maximum then, because all that confidence has removed the margin of safety. Prices at the bottom are crushed and everyone is terrified, so the risk of further permanent loss is at its minimum. The bad news is already in the price. "The riskiest thing in the world is the widespread belief that there's no risk."
That turns the beginner's instinct upside down, and it's the most valuable sentence Marks ever wrote.
What is the pendulum, and how do you act on it?
Marks pictures the market as a pendulum. It swings from euphoria to depression, from greed to fear, from credulity to skepticism, from overpriced to underpriced. It spends very little time at the "happy medium" it's theoretically centered on, and mostly rushes from one extreme toward the other. Cycles in the economy, in credit availability, and in psychology feed on each other. Good times loosen credit. The loose credit funds excess, which sows the next bust.
His practical advice comes in two parts. Phase 7 and Phase 9 both build on it:
- You can't predict, but you can prepare. Nobody reliably forecasts the timing of cycles. You can still judge where you are in the cycle by reading signs you can observe: valuations, credit spreads, the quality of deals getting funded, the tone of the news, how the crowd reacts to bad news. "We may never know where we're going, but we'd better know where we are." Take the market's temperature.
- Calibrate aggressiveness to the cycle. When the pendulum has swung to euphoria (cheap credit, sky-high prices, universal optimism), lean defensive. Raise the bar, hold some cash the way Klarman does, and size down. When it has swung to despair (frozen credit, crushed prices, universal gloom), lean aggressive. You aren't timing anything. You're adjusting your posture to the risk that price has created.
Marks's famous compression, the three stages of a bull market, is worth memorizing, because it describes how the pendulum swings up. In stage 1, a few farsighted people begin to believe things will get better. In stage 2, most investors realize improvement is actually happening. In stage 3, everyone concludes things will get better forever, and pays any price on that belief. That's the top. The bear market mirrors it. In stage 1 a few people realize the optimism was overdone. In stage 2 most see the deterioration. In stage 3 everyone believes it will get worse forever and sells at any price, and that's the bottom.
"What the wise man does in the beginning, the fool does in the end." Your edge is to buy near the psychological bottom (bull stage 1) and sell near the top (bull stage 3). That means acting when it feels most wrong, a skill behavioral finance dissects bias by bias.
Worked example: reading the cycle, and where it fails
Worked application (the cycle read, India and US). Marks's method is a thermometer. It doesn't forecast, and you can run it on any episode. Take global and Indian markets in late 2021. Interest rates were near zero. IPOs and SPACs of profitless companies were mobbed. Crypto and meme stocks went vertical, and credit spreads were at record tights. "This time is different" was everywhere, and bad news got shrugged off. That's bull stage 3, maximum risk dressed up as safety. The Marks response is defense. A crash wasn't forecastable. Price had destroyed the margin of safety, and that's reason enough.
Now take March 2020, or the depth of the 2018-19 Indian NBFC and credit freeze, or late 2008 globally. Forced selling, quality thrown out with the junk, and a universal conviction that things will only get worse. That's bull stage 1 hiding inside a bear stage 3, and the Marks response is offense. You deploy the cash your standards piled up at the top.
You didn't predict either turn. You read the temperature and adjusted your posture. Phase 7's macro dashboard puts instruments on that skill, and Phase 9's process makes it routine.
As a way to set your posture, and as a check on your own greed and fear, the cycle-and-risk lens is invaluable, and it's nearly always right eventually. It "fails" as a timing tool. Marks is emphatic that "eventually" can be years away, that markets stay irrational longer than you can stay solvent, and that reading the temperature tells you the odds. It doesn't tell you the date.
Push it too far and it turns into an excuse for permanent bearishness, since there's always something to worry about. It also makes you miss the long compounding that Fisher and the quality school capture. The synthesis to aim for lays Soros-and-Marks cycle awareness over Buffett-and-Fisher business ownership. You own great businesses for the long run, and you let the cycle set how aggressively you buy and how much cash you hold, without ever pretending to know the date of the next turn.
What three postures run through Marks's memos?
Read enough Oaktree memos and the same three postures keep turning up under different titles. They're worth naming, because each one is a rule you can act on and none of them needs a forecast.
Patient opportunism. When Marks does nothing, he's standing ready to wait for a price that meets a standard he set in advance. That's the same rule behind Klarman's residual cash, reached from the cycle side instead of the bottom-up side. The two converge because a standard that doesn't move produces cash at tops and deployment at bottoms, with nobody forecasting either.
The arithmetic is worth carrying around, and the portfolio-construction work runs it in full. Hold 20% in cash yielding 6% against an equity expectation of 12% and the blended expectation is 10.80%, a drag of 1.20 percentage points a year. Compound that for three years and the patient investor is 1.108³ ÷ 1.12³ − 1 = 3.18% behind. Now deploy the same 20% in a dislocation at a 40% discount. If the price merely returns to where it was, that sleeve gains 1 ÷ 0.60 − 1 = 66.67%, which adds 0.20 × 66.67% = 13.33% to the whole book at once. Three years of looking foolish costs about 3%, and one deployment at the right price pays about 13%. That's the trade. It also explains why the posture fails in a long bull market, where the dislocation never arrives.
Knowing what you do not know. Marks splits investors into those who think they know where the economy and the market are going and those who know they don't, and he's emphatic about which camp Oaktree is in. In practice that demotes forecasting and promotes two things you can actually establish. One is where you are in the cycle now, which you can observe. The other is what the price already implies, the reverse-DCF habit behind second-level thinking. A forecast is a claim about the future. A cycle read is a claim about the present, and only one of them can be checked.
Defensive investing as a posture. The third theme is that avoiding the losers matters more than finding the winners. The arithmetic of drawdowns is asymmetric, and most portfolios are destroyed by a small number of large mistakes. Defence here means margin of safety, insisting on downside cases, and modest position sizes in the situations you understand least. That's different from holding defensive sectors, and Marks is careful about the distinction. A defensive posture can be expressed in aggressive assets bought at prices that already assume trouble.
The second and third themes stop being attitudes in the market-valuation elective, where they become a written policy. You build a market-temperature gauge that shows each reading's historical percentile, and a rule that calibrates aggressiveness to the gauge without forecasting a date.