By Tom Bradley

One of my favourite investors, Howard Marks of Oaktree Capital Management, has been busy. Mr. Marks usually writes 3 to 5 memos a year, but in the last week he’s put out two - January 14th and 19th.

I thought the following section from the first memo, in which he discusses the psychology of investing, is particularly poignant right now.

“... Investors rarely maintain objective, rational, neutral and stable positions. First they exhibit high levels of optimism, greed, risk tolerance and credulousness, and their resulting behavior causes asset prices to rise, potential returns to fall and risk to increase. But then, for some reason – perhaps the arrival of a tipping point – they switch to pessimism, fear, risk aversion and skepticism, and this causes asset prices to fall, prospective returns to rise and risk to decrease. Notably, each group of phenomena tends to happen in unison, and the swing from one to the other often goes far beyond what reason might call for.

That’s one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not so hot.” But in the world of investing, perception often swings from “flawless” to “hopeless.” The pendulum careens from one extreme to the other, spending almost no time at “the happy medium” and rather little in the range of reasonableness. First there’s denial, and then there’s capitulation.”

Neither Mr. Marks or I are suggesting the “pessimism, fear, risk aversion and skepticism” has got us to the point of “capitulation”, but investor sentiment is definitely on the gloomy side of the spectrum. Given the state of investors’ psychology, and what appears to be more reasonably priced assets for our managers to choose from, at Steadyhand we’re shifting from defence to offence.

We’re not going crazy or mortgaging the house just yet, but in the Founders Fund Salman and I have been using down days in the market to allocate more money to stocks. In July, our cautious outlook had us at 55% stocks (as a percentage of the total fund). At the end of September we were at 60%, having done some buying during the weak period of late August and early September. With the markets again in decline, we needed to do some buying just to remain at that level (i.e. rebalancing), but have continued to increase the stock allocation to 62% (for more details, see our revised Outlook).

We don’t know where markets are going from here. The swings in the market mood that Mr. Marks talks about are unpredictable in their timing, even if they’re highly predictable in their inevitability.

We do know, however, that from where we are today, future return expectations have risen and risk has decreased. We’re comfortable buying stocks today given valuation levels and the gloomy consensus among investors. This isn’t a time to seek precision, let alone perfection. Approximately right is the goal.

For clients who are not in the Founders Fund, it’s time to start doing some rebalancing, perhaps with this year’s RRSP and/or TFSA contributions. For those who are not at or near their long-term asset mix (in my latest Globe article, I refer to Jason), then it’s absolutely the time to get started on narrowing the gap.