Are markets getting frothy? Should we be more cautious? Where do we stand?

Although the May jobs report sent the Market into a bit of a tailspin, overall stock market performance has been improving since the correction in January. As all prudent investors know, good performance should never be a reason to get complacent. How should we interpret this improvement in performance?

In his seminal book "The Most Important Thing" Howard Marks reminds us that we must develop a sense for where we stand. Instead of trying to predict where the market will be in the future we must develop an ability to “take the temperature” of the market. More specifically, market cycles present the investor with a daunting challenge given that:
-Their ups and downs are inevitable
-They will profoundly influence our performance as investors
-They’re unpredictable as to extent and, especially timing

In the face of these challenges the investor has a few options:

1) Believe that market cycles are predictable and put more effort behind trying to predict the future

2) Accept that the future isn't knowable and simply try and ignore cycles by buying and holding high quality businesses

3) Figure out where we are in terms of each cycle and make intelligent investment decisions accordingly

Knowing where we are in the cycle doesn't imply predicting the future but what it does mean is that we can gain better insight into the probability of events occurring in the future. The challenge is developing an alertness to the behavior of market participants as well as an ability to make inferences. What are the deeper implications of what we observe around us? If a majority of people are exhibiting extreme pessimism, can we be more aggressive?

This isn't about forecasting, it is about deep reflection on present observations.

Yet what factors should we be alert to? What observations matter more than others? What signals should we watch in order to make intelligent inferences? To answer these questions, consider Marks’ poor man’s guide to market assessment included below. Listed are a number of market characteristics. For each pair, think deeply about the one you think is most descriptive of today. If you find that most of your findings are in the left hand column, then hold on to your wallet. If most are in the right then consider a more aggressive capital allocation strategy. We believe that at present the balance seems to be tilted to the the right…..