Anatomy of a bubble

Investing isn't just about numbers—it's about understanding human psychology, market cycles, and the subtle dance between risk and reward. Howard Marks, the co-founder of Oaktree Capital, has been guiding investors through this intricate terrain for over three decades. And if there's one thing we've learned from his renowned memos, it's this: there are always lessons to be learned, no matter the market conditions. His latest missive tackles a topic that seems to be on everyone's mind—market bubbles. Specifically, Marks explores how to recognise the signs of a bubble, how they form, and what investors can do to avoid getting caught up in the frenzy. While we've highlighted some of the key takeaways here, the full memo is a must-read. You can find it at: https://tinyurl.com/47rr7dbv. What is a bubble? Marks tackles a question that's on every investor's mind: Is the market in a bubble? The catalyst for this reflection is the Magnificent Seven—the seven largest companies in the S&P 500, which now dominate the index like never before. As these companies continue to push the boundaries of market dominance, it raises the question: Are we seeing another bubble in the making? Reflecting on the two massive bubbles—the dot-com bubble and the housing bubble—that investors experienced in the early 2000s, Marks acknowledges that many are now hypersensitive to the possibility of another. He shares that he's often asked whether there's a bubble surrounding the S&P 500 or the select group of stocks driving its gains. He offers a thought-provoking answer: "For me, a bubble or crash is more a state of mind than a quantitative calculation." He doesn't believe bubbles can be reduced to a simple formula or a mathematical metric. Instead, they're a psychological phenomenon, driven by extreme optimism or pessimism that clouds judgment. He outlines four key characteristics that define a bubble, which investors should watch out for: The four horsemen of a bubble Irrational exuberan

This article was originally published on February 01, 2025.