Market fluctuates at the whims of its most volatile participants: Oaktree's Howard Marks

Markets are not built on natural laws, but rather the shifting sands of investor psychology, according to OakTree's Howard Marks.

Volatility, commonly associated with riskier assets such as equities, stems from investor behaviour that leans more on sentiment than rational analysis, Oaktree Capital's Howard Marks said in his latest memo, explaining the sharp sell-off that rattled world markets in early August.

Markets were upbeat at the end of July when Fed Chair Jerome Powell hinted that the central bank was moving closer to a rate cut, and US macroeconomic data indicated prospects of growth and further stock market appreciation.

Read More: Which came first—yen carry trade unwinding or equity selloff?

Soon after Bank of Japan announced its biggest increase in short-term interest rate in over 17 years, the unwinding of yen carry trade began, with investors selling a variety of assets to trim leverage. Compounding the situation, mixed economic data from the U.S. emerged in early August.

While the US Manufacturing Purchasing Managers’ Index fell and initial jobless claims rose, corporate profit margins remained strong, and America's productivity gains exceeded expectations. Simultaneously, Warren Buffett’s Berkshire Hathaway reduced a substantial shareholding in Apple, adding to an already negative sentiment.

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All the mixed cues - mostly negative - constituted a triple whammy, resulting in a sell-off across assets. Howard Marks highlighted that the flip from optimism to pessimism, which precipitated the market downturn, illustrates how investor mood swings can distort perception.

"In the real world, things fluctuate between pretty good and not so hot, but in investing, perception often swings from flawless to hopeless," Marks wrote in the memo.

Mood swings heavily influence investors' perceptions, causing drastic price swings. According to Marks, when prices plummeted earlier in August, it wasn't due to an actual deterioration in conditions but a shift in perception making them seem negative.

"In good times, investors obsess about the positives, ignore the negatives, and interpret things favourably. Then, when the pendulum swings, they do the opposite, with dramatic effects," he observed.

What further complicates things in terms of rational analysis, according to Howard Marks, is the fact that most developments in the investment world can be "interpreted both positively and negatively, depending on the prevailing mood." Markets are not built on natural laws, but rather the shifting sands of investor psychology, the veteran investor said.

The market fluctuates at the whim of its most volatile participants, added Marks. The volatile participants include those who are willing to buy at a big premium when the news is good and enthusiasm is high, and those who sell at a big discount when the news is bad and pessimism is rampant.

Cautioning investors against sentimental moves amid a wave of good news or bad news, Marks said, "It’s the primary job of the investor to take note when prices stray from intrinsic value and figure out how to act in response. Emotion? No. Analysis? Yes".

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