Gross: Pretty smart.

Moser: -- he said it'd be crazy to be in cash at the beginning of the year in. Well, how's that working out? It's not to knock him, it's to say it's unpredictable to try to figure out what's going to happen month to month, year to year. The long haul is what we're focused on. And hey, you know what? Things will get better.

Cross: But guys, things were going so well! We had our first trillion-dollar companies. Apple had passed that mark, Amazon (NASDAQ: AMZN) up there, too. Things were going so well for the first three-quarters of the year.

Gross: And then...

Cross: The story for me is volatility. We've been talking about it for the past couple of years. We saw it come back. So far in 2018, we had 17 days with the S&P 500 crossing a daily gain of more than 2%, either positive or negative. We had zero days in 2017. Actually, I calculated this, the average going back over the last 20 years, two decades, is about 20 days per year of the S&P 500 moving plus or minus 2%. Now, some of those days, obviously, during the market volatility days of 2008, 2009, were really extreme. Same thing with 2001, 2000. But generally, over the last two decades, the markets are moving. We didn't see any of that in 2017. 2018 is a little bit more normal, it just happens to be that it came over a few months here to end the year.

Moser: I'll refer back to a tweet Matty Argersinger sent out not all that long ago, that volatility is really actually our opportunity. You have to embrace it when you do see it, because that's what gives us the opportunity to separate ourselves and outperform over longer periods of time.

Gross: Having said that, I'd like to go on record as saying I prefer the up years.

Cross: [laughs] Well, you had them!

Gross: You can quote me on that. That can be a famous quote someday!

Cross: You had a good run, Ron! You had a good run!

Moser: I feel like you could put that on the studio door or something.

Hill: Up next in our year in review, fill in the blank, Ron: This year, I was really surprised by _____.

Gross: The fact that retail came back from being on life support. Many predicted retail, brick-and-mortar retail specifically, was dead thanks to the likes of Amazon and online shopping in general. And it partially has taken quite a hit, for sure. Many retailers have been forced to close stores. Many of the most egregious and unprofitable retailers have actually gone out of business. But the rate of store closings has slowed, the stronger players are capitalizing on industry failure, and some online stores are actually moving to brick and mortar, like a Warby Parker or an UNTUCKit. UBS is actually forecasting brick and mortar can still deliver about 1% sales gains annually going forward. So, the demise of retail was a bit premature.

Hill: Jason?

Moser: I'm surprised at how quickly the leadership team at Facebook of Mark Zuckerberg and Sheryl Sandberg went from what I would consider a reason to invest in the business to a dude that I don't think I can ever trust anymore, in the course of just one year. There were privacy issues abound. It seemed like there was a new headline every week, and that has a lot to do with it. But they really haven't been very up front and transparent about what they're doing about it, and how they're going to make this right.

Here's the thing. I personally don't own Facebook stock, it's not something I'm interested in. But as an analyst, I have a hard time seeing a scenario where investors would lose money on the stock five years from now. It's a massive network. I think it ultimately boils down to, we'll sit here around the table and criticize and complain about what Facebook does, but when you look at people in general, they will get past it. Ultimately, they value the access to that network above all else.

There's actually data out there that proves that. There's a 2017 Deloitte survey of 2,000 U.S. consumers, found at 91% of respondents willingly accept legal terms and conditions without reading them before installing apps. I'd be willing to venture a guess that all four of us around the table fall under that charge.

Gross: Guilty as charged!

Hill: That's not a surprise, is it?

Moser: It's not a surprise at all.

Gross: It's a surprise that it's only 91%.

Moser: I think that's the point. Regardless of the behavior, I think people are still going to want to access to those networks. It really shows that the advantage that network effect really has for Facebook and its properties.

Hill: Andy, what surprised you this year?

Cross: Gentlemen, the industrial conglomerate is dead. Long live the industrial conglomerate. Look at what has gone on with General Electric, United Technologies announcing they're separating. The GE story just continues to get worse and worse throughout the year. We actually shorted it in our Neverlasting service and made some good money on it, but only $1 or $2. If we had held on, we would have gone from $14 to $7 now. As they continue to struggle with their industrial business, finding the right units that work out, it's been a decade of disasters at GE, unfortunately. I don't think the nail in the coffin in GE. It's still a $60 billion business. But, going that direction.

And then, United Technologies splitting up, trying to find more opportunity for shareholders as three distinct businesses rather than just one. I think conglomerate is just going the way of the dodo bird now.

Hill: I'll add on to that. I was surprised that John Flannery, who was CEO at General Electric when the year began, I was surprised they fired him a little over halfway through the year. At the beginning of the year, we talked about Flannery as being a CEO to watch in 2018, in part because he was so transparent, he did such a good job of communicating, "This company has problems, everything is on the table in terms of the levers I'm going to pull to try and fix this." And they had no patience.

Cross: Yeah. It was one of the risk factors that we identified. They're selling off assets, trying to cut the costs dramatically by cutting staff. But when the dividend got cut, they continued to see the dim prospects at GE, and that he wasn't the person to solve it.

Hill: Another fill-in-the-blank, Ron. Looking back, _____ got way too much attention in 2018.

Gross: I will go with Tesla Model 3 production levels, but specifically Elon Musk, who just sucked the air out of the room too many times in 2018. No respect for the SEC or corporate governance or the Wall Street community.

Hill: Hard to argue with that, Jason.

Moser: You know, I was actually considering that. But I will go with something we mentioned earlier, this race to a $1 trillion market cap. We're complicit.

Cross: I just mentioned it!

Hill: As much as any one business or investing program, we're guilty of this.

Moser: Yeah, we'll step right into the spotlight there. But I think we also made a pretty good point when we spoke about it that it ultimately was more or less meaningless. It was a neat subject to talk about because it's something that's never happened before. But you look at where everything stands today, and we no longer have any companies out there with a $1 trillion market cap anyway.

Gross: We get to do the whole story over again!

Moser: Exactly! We've got a whole spate of content for 2019 setting itself up so nicely. Listen, Microsoft, all these businesses, they're wonderful businesses regardless. They'll get there, they'll pass it, they'll stay past it. Then we'll talk about $2 trillion at some point, I'm sure.

Hill: Andy, what about you?

Cross: You guys may have heard that Amazon was searching for a new headquarters.

Gross: [laughs] That's a good one!

Cross: They ended up not just with one. They went with two. Jeff Bezos went with two, and two of the most obvious ones. I mean, really, didn't they just kind of waste everyone's time? A lot put into this. Cities all around the country put in bids and tax breaks for Amazon. Amazon collected a ton of data. And it's not done, by the way. Here in Crystal City, Virginia; up in Queens, New York, they're going to build these facilities and hire a lot of people. It's going to be a long-term story. But boy, the whole process of how it went on, got dragged on. And then, they announced, "It's not just one headquarters, it's two!" A little bit disappointing, there.

Moser: Have you read the articles that are coming out since these announcements that are like, "By the way, this is going to be a lot slower rollout than you all anticipated. It's only going to be maybe a couple of thousand people the first year, maybe a couple of things." It sounds like it's going to be something that we probably won't feel as quickly as we thought we might have.

Hill: Real quick, Ron. If Elon Musk got too much attention in your mind, what was under the radar? What needed a little bit more oxygen in 2018?

Gross: Harking back to my earlier thoughts on retail not being dead, it's something we talked about a few weeks ago on this show, the rebound of RH, formerly Restoration Hardware, was very much under the radar for me. I had no idea the company was performing as well as it has this year, the stock up 42%. Left for dead at one point. They really reinvented themselves with a subscription-based membership program, reducing inventory, rebuilding the stores to look more like galleries. They bought back a bunch of stock, which was a very good allocation of capital, at least it appears to be so far. And I just think most investors don't even realize.

Hill: Can I just throw in on top of that, Burlington Stores?

Gross: Yeah, same thing!

Hill: Over the past five years, shares of Burlington Stores have outperformed some of the best companies in America. Jason, what about you?

Moser: I was thinking about this earlier. It's been such a tough year. We talk about the market being down. There are a lot of reasons why we invest in individual stocks. I think one of the reasons is, while the market may be down for the year, that doesn't mean that all of your holdings necessarily have to be down. One of mine, thankfully, McCormick, is not down for 2018! It's had a nice year. The stock up between 35-40%, fluctuating here with this volatility. But in the face of the market that is looking like it's going to chalk up negative returns, McCormick has been a nice little ray of light on the portfolio.

I think a lot of that has to do with the fact that the RB Foods acquisition that they just finished digesting, no pun intended, really turned out to be a good move. I think the market rightly was a bit skeptical. They had to take out some debt to make that deal happen. It wasn't like it made perfect sense at the beginning. But it has made sense here in hindsight, and I think they're getting the credit for it now.

Hill: And a total outlier when you look at the packaged food industry.

Moser: Oh, yeah, really. Absolutely!

Hill: Andy?

Cross: It has not been an easy go for actively managed mutual funds. They continue to see money flow out the wrong way and not into the funds, out as ETFs take on more and more assets under management. The one bright spot has been socially responsible governance investing. Some estimates, up to a quarter of all assets around the around the world are tied to ESG, environmental, social and governance investing. I think that is going to be a big spot in 2019 as more and more investors look for better ways to both support their own personal interests, as well as, it's historically been a very good place to put money recently. There are a lot of great businesses out there that qualify. The ESG movement is real, and it's here to stay.

Hill: It's our year-in-review special. Let's talk about the best CEO of 2018. You know what, Ron? If you want to throw in, maybe it can be a worst CEO, or just someone or something that you can't believe is still around.

Gross: Throw it in for good measure?

Hill: Sure.

Gross: Let's start with best. Marc Benioff of salesforce.com. A leader in the cloud computing industry. 97% Glassdoor rating from employees. Company continues to put up strong results in a competitive business. Growth continues. The stock's up 27% in 2018.

For worst, I'm going to go with Mr. Zuckerberg of Facebook. I don't really think he should be thrown out the door, but the media and the conventional wisdom certainly thinks he should. More likely, I think we'll see Sheryl Sandberg, COO, depart in the near term.

Hill: Save the predictions for our 2019 preview. Jason Moser, what about you?

Moser: Best, let's go with Josh Silverman with Etsy (NASDAQ: ETSY). Brought into the company in mid-2017 when the business was dealing with some challenges. He right-sized, he focused on growing out its mobile offering. It was able to push through a little price increase without having customers defect from the platform. The stock has had a phenomenal year, up around 150%. I'm a proud owner of shares. I'm rooting for him to keep doing what he is doing, Chris.

As far as worst CEOs, and this really probably qualifies as one of the worst human beings out there, is Les Moonves.

Let's shine a light on everything that he really did. It really just seemed to come to a head there. I'm glad that CBS denied him that $120 million severance package, because clearly, he's been behaving very badly for a very long time. Good riddance, in my opinion.

Hill: Fired with cause. Andy Cross?

Cross: Satya Nadella of Microsoft has done the impossible: he's made Microsoft hip again. It's a place that people want to work. His acquisition of GitHub over the last couple of years has been an example of that. The stock is up 20% over the last year. It was one of the largest companies in the world. Revenue is growing 15% a year. That's way up than what they were a couple of years ago. Returns on equity, 20%. Satya Nadella continues to do a great job at Microsoft.

I can't believe -- and I just shopped there last night -- Barnes and Noble continues to be around. It does $3.5 billion in sales. It's a $500 million market cap. It has 600 stores! The process for Barnes and Noble, just not very smooth, considering you can just go online and use Amazon so smoothly. They have some troubles and they continue to struggle. I'm not sure where they go from here, Chris.

Hill: All right, just a couple of minutes left. Ron, the dumbest investment of 2018.

Gross: It would have to be Bed Bath & Beyond's share buyback program. $2.8 billion since 2015. $100 million in 2018 alone. Terrible allocation of capital. They have a remaining balance of $1.4 billion on that program. God help us if they do it. The stock's down around 45% this year.

Hill: Jason?

Moser: I feel like I've been batting a thousand with Snap so far, but I'm going to go and stick with what works. It's pretty amazing to see them doubling -- nay, tripling down on the failure that is Spectacles. It appears that SnapLab is going on its third boss in six months. To me, that tells you all you need to know. And that's fine, if they want to dabble with this stuff and try to figure whether there's an opportunity out there. But as it stands right now, it looks like they are falling flat on their filtered faces.

Hill: Andy?

Cross: If history repeats itself, the acquisition of Time Warner by AT&T will not be a good move, considering the acquisition that AOL did of Time Warner back into 2001 was a disaster. I think AT&T buying Time Warner is a stretch. It loaded the balance sheet up with a lot of debt. We'll see how that plays out.

Gross: Anything involving Time Warner and the word "acquisition" is just not good.

Cross: Not good.

[...]

Hill: Warren Buffett has said of our guests this week, "When I see memos from Howard Marks in my mail, they're the first thing I open and read." Howard Marks is the co-founder of Oaktree Capital, where he's crushed the market and earned billions for investors. A few months ago, Motley Fool analyst Bill Mann had the chance to talk with him about Mark's new book Mastering the Market Cycle: Getting the Odds on Your Side. Bill kicked things off by asking him how investors can determine where we are in the market cycle.

__

Howard Marks: I think you really have to understand what produces cycles. I go through examples of what led up to the tech bubble and the subprime bubble and the unwinding of the subprime bubble, and so forth. I go through these progressions step by step to give an appreciation. As you say, it's not science, it's not numbers, it's not formulae. It's understanding developments in the real world and how they occur and how the elements combine to produce those cycles. Only by having an appreciation for the workings of these things, not by expecting to be given a formula that you can plug and play, can investors perfect this essential skill.

Bill Mann: When I read this book, I thought of one word over and over, and you've used this also in your memos. That is temperament. I once had a really fun conversation with Daniel Kahneman, who won a Nobel Prize for his work in behavioral finance. He spoke about how he actually panicked during the financial collapse and sold everything. How do you think that one becomes more unemotional about investing?

Marks: That's a great question! The first answer is, as they say in basketball, you can't coach height. No matter how good a basketball coach is, his players are not going to get any taller. The improvement has to be intentional.

The first thing you can learn is why it's important to be unemotional, and why emotionality is the enemy of the investor, why human emotion conspires to constantly make investors do the wrong thing. Then, the second step is to do it. I think probably many more people can understand the need for it than can actually apply it, but you don't have to play it perfectly, you only have to do a better job than you used to do. I think that most people should be able to attain that skill.

Mann: I think the very interesting thing when you think about market cycles is that they're very real things, of course, but it's not like these things are naturally occurring. They're entirely driven by human behavior. Maybe a good piece of background would be for you to describe what you think actually causes market cycles.

Marks: Sure. And to reinforce what you just said, let me point out that, starting at the University of Chicago in the 60s, people, even before the computer age, figured out what the return on stocks had been. Since '29 to '62, I think they did the work, 9.2%, then it's been extended since then. So, stocks return 9-10% a year on average for long periods of time. We know that.

Mann: And I think they've never actually returned exactly 9.2% a year.

Marks: That's right. And the point I was going to make is that they rarely return between 8-12%. Many more observations are outside of the 8-12% range than inside it. So, my first observation is that the average is not the norm. If stocks return 10% a year on average, why don't they just return 10% every year? And the biggest answer is emotional excesses to the upside, which then require correction to the downside.

If you think about the value of a company, and what it's going to be worth in 50 years, that does not change very much from day to day, week to week, month to month, even year to year. It's pretty stable. The changes in this year's or this quarter's earnings are not that important. But people react excessively to these things. We want to be on the right side of those reactions and not the wrong.

When things are going well, the economy is humming, and corporations are doing well, they're reporting earnings which exceed on the upside, the media are issuing only positive reports and interpreting the news positively. The prices are going up every day. People feel terrific. They love the things they hold, they want to go out and buy more. The only people who are unhappy are the people who don't hold, they want to buy for the first time. All of these things together produce rising optimism, rising euphoria, and greater self-satisfaction, and, consequently, higher prices.

So, as the prices rise, the emotion turns more positive, until you reach a top when the price is at its maximum and the emotion is at its maximum. Now, that's when you want to be selling, when the price is high. And by definition, very few people do, because they are feeling so positive. And of course, the reverse is true in the opposite direction. I will not belabor it. But at the bottom, the price reaches its minimum at the same day that the investors are the most depressed and the most unlikely to buy.

We must do the opposite. We must stand against the herd. We must stand against mass psychology. We must sell when fundamentals are at their peak, and emotions are the most positive. We must buy when fundamentals are at the trough and people are most depressed. The goal is to buy low and sell high. More people buy high than buy low. We want to be different from most people. We have to understand what's going on, we have to understand why people are doing what they're doing, you have to understand what's wrong about it, and you must be able to stand against it.

Mann: I think we would maybe best describe the market as being one part psychology and the other part path dependency.

Marks: Probably right. And the psychology part is very important. The people who learn financial analysis in school don't learn much about psychology. But this is the thing that's really going to determine whether you have good days or bad days.

Mann: I love that you said that. As I've looked through your background, and I've read your memos for decades now, they're an absolute gift to me, but as I was reading this book, I'm reminded of the fact that you have a fairly formal traditional finance education, having gone to Wharton and the University of Chicago. But when I read this book, and when I read your memos, I feel like I'm reading the works of a history major, in particular in your focus of tendencies over predictions.

Marks: I started 50 years ago this summer. I've seen a lot. I've seen a lot of mistakes made. If you have your eyes open and you're conscious of what's going on, you learn from mistakes, and you put together a view of the world which can be helpful. I started in '68 at Citibank. Citibank, and most of the banks, were what we call the misty 50s buyers. They bought the stocks of the 50 greatest, fastest-growing companies in America, to which nothing bad could happen. Well, No. 1, a lot of the companies to which nothing bad could happen had bad things happen. So much for predicting the future. But No. 2, because the companies were so highly rated, they were extremely highly priced. If you joined when I did in '68 and you bought those 50 stocks and you held them diligently for five years, you lost almost all your money. Not because in every case, the companies were troubled, but because in every case, they had been overrated. Psychology had been too positive, leading to excessive pricing, and then the air went out of the balloon. It's not what you buy that makes you a successful investor. It's what you pay for it. What matters most is not the quality of the asset, but the relationship between the price and the intrinsic value. You get bargains, you get easy, safe profits, by buying things for less than they're worth. If you pay more than they're worth, you're going to have trouble wringing out a profit.

Relationship between price and value. What determines that? Emotion. Not what's going on, but how are people reacting to what's going on? How much are they paying for the fundamentals that are present in that situation? I think it's extremely important to understand it. I sum it up with the word "emotion," but that's an oversimplification. You want to understand what's going on in people's minds and emotions when they price assets. You want to buy the ones they're underpricing and sell the ones they're overpricing. You want to buy the market when it is underpriced, and you want to sell it when it's overpriced.

Mann: I love that you've made this point. I do want to challenge something. A lot of people who will be reading and listening to this will think that what you are talking about is market timing. But you're not. You're not talking about getting in and out of the market at the right time. You're not talking about reading the tea leaves and thinking about the trade sanctions in China and pulling out of certain parts of the market. You're talking about focusing on the areas where there is opportunity based on what's out there and where the market sits at any given point in time.

Marks: Exactly. Nothing in the book, nothing that we do at Oaktree, is based on forecasts. I am strongly opposed to basing investing on forecasting. What I say is, we never know where we're going, but we sure as hell ought to know where we are. Where is the market in its cycle? Is it depressed or elevated? When it's depressed, the odds are in the buyer's favor. And when it's elevated, the odds are against him. And it's really as simple as that. Your listeners should distinguish between markets that are high in their cycle and markets that are low. They should vary their behavior on that basis. They should take more risk when the market is low in its cycle, less risk when the market is high in its cycle. This is not saying, who's going to win the election? What will the earnings be? When will rates be increased?

So many people asked me for so many years, "What month is the interest rate increase going to take place?" And I would say, "Why do you care? That's not what matters! What matters is whether interest rates are going up or down, whether it's going to go up a lot or a little." People don't understand how money is made. They think that knowing which month the interest rate increase is going to take place is going to make them money. That's not what it's about. It's about investing more and more aggressively when the market is propitious, and less and more conservatively when the market is precarious.

Mann: To me, there's so much voodoo that gets thrown about when it comes to the to the markets. I'm going to take a little bit of a risk here in that I believe that we are perhaps kindred spirits, but it drives me to the point of insanity when pundits who ought to know better either credit or blame or the performance of the stock market or the credit markets based on who happens to be sitting in the Oval Office.

Marks: Right, absolutely.

Mann: How do you think that people should put either political conditions or macroeconomic events into the context of market cycles themselves?

Marks: It's obviously complex. By the way, let's go back two years ago to October 16th. Most people in America believed two things. No. 1, that Hillary Clinton would win the presidency. No. 2, if Donald Trump did, the market would collapse. Instead, Hillary lost, Donald won, and the market soared. I think that mere fact should be enough to convince most people that they don't know what events are going to happen. They don't know how the market is going to react to the events that happen.

Mann: You would think. [laughs]

Marks: You would think. Having said that, how do you factor in politics? All things being equal, it is more favorable for the market that we have a president who is extremely pro-business. I think, clearly, Donald Trump is, and his Administration. Hillary would not have been to the same extent. Hillary would have been under pressure from the progressive wing of her party to actually be somewhat hostile to business. This is going to continue with the Trump Administration. All things being equal, that'll be a positive. Now, that doesn't mean it's all good.

Mann: Or that it's not already in the market.

Marks: Exactly. I was just going to say that. You're absolutely right. One of the biggest mistakes that most people make -- you and I were talking a minute ago about the voodoo -- is that they sit here, and they say, "I think there will be positive events, which means I think the market will go up." That identity is not dependable. Maybe there will be positive events, but maybe they're already priced into securities, in which case, there will be a big yawn. Or, maybe there will be positive events, but not as positive as were factored in when stocks were priced, which means you'll get a positive event and the stocks will go down. As I say, predicting these events and predicting the market's reaction to them is very thorny.

Mann: Are there opinions or beliefs in the market that you find to be particularly unhealthy for investors?

Marks: The first thing, and I try to make this clear in the book, and it's essential if people are going to be able to deal with cycles, everybody wants an easy answer. Everybody wants to say, how long does an upswing last? The first step is, you must dispense with any concept of regularity.

The whole book is based around Mark Twain's statement that history does not repeat, but it does rhyme. When he says it doesn't repeat, he's saying that, in our case -- he wasn't talking about the market, he was talking about history. But the truth of the matter is, market cycles vary one to the next in terms of their amplitude, their speed, their violence, their duration. It's all different. People want to know, how long is an upswing? The answer is, we absolutely can't tell them. Expecting regularity, and thus predictability, is wrong.

And then, you can go from there to the whole concept of predictions. What makes the market go up and down? To a small extent, it is what I call fundamental developments in the economy and the companies. But to a large extent, it's psychology, or let's say popularity. It should be clear by now to everyone that the swings in popularity are unpredictable.

[...]

Hill: Howard Marks' latest book is Mastering the Market Cycle, and it's available everywhere.

That's going to do it for this week's edition of Motley Fool Money. Our engineer is Steve Broido. Our producer is Mac Greer. I'm Chris Hill. Thanks for listening! We'll see you next week!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Andy Cross owns shares of Facebook. Bill Mann owns shares of Oaktree Capital. Chris Hill owns shares of Amazon. Jason Moser owns shares of Amazon, Apple, Etsy, and McCormick. Ron Gross owns shares of Amazon, Apple, Facebook, and Microsoft. The Motley Fool owns shares of and recommends Amazon, Apple, Etsy, Facebook, Oaktree Capital, Salesforce.com, and Tesla. The Motley Fool owns shares of Microsoft and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends McCormick and RH. The Motley Fool has a disclosure policy.