The Second-Level Thinking Model
Think beyond the obvious consensus to find where the crowd is wrong
The Second-Level Thinking Model is Howard Marks' framework for developing the cognitive discipline that separates above-average investors from the rest. First-level thinking is simple, superficial, and arrives at the same conclusion as everyone else: this is a good company, therefore buy the stock. Second-level thinking is complex, convoluted, and looks for where the consensus is wrong: this is a good company, but everyone thinks it is a great company and has priced it for perfection, therefore the stock is overvalued and I should sell. The framework recognizes that in markets and in strategy, you cannot earn above-average returns by thinking the same way as everyone else. If your analysis leads to the same conclusion as the consensus, you will earn consensus returns at best. To outperform, you must think differently AND be right - which requires deeper analysis, more nuance, and the willingness to stand apart from the crowd. Second-level thinking asks not just what will happen, but what does everyone else think will happen, and where is the gap between consensus expectations and likely reality? This gap between expectations and outcomes is where superior returns live.
- First-level thinking leads to consensus conclusions and average returns
- You cannot outperform by thinking the same way as everyone else
- The gap between expectations and outcomes is where superior returns live
- Being different is necessary but not sufficient - you must be different and right
- Second-level thinking considers what everyone else thinks will happen
- Identify the Consensus ViewBefore forming your own opinion, clearly articulate what most people believe about a situation. What does the market expect? What are analysts predicting? What is the dominant narrative? You cannot think differently if you do not first understand what the crowd thinks. Map the consensus view explicitly rather than assuming you already know it.Pro tipRead the most popular analyst reports and media coverage to understand the prevailing narrative before doing your own analysis
- Ask Where the Consensus Could Be WrongSystematically challenge each element of the consensus view. What assumptions is it based on? What could change those assumptions? What information might the consensus be ignoring or underweighting? What historical parallels suggest the consensus is overconfident? The goal is not to be contrarian for its own sake but to find genuine gaps between what everyone expects and what is more likely to happen.Pro tipCreate a two-column list: consensus assumptions on the left, potential challenges to each assumption on the rightWarningBeing contrarian without rigorous analysis is just as dangerous as following the crowd. The goal is independent thinking, not reflexive disagreement.
- Assess the Risk-Reward of Non-Consensus PositionsWhen you identify a gap between consensus expectations and your analysis, evaluate the potential payoff versus the potential cost of being wrong. Non-consensus positions should only be taken when the asymmetry is favorable: the upside of being right significantly exceeds the downside of being wrong. This prevents you from making contrarian bets that are intellectually interesting but financially reckless.
- Build Conviction and Hold Through DiscomfortNon-consensus positions are psychologically uncomfortable by definition because everyone around you disagrees. Build conviction through thorough analysis rather than gut feeling, and establish clear criteria for when you would change your mind. The ability to hold a well-researched non-consensus view through periods of doubt and social pressure is what separates successful second-level thinkers from those who capitulate under pressure.Pro tipWrite down your thesis and the specific conditions that would invalidate it before taking the position. Review this document when you feel pressure to conform.
Marks has written investment memos for decades, each one demonstrating second-level thinking in real time. His memos during the dot-com bubble, the 2008 financial crisis, and subsequent market cycles showed how he identified gaps between consensus expectations and likely outcomes before they became obvious. Warren Buffett has said he reads Marks memos immediately when they arrive.
Marks developed the concept of second-level thinking through decades of observing how the most successful investors at Oaktree and elsewhere consistently thought differently from the crowd. He noticed that many smart investors reached the same first-level conclusions, leading to crowded positions that offered ordinary returns. The investors who consistently outperformed were those who looked for where these consensus views were slightly or significantly wrong. He codified this into his investment philosophy and his famous memos, which became required reading for institutional investors worldwide.