Generally speaking, only time and the relative calm between major crises allow us to gain a reasonable sense of the truth. Currently, in assessing the recent market environment, the answer will take a little longer to be revealed due to the SVB Financial collapse on March 10th.
Of greater significance, with the S&P 500 down 3.0%, this is still a tolerable outcome, particularly if it means the story of 2023 remains intact (at least for now).
But what is that story?
Simply put, this has been a year of recovery—not from market declines but from irrational pricing. It’s worth remembering the timeless rules of capital market behavior; during a market such as the one we’ve been navigating since late 2021, three basic phases typically unfold:
Phase 1—a shocking event leads to panic and indiscriminate price declines
Phase 2—the passage of time softens emotions as we adapt to change. As this occurs, the most egregious mispricing quickly corrects.
Phase 3—slowly but surely, a broader array of mispriced assets shifts towards a more sober assessment of risk and opportunity.
2023 started out with a quick pivot to phase 2 and Phase 3 appeared imminent. What’s fascinating about this is that much of what’s happening is taking place quietly, with many people dismissing the changes as “noise” or “irrational and unsustainable.” However, the more people doubt a shift in market conditions, paradoxically, the more likely it is to be real, which is why meaningful success is so rare—you have to do the things that everyone is telling you not to do.
This gets at the heart of the reason why a lot of what we do can make us feel uncomfortable. Simply put, it’s fear. We do things that have a high probability of success, but we know the risk of a temporary but still poor outcome is much higher in the short term.
The following definition is copied from Northwestern Medicine's website.
"Fear is experienced in your mind, but it triggers a strong physical reaction in your body. As soon as you recognize fear, your amygdala (small organ in the middle of your brain) goes to work. It alerts your nervous system, which sets your body's fear response into motion. Stress hormones like cortisol and adrenaline are released. Your blood pressure and heart rate increase. You start breathing faster. Even your blood flow changes....Your body is preparing for fight or flight."
All of us prefer not to be in this state, so we have a natural tendency to minimize or eliminate the risk of negative scenarios.
Now we've reached the heart of the matter—valuation, extreme popularity, and cycles—are all saying the same thing: avoiding fear now may defer short term pain but lead to a much higher price paid long term. Yet, it seems as though even those who acknowledge this often do very little about it.
This is partially due to a tendency to avoid looking back to acknowledge mistakes or find fault with decisions. Such reflection can trigger a range of emotions, from mild anger to a bit of jealously, as looking in the mirror can be difficult. But difficulty is no reason for inaction.
If one's goal is meaningful success, the only way to lead through a challenging period is to pursue an approach highly likely to succeed and then maintain the conviction to stick to the plan even when the desired outcome is less than imminent. This demands strong, unambiguous statements and a full accountability for their implications.
The phrase "likely to succeed" is a critical part of the statement above. Our philosophy is not applied to pursuits such as short-term market forecasts, for example. Instead, we aggressively pursue diversification (geographic, concentrated versus diversified, variant perception, etc.). This is not bold nor is it likely to be misguided—in fact, the Nobel prize was awarded to Harry Markowitz for his research into this topic1. All we've done is take this concept and sought as many ways as possible to magnify it in the pursuit of higher returns.
However, to continue to learn and grow, we must continue to see our work as imperfect and therefore continually subject to improvement. To do this, we must look back unemotionally at both our successes and, more importantly, our mistakes.
I believe a passion for extraordinary client outcomes is the antidote to dogmatic thinking, anxiety, and lackluster performance. You have to be strong in the face of criticism, yet when we stop learning, stop growing, and stop pursuing a world of ideas and people yet to be discovered, we become permanently enclosed in a static loop of what we learned before.
Nothing great ever comes from that. Delivering on a promise of success takes the strength to shoulder criticism while seeing what you can learn from it, while keeping the ultimate objective firmly in mind past the noise of today.
1 Markowitz’s “portfolio theory” which sought to prove the practicality of a diversified, or “optimal,” portfolio—one that mixes assets so as to maximize return and minimize risk.