The first quarter of 2024 provided yet another period of strong, seemingly risk-free gains, with the S&P 500 rising 10.6% for the quarter alongside the MSCI ACWI Index’s advance of 8.2%.  Once again, US large-capitalization growth stocks led the way. further cementing the impression that this group can be relied upon to produce market-leading returns and provide a strong hedge against difficult economic and geopolitical conditions.

If all of this wasn’t good enough, the S&P 500’s worst intra-quarter decline was a mere 1.7%; if this figure were to hold, it would be the smallest decline in over 80 years and a rare situation in which equities experienced an intra-year decline less than that of US treasuries.

Source: Strategas Research Partners

Considering the past, present, and future for markets, we find ourselves regularly thinking about the concept of complacency.  Merriam Webster defines the term as “self-satisfaction especially when accompanied by unawareness of actual dangers or deficiencies.”

Despite the clearly negative connotation, the word does not generally strike overt fear into those who hear it—therein lies its true power, as it is among the most dangerous of the behavioral tendencies that lead to poor/mediocre long-term outcomes.

Interestingly, like trust, complacency takes time to build and entrench itself, but it can dissipate in moments.  Its manifestation within markets today is quite typical, yet atypically dangerous given the broad appeal of the securities that underpin this cycle.

One can draw a straight line from strong outcomes to overconfidence to complacency.  Today, this trajectory has the potential to be unusually pronounced, as a direct correlation has existed between simple/inexpensive investment strategies and exceptional success.  

To illustrate, for the ten years ending December 2023, a 70% S&P 500/30% Bloomberg Aggregate portfolio generated a 9.1% annualized return, outperforming the median endowment and foundation by more than 3% per year and ranking in the top 1% of participants.  Depending on one’s perspective, this is either a stunning outcome or entirely expected; either way, it’s self-evident that the latter perspective was rare to non-existent across the E&F community for a good part of the last decade.   

Yet, this has clearly changed, as many investors now allocate capital heavily to index funds such as the S&P 500 or MSCI All Country World Index.  While most do not expect returns that exceed virtually all endowments and foundations, they do expect both top results and an outcome that supports their missions.

Is this fundamentally sound, or reactionary?  While we won’t definitively know the answer for another seven to ten years, we can wonder if such a strategy will continue to prove as successful as it has been for the past ten years.  Never say never of course, although prudent investing should be based on probabilities and the fundamental factors that drive long-term returns.  Perhaps the most important and reliable of these factors is human nature.

Why didn’t more E&Fs simply allocate to the 70% S&P 500/30% Bloomberg Aggregate portfolio a decade ago?  Wasn’t a universally known, simple, two-fund portfolio focused on our home markets an obvious choice?   Perhaps an avoidance of this strategy can be attributed to an investment advisory community looking for job security by introducing needless complexity; yet even that explanation seems incomplete.

Instead, a far more likely reason is that the 70/30 mix had a very weak long-term track record a decade ago.  For the ten-year periods as of year-end 2009, 2010, 2011, and 2012, such a portfolio ranked in the bottom quartile of the E&F universe and generated low-single-digit annualized returns.  Exactly a decade ago (year-end 2013), the 70/30 portfolio snuck into the top half of the E&F universe, but still only delivered 6.8% per year while top endowments were producing returns of 8% or more.  

Not only was today’s popular index blend a poor performer, but its extended inability to support spending policies naturally drove capital elsewhere.

To be clear, we are not suggesting that overly complex, expensive strategies are inherently superior to a straightforward index blend; in fact, there is little doubt that the opposite is generally true.  What we are saying is little to no logic exists behind the idea that a commoditized index strategy should rank in the top 1% of the E&F universe while generating a 9.1% annualized return.  Essentially, allocators were wrong in 2013 to see the index as a perennial loser; they are equally wrong today to see it as a perennial winner.

Generating mission-supporting returns over multi-decade periods is difficult and each investment strategy must be designed with this in mind.  Complexity may contribute to the solution, but only when executed with great respect for the challenging set of hurdles that must be overcome—of far greater importance is recognizing the behavioral traps that investors must actively work to avoid.

Near the top of this list should be a mistrust of “conventional wisdom,” in part because it’s typically wrong and can change quite quickly with the prevailing convention.  Market expectations for interest-rate cuts by the Federal Reserve provide a prominent recent example.

Note that six rate cuts (dark-blue shading) were far and away the most likely predicted outcome just over two months ago.  This always seemed absurd given the obvious structural changes across geopolitics and monetary policy underway, but nevertheless, its rapid about-face still reflects some interesting behavioral truths, including how popularity impacts opinions and how quickly these opinions can change once a trend reverses.