Market Views

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Education is expensive.

But try ignorance.

- The Mind of the Market

 The Narrow Whirlpool of Personal Experience…..As market strategists, it is incumbent upon us to deal with some peculiarities of mass market movements, especially when it capitalizes upon its adherents’ frustrated states of mind. This frustration will seize upon a catalyst to advance its interests and convert its participants into true believers. It is necessary these days to have insight into the motives and responses of the true believer because he is ever present in our market journey.

In Q4-2024, market action in the U.S. was muted as investors tried to assess the implications of a dramatic electoral season and its potential geopolitical consequences. For Q4, most major U.S. equity indices (except for large-cap tech) took a pause, while bond indices fell back. For 2024, it was abundantly evident that all the action in world markets was centered in the U.S. while the rest of the world was moribund. The broad EAFE index and Emerging Markets index were essentially unchanged in 2024. Notable international exceptions were the Shanghai Composite (+12.7%) and Japan’s Nikkei (+19.2%).

Even as the U.S. stock market surged in the last two years, it has become extremely concentrated. Now dubbed the Big 6, companies like Amazon, Apple, Alphabet, Meta, Microsoft and Nvidia are at the forefront, shaping the future of key industries, influencing job markets, technological progress and long-term economic growth. The 20 largest U.S. stocks represent $24 trillion in market capitalization, approximating the total of the 480 other stocks in the S&P 500 ($29.8T) as well as the entire U.S. economy, measured at $27T in GDP in 2023.

An analysis of returns highlights the importance of the Big 6, which now constitute 31% of the market cap of the S&P 500. Excluding this group from the S&P 500 would have lowered returns from 25% to 16% in 2024, 70% to 48% over the past 2+ years. NVDA alone would have reduced the index's return by 5% and 10%. This handful of companies also explains a big chunk of the relative underperformance of small caps and non-US stocks.

The U.S. market is at its highest valuation relative to the rest of the world on forward earnings since 1988. Even if AI portends a new age of American prosperity and the rest of the world is weighed by tariffs, state intervention and geopolitics, how large should a U.S. premium be? U.S. stocks trade for 22.5x 2025 earnings, while the rest of the world is at less than 14x earnings.

America is the envy of the world right now, for its tech giants in particular. The S&P 500 now accounts for more than 50% of global stock market cap. Market allocators may want to rebalance to international stocks but, in the longer run, the smart money gravitates towards the market that has the best growth and innovation opportunities--even when its valuations are looking exuberant.

Following 2024's broad market advance that pushed valuations, particularly in large caps, to elevated levels, single-digit returns in 2025 are likely for major indices amid a challenging backdrop of full employment and complex yield curve dynamics. On the fixed income side, except for high yield bonds, 2024 was another year to forget for most investors. The major market debate among savvy investors is whether to maintain an aggressive exposure to U.S. Big Tech or adopt a much more defensive posture. Given these volatile and shifting market trends, an over-weight in the safe harbor of cash equivalents yielding nearly 5% does seem like a credible hedge.

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The True Believer….. Human beings are herd animals, and group identification and solidarity seem to be a basic mechanism of survival in a threatening world. But when individuals in a group stop thinking as individuals. groups become dangerous. When this occurs, groups become out-of-control and veer towards excess. Since a large mass does not have a conscience, individuals in groups become untethered to the restraints of reason, morality or ethics.

Conscience always belongs to an individual alone. Group identity typically triumphs over individual morality. To surrender individuality equates to a surrender of free thought. Since one must consider oneself an individual in order to recognize another as an individual, depersonalization of self always leads to depersonalization and debasement towards the other.

In Freud’s famous maxim about the “narcissism of minor differences,” he hypothesized that the degree of tension or animosity between two neighboring groups is inversely proportional to the degree of difference between them. Tremendously small differences - so minor or seemingly irrelevant to outsiders - can result in intense hatred between “us” and “them.” The basic problem

isn’t simply surplus aggression, but also a lack of reflection. This lack leads people to accept and even participate in the most outrageous transgressions against others.

Informing someone that something is false often fails to change people’s convictions. People are predisposed to accept information compatible with their existing beliefs, and dismiss data that disrupts existing attitudes. They gravitate towards those that share their worldview and reinforce their biases. Ironically, pushing countervailing evidence on the true believer often reinforces a false belief. Moreover, people tend to be more influenced by images, narratives and anecdotes than by statistical trends. All these behavioral reflexes increase the likelihood that misleading information will be accepted, and that any corrective evidence will be rejected. The supreme irony is that the “true believer” does not like to be told what to think or how to act. The instinct for self-preservation and ego-enhancement can override all facts, especially when deeply held beliefs are threatened.

Nietzsche argued that the so-called “truth” was often not useful. He believed that errors, disasters and profound misunderstandings could be much more constructive. Sometimes failures provide humbling and liberating incentives to pursue fresh ideas. We devalue the confrontation with the “facts” when its source is from outside of our own group. Conversely we give weight to selective representations of the truth if it confirms our own biases and preconceptions. This psychic myopia makes it difficult to get out of our own way. Fortunately, in an open society (and in open markets as well), we can collectively compensate for each other’s biases by being able to criticize them, airing disagreements and subjecting dubious assertions to empirical tests. We can replace the rhetoric of “us versus them” and go “beyond good and evil,” with a relational ethics that offers a basic respect for the autonomy and validity of others’ experiences.

This discourse applies as much to major market movements as well as to socio-political movements, especially when the true believer is on the march. Thus, the ultimate goal of education is to instill humility and critical thinking as essential life skills, so as to give human reason the widest possibility to recognize the truth. A real education leads us toward a psychological maturity that counteracts the impulse to simplify and polarize, and move together towards real solutions. In these uncertain times, which can sometimes feel dark and disturbing, that goal offers the most inspiring source of positivity.

Money, which represents the prose of life, 

and which is hardly spoken of in parlors without apology, 

is, in its effects and laws, 

as beautiful as roses. 

- Ralph Waldo Emerson

Is IT in You ??? …..   In Q3-2024, positive sentiment from H1 carried over into Q3, with the S&P 500 closing at all-time highs. For Q3, most major equity and bond indices surged, even as the red-hot NASDAQ Composite took a pause. The DJII remains a modest laggard (YTD +12.3%).  

While the artificial intelligence tailwind remains intact, favorable inflation trends added fuel to the market fire, with headline and core CPI surprising to the downside. Meanwhile, the macro backdrop for US equities remain constructive. Markets are supported by solid earnings growth, strong AI investment, and the potential for lower interest rates later in 2024.  Lower inflation and lower interest rates should support stocks and bonds.

A broadening bull market is supported by bond yields declining, inflation moderating, and expanding fiscal support which is beginning to boost consumer and business confidence. Up until recently, the market had exhibited narrow leadership, with most stocks left behind.  Now that’s changing.

The market has been riding a technology-centered recovery, albeit a roller coaster since March.  The Fed and the ECB lowered rates and warned the balance of risks is skewed to the downside, but yields fell and equities rose globally regardless.  All major U.S. indices are at or testing record highs, as we’ve digested at least three meaningful pullbacks since March (April, early Aug, early Sept). This indicates the market’s nervousness about this regime transition as rates start getting lowered is abating, signaling a soft landing.

Easing policy alongside stable growth is a welcome tonic for U.S. equity markets. From a sector stand- point, we remain positive on financials, utilities, and information technology.  In our view, financials’ balance sheets should benefit from a lower interest rate environment, as liabilities decline, and revenue is fueled through loan growth. Furthermore, we believe the utilities sector offers portfolio resilience and exposure to AI trends owing to data centers' significant electricity demands.

Looking towards Q4, investors need to remain vigilant. The Federal Reserve has begun to reduce interest rates. The US election race is close. And amid uncertainty about the path for economic growth, market volatility will persist. 

How should investors prepare?   First, redeploy cash, money-market fund assets, and expiring fixed-term deposits. Interest rates are likely to fall further, and potentially much further if economic data deteriorates. Investors can find more durable sources of portfolio income in diversified fixed income portfolios and equity income strategies. Second, consider capital preservation strategies and diversification into alternative assets. Diversification into alternative assets, including private equity and credit, hedge can also help reduce portfolio volatility. 

Finally, get ready to seize the artificial intelligence (AI) opportunity.  AI could well prove to be the next great American industry, like railroads in the 19th century or automobiles in the 20th century. Tech has done so well over the past few decades because of its seemingly limitless capacity for growth.  Under-invested portfolios should prepare to use periods of volatility to buy AI beneficiaries, including mega-cap stocks and semiconductor stocks. Beyond technology, we also believe investors should build exposure to quality growth companies, including those in the health care and consumer sectors. 

In the international arena, there has been a renewed burst of optimism across many parts of the global marketplace following the recent announcements over China’s substantial stimulus proposals. Emerging-market equities remain undemanding and under-owned, with the the MSCI emerging index’s 12-month forward price-to-earnings ratio relative to developed markets near its lowest in 20 years. 

Authorities in the world’s second-largest economy unveiled stimulus measures, including rate cuts on existing mortgages, to aid the struggling property market and bolster overall growth.  China's markets surged after the PBOC announced broad rate cuts, a new stock market stabilization fund, and other stimulus measures.  Even after the huge PBOC stimulus measures and the resulting stock price surge, the China market is still shockingly cheap.  One major hedge fund investor said that major Chinese names offer "single digit price-to-earnings multiples with double-digit growth.  Investor positioning to China is very low, and its valuation of 8.9 times forward earnings is below its 15-year average of 11.  If U.S. exceptionalism fades as the U.S. economy stalls, investors might turn to emerging markets and China for higher growth, low valuation and under-positioning.

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What Spiritualists Know About Money…..In 2012, I inscribed the following quote in this column from Erica Jong:  “Bankers talk about meditation; writers talk about money.  Spirituality is expensive.”  By this I meant that only those with money can really afford not to think about it.

The American economy has long profited from a tradition of parsimony and fiscal adroitness.  The uniquely American conception of political economy conceived of the market as a vast, self-correcting mechanism, pivoting on the crux of supply and demand.  This dynamic profoundly shaped the nature of American character, creating a cultural ethos of self-reliance and social Darwinism.  In this tradition, deeply original thinkers - from Thomas Malthus and Adam Smith to Henry David Thoreau and Thorsten Veblen - all wrestled with the issue of how to live with the task of managing money, and also with the dilemma of how to live without it.

These days people often feel that their lives have fallen into an insidious trap.  Within their everyday worlds, they feel troubled by the incessant pressure to sustain an economic livelihood for themselves and their families.  American culture is an overwhelmingly pecuniary culture precisely because the vast majority of its citizens are immersed with the conundrum of how to live with money, and dread the prospect of living without it.  This is crucial in being able to relate to the contemporary wage-earner, the Everyman who is preoccupied each day with supporting a household, a mortgage and credit card debts.  After all, we all need to bring in the bucks!

This is why we sometimes get tangled in our own conflicting impulses about money.  In order not be be naive about money, one must first go about the process of attaining actual assets. It is difficult to contemplate Transcendental ideas if one cannot keep body and soul together, or if the debt collector is at the door.  For only with a healthy income derived from one’s own talents and labor, buttressed by dividends and capital gains from an investment portfolio, can one speak wisely and dispassionately about wealth.

The Second Law of Thermodynamics defines the ultimate purpose of life, mind, and human striving: to deploy energy and information to fight back the tide of entropy and carve out refuges of beneficial order. 

An under-appreciation of the inherent tendency toward disorder, and a failure to appreciate the precious niches of order we carve out, are a major source of human folly.

Steven Pinker

Instability Rules…..  In Q2-2024, positive sentiment from Q1 carried over into Q2, with the S&P 500 hovering near record highs. For Q2, most of the action was in the S&P 500 (YTD +14.5%) and its more turbo-charged cousin the NASDAQ Composite (+18.1%). The DJII has been a notable laggard (YTD +3.8%), while the EAFE and most other major global equity indices showed muted gains.  

International equity out-performers include Japan’s Nikkei (+18.3%), driven by a depreciating yen and corporate efficiency restructurings; and India’s Sensex (+9.4%) as the nation strives to become a viable economic alternative to China.  Meanwhile, China’s Shanghai Composite (YTD -0.3%) is mired in corporate debt restructurings and sluggish overall economic growth.

While the artificial intelligence tailwind remains intact, favorable inflation has added fuel to the market fire, with headline and core CPI surprising to the downside. Meanwhile, the macro backdrop for US equities remain constructive. Markets are supported by solid earnings growth, strong AI investment, and the potential for lower interest rates later in 2024.  Lower inflation and lower interest rates should support stocks and bonds.

The AI theme has dominated the equity markets this year.  The bifurcation in relative market valuations is stark:  AI-related stocks are trading at a PE of 27x while all other stocks are trading at 17x. Nvidia entered the pantheon of companies with market values north of $3 trillion.  Joining Microsoft and Apple is quite an achievement, and it certainly helped the S&P 500 and Nasdaq hit new records. But this trio now makes up more than 20% of the S&P, giving them a disproportionate amount of sway.  It’s benefiting from ever-growing optimism about the possibilities of artificial intelligence. The chip maker, along with firms such as Taiwan Semiconductor and chip machine maker ASML, represent the hardware needed to bolster productivity and profits.  The next link in the chain to benefit will probably be big U.S. software firms such as Salesforce and Adobe. 

We anticipate that increasing investment in artificial intelligence capabilities by technology firms will contribute to significant profit growth in the enabling layer of the AI value chain—notably in the semiconductor industry. Eventually, artificial intelligence should lead to value creation across a broad range of industries and applications. For now, we see AI enablers as the most tangible and profitable opportunity for investors. Moreover, we see evidence that the AI tail- wind is rippling outside of tech, with upside earnings surprises showing up in sectors such as utilities, industrials, and material sectors – all of which seem to be benefitting from the build-out of AI related infrastructure. 

Looking out into 2024, we believe equity markets can move somewhat higher from current levels as earnings growth resumes. The broadening of the equity market rally—both in terms of earnings and performance—should widen the opportunity set for investors looking to diversify sources of return beyond technology.  That notwithstanding, investors need to be cognizant of the potential for political and geopolitical risks to drive volatility and impact markets as the year progresses.  For the past year, higher interest rates have led many investors to hold more cash or money market investments than usual. For the most part, fixed income investors have had a disappointing year so far, although they need to be proactive and be ready to shift their cash and money market holdings toward fixed-term deposits, and medium-duration high-quality bonds.  


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Things Fall Apart….. As the psychologist and cognitive scientist Steven Pinker advises, any isolated system that is not continuously taking in energy, entropy always increases over time.  Such systems inexorably become less structured, less organized, less able to generate useful outcomes.  The human mind naturally thinks that when bad things happen, there must be someone to blame. But there is no cosmic morality play with a clockwork universe in which events are caused by any grand design.  Instead it is randomness that reigns.  Outcomes are determined by conditions in the present, not by our goals for the future.

Not only does the universe not care about our desires, but it often seems to thwart them, because there are so many more ways for things to go wrong than to go right. In the economic realm, what needs to be explained is not poverty but wealth.   It is in the very nature of the universe that life has problems. It’s better to figure out how to solve them, by applying information and energy to expand our niche of life-enhancing order.

Instead of sinking into fatalism, choose to rise each day to grasp for meaning and order.

As active investors, we learn that markets are perpetually slipping and sliding. Our minds are constantly rewiring themselves to account for unforeseen developments, renewing or growing or misfiring, as the case may be. Within our idiosyncratic universes, there is a churning sea of uncertainty and change.

Individually, this should remind us to tolerate discontent and uncertainty, to keep searching and stretching, and to be vigilant in our efforts to move forward. Get off the well worn path regularly and venture into surprise, serendipity and uncharted territory.  Be intentional about building and strengthening your relationships.  Do not let good relationships coast along untended. Everything falls apart without tending.

Time is a flat circle, and we’re just all stuck in it.

True Detective 

Social Amnesia…..  Is Everybody In?   AI: as in ALL IN?  That haunting question, voiced by a seductive troubadour from another cultural era, opens the Doors to today’s most impassioned object of desire.

At the end of Q1-2024, equity markets are buoyant and a strong U.S. economy has diminished expectations for rate cuts. Despite geopolitical uncertainties, volatility has remained low. The S&P 500 was the standout major index in world markets, surging 10.1% in Q1.  Looking ahead to Q2, the next stage of two primary market drivers are playing out: the start of rate-cutting cycles by major central banks, and the broadening-out of AI adoption and implementation across a wider range of companies.

Nvidia’s historic run and its repercussions are supercharging investors’ account balances. Many are betting the boom is just beginning. They are piling into the chipmaker’s shares and options to look for ways to turbocharge their bets on artificial intelligence.  The exuberance reflects hope that the company is in the vanguard of wide adoption of artificial intelligence—and an intense fear of missing out among investors who have sat on the sidelines while the company’s valuation has surged to the rarefied $2 trillions level. Generative AI may actually increase productivity growth by several percentage points, fueling a robust positive return for equities in 2024.

There is little doubt that recent technological and scientific innovations have provided a foundation for transformational technologies that could advance humanity. The power of artificial intelligence and machine learning notwithstanding, the current situation appears uncomfortably similar to the dot-com bubble seen a quarter-century ago, when the Nasdaq lost more than three-quarters of its value from its peak in 2000 through late 2002. If that pattern were to play out again, the stock market’s gains could swiftly turn to losses that might take years to overcome.

For those investors too young to remember, the six largest tech companies at the close of 1999 were Microsoft, Cisco, Intel, IBM, Oracle and Qualcomm. Their shares took anywhere between seven and 20 years to recover after the bubble burst. Overall, a new investor to the Nasdaq in March 2000 would have had to wait 14 years to break even. For even older investors, the 1970s “Nifty Fifty” stocks (Polaroid, Kodak, Xerox, etc.) augured in the “death of equities” decade.  Is history repeating itself: new technology hype, significant liquidity, bubble outperformance, investors’ enthusiasm and risk-taking?   Although concentration today is higher than the peak of the 2000 and 1973 markets, today’s stocks have much lower multiples. The P/E ratio of 2024’s largest stocks is 31x for the last 12 months. It was 53x in 2000, and 35x in 1973.

Against this backdrop, investors should focus on recalibrating their exposure to the technology sector, and ensuring that portfolio income streams are sustainable. First, it’s important to hold a diversified strategic exposure to the technology sector and to some of the likely winners from tech disruption. The rising excitement over artificial intelligence and its implications could lead to a scenario in which future gains are front-loaded.  After such a strong run in AI-related stocks, the risk of over-concentrated portfolios has risen.

Second, although the US economy has remained strong, we still expect the Federal Reserve to cut interest rates, likely starting in June. Other major central banks are also on track to start easing policy. Fixed income investors need to be proactive and shift their cash and money market holdings toward fixed-term deposits, and medium-duration high-quality bonds. 

Looking out into 2024, we believe equity markets can move somewhat higher from current levels as earnings growth resumes.  With uncertainty over the outlook for economic growth likely to persist,  we believe high-quality stocks are well positioned.  However, with inflation now closer to the Fed's target, further improvements in inflation will be more incremental.

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What Oracles  Teach Us…..Warren Buffet - the Oracle of Omaha - periodically reminds us that spectacular outbreaks of fear and greed will always occur in the investment community. Like black swans, the timing and extent of these epidemics are unpredictable, so it is futile to try and anticipate either their arrival or departure.  Buffet’s contribution to investor wisdom is to help us to ask the right questions;  even if not every question has an answer.  

For the philosophically minded, the Nietzschean theme of eternal recurrence suggests that the entire history of life and the markets will repeat itself throughout eternity, if not down to the very last detail, then at least to its rhyming analogue.  If this is true and one believes that whatever one does will be repeated throughout eternity, we would be compelled to accord incredible importance to each and every action. Therefore, errors, disasters and profound misunderstandings are precious experiences to learn from.  

Accordingly, we need to affirm the value of one’s decisions in every single detail as something to be endlessly repeated through time.  This revelation brings about a radically new conception of the individual and the world.  Instead of striving to discover the “truth or the “real self,” we should be ever striving to becoming stronger, wiser and more fulfilled.  In this vein, we construct ourselves by assembling our experiences, desires and actions through a continuous act of self-creation.

The world is richer than what we can see, and coincidences are clues to its concealed depths. But let’s take the opposite position — that there’s a careless randomness to the markets.  The hypothesis that “time is a flat circle,” understands the thematic resonance of individuals looking for a way past their own  failings and limitations.  The spiral structure is meant to emphasize the iterative nature of experience across time. The thesis argues that the outcome we experience doesn’t change until we change the story.   Ignoring or explaining them away may render them more comprehensible, but eventually they come back around again. 

There is a crucial link between investment capital and human capital.  Investing, as an art or a science, has advanced to the stage where the optimal portfolio seems to be just an algorithm away; with advice dispensed by pundits on seemingly every digital street corner.   It’s not that we can’t learn from the past; it’s just that each successive generation of investors must learn it anew. This phenomenon speaks as much to the fallibility of human memory as to the mind’s capacity for self-delusion.  

The psycho-historian Russell Jacoby, in his seminal work Social Amnesia,  early on sparked my interest in the transformative potential of restored memory and its dialectical implications.  The willful repression of things we already knew can be attributable to two insidious psychic mechanisms:  avoidance of negative memories, and delusional wishful thinking.  We discount or negate painful experience because it upends our narcissistic world view.  Similarly, we deny historical fact because it disrupts our wishful thinking.  Hence, the reflexive tendency to say “this time is different.” The most important point of this discourse is to internalize the benefits of applying this method of behavior and judgment, as we strive everyday to convert our opinions and unknowns into facts and insight.  At a minimum, this may offset our inclination to fetishize investment ephemera, or to debase time-tested investment principles.

As for oracular pronouncements, this writer is inclined to reference another oracle - Hegel, the triumphalist of German Idealism - who opined:  “The only thing we learn from History is that we learn nothing from History.”  A more contemporary and practical iteration of this theme is from Benjamin Graham:  “Wall Street people learn nothing and forget everything.      

The two most important days in a man’s life

are the day he is born and the day he learns why.

Mark Twain

Charlie Munger and the Art of Liberation….. Since an iconic and singular investing legend passed in Q4 2023, I will start by highlighting some of his convictions about investing and living.  Along with Warren Buffet, Munger built Berkshire Hathaway into a behemoth $350 billion stock portfolio concentrated in just a small number of positions, along with a $150 billion war chest.  

He viewed today’s market, dominated by the rise of the stock-picking profession and algorithm-driven quants, as having fewer opportunities for above-average gains.  Outperformance will hinge on identifying and holding on to a small number of super competitors such as Apple, Google and Costco (where Munger long served as a Board Director).  Munger avers that most investors should gravitate to index funds since they have no advantage as stock pickers.  He says  “Why should he try and pick his own stocks?  He doesn’t design his own electric motors and his eggbeater.”  He likens stock picking “to hunting and fishing because any day you can have a new thing that might be interesting.”  His motivation is doing something well and not to become extraordinarily rich, since he prefers a less expensive way of life.  “Who in the hell with my wealth lives in the same house he built 70 years ago?”  Finally, he thinks he is economically successful because he read books all his life and tried to learn from everything he read. In his independence and idiosyncratic investing style, Munger epitomized the art of freedom and liberation.

In Q4, all the major global equity indices surged ahead, ending 2024 with a combination of relief and optimism. For the year, the S&P 500 rose +24.7% while the NASDAQ Composite catapulted by +44.5%.  On the global front, the MSCI World Index (+21.8%) and the EAFE (+14.1%) followed the U.S. lead.  The main contributors to this resurgence were the seeming likelihood of an economic soft landing, the prospect of interest rate cuts in 2024, and the exuberant boost of the AI revolution.

The Magnificent Seven - consisting of Apple, Amazon, Alphabet, Meta Platforms, Microsoft, Nvidia, and Tesla - had a tremendous year, fueled by the artificial intelligence boom caused by the rapid growth of generative AI products like ChatGPT. As a result, these 7 stocks have generated roughly two-thirds of all the S&P 500 gains in 2023. While this performance has been extremely impressive, it is likely not sustainable.

Winner-takes-all can dominate over shorter time frames but is rarely a winning bet in the long run. At some point, this narrow market supremacy will end, to the benefit of many overlooked issues. The mid- to smaller companies in the Russell 2000 index are among the most neglected shares waiting to get their due. The index has been languishing in a bear market since 2021—partially driven by their perceived economic sensitivity and partially driven by Wall Street indifference. 

Looking out into 2024, we believe equity markets can move somewhat higher from current levels as earnings growth resumes.  With uncertainty over the outlook for economic growth likely to persist,  we believe high-quality stocks are well positioned, particularly those companies that have strong returns on invested capital, relatively stable operating margins, and healthy free cash flow yields. We favor a barbell approach of defensive growth and late-cycle cyclicals, traditional defensive industries (healthcare, staples and utilities), and late cycle cyclicals (industrials and energy).

With inflation now closer to the Fed's target, further improvements in inflation will be more incremental. So we could be transitioning to a period of both slower growth and slower improvements in inflation. Equity markets may be somewhat range-bound in this transition period.  We are expecting cuts from both the U.S. Federal Reserve and the European Central Bank in June next year, and also expecting China to find its footing.  2024 should once again be a good year for income investing. Even if rates don’t fall as much as we expect, for yield-focused investors U.S. core bonds at 6%+ yields are the most attractive since 2009. 

As one pundit has observed, “the big winners in 2023 were bigotry, terrorism, savagery, the familiar fruits of the human curse.” Add to this the toxic polarizing nature of politics and culture wars in the country, it is understandable when people say things are bad even though the economy is good.  The media, especially, enables this obsession with bad news. A much more systemic trend, however, is for at least 30 years or more, Americans have developed immense expectations and a powerful sense of entitlement because of years of rising living standards. They are hypersensitive to any change or setback that produces a gap between how they live and how they expect to live.  Even when inflation is not going up, or that America is at full employment, or that pay is increasing fastest for the lowest-paid workers, none of it matters. Such a paradox is now a fashionable expected response, —as a reflex that prevents people from saying that they are doing well, even if the data indicates that the economy is doing fine.

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MetaCognition…..In these times of anxiety and uncertainty, it is tempting to yearn for principles that can buffer us from daily market confusion and threats to our financial security.  But uncertainty is built into the very structure of market reality, and so we should accept the limitations of our capacity to comprehend and anticipate market changes.  Since the exactitude of market changes is inherently unknowable, the best perspective to maintain is one of affirmative skepticism.  We don’t know for sure what will happen, but we perpetually integrate all the available data to make sense of what actually transpires day to day.  The Stoic philosopher Epictetus describes this “dichotomy of control” that emphasizes the distinction between things that are within our control and things that are not. It’s a method of remaining calm when everything else seems chaotic.

As Charlie Munger advises, the most straightforward path to profitable long-term investing often seems the most difficult to follow:  diversification, buy-and-hold quality stocks for the long run, mindfulness to market disruptions, and not buying into bubbles or selling into crashes.  Investors who can keep their nerve maintain the strongest probability of navigating future financial storms. Accentuate a long-time horizon, eliminate the negative factor of emotions, and position oneself for winning.

How do we focus on maintaining control under difficult circumstances so we can manage our emotional responses?  One way is to think about our thinking or understanding our emotions to shape our actions.  In modern life, stress and anxiety are usually chronic, not episodic.  This means we must find a more sustained method of achieving cognitive control.  For investors, a very effective method is keeping detailed written records of all trades over a long period of time.  This provides an unambiguous record all the good and bad decisions made over various market cycles. Embrace one’s mistakes, because the knowledge and humility gained from mistakes will differentiate you over a lifetime of investing.  

A related method is to regularly chart market prices of individual positions over a 1-year / 3-year / 5-year / and 10-year time frame.  This forces us to judge market pricing over a long period of time, thereby imposing a discipline that insulates us from the vagaries of short-term emotions.  The seduction of efficient markets isn’t that prices are always correct.  What efficiency implies is that market prices immediately reflect the ever-changing judgement of hundreds of thousands of investors.  In the very short term, this may mean the “madness of crowds;” but in the longer term, it always reverts to the “wisdom of the market.”  Finally, the most reliable way for modern investors to get ahead is to keep learning something from all available sources.  Economic success demands a lot of effort and perseverance. That is the real elegance and meaning of true market capitalism.       

I’ve learned a thing or two in the past 20 years. For starters, I’ve become less enamored of a largely mathematical approach to personal finance. It does little good to master the math if you fail to understand financial history, the madness of crowds, and the enemy staring back at you in the mirror.

William Bernstein

Winning the Loser’s Game….. In Q3, all the major global equity indices fell hard. The S&P 500 declined -3.6% while the NASDAQ Composite fell 4.6%.  On the global front, virtually all international markets turned in a dour performance in Q3, as the MSCI World Index (-3.8%) and the EAFE (-4.7%) followed the U.S. downtrend.  A broader index of U.S. equities including the Russell 2000 (-6.1%) and the S&P MidCap (-5.4%) declined even more in September, such that their YTD gains are barely positive.  Even the venerable DJIA’s YTD gain is merely +1%.

Are investors on the brink of losing a hard-fought recovery for the stock market this year? September delivered the S&P 500’s worst monthly performance since December 2022 — a 4.9% drop.  If the index can hang onto the 11% return earned so far this year, that’s better than 2022, but maybe not the rebound many hoped for. And rising fear among investors could make the next three months tough.

Investors are struggling to come to terms with with higher-interest-rates-for-longer. Stocks have slid, government-bond yields have risen, and the U.S. dollar has climbed since the Fed recently signaled that it might hold rates near current levels through 2024. Entering Q4, much of the enthusiasm that characterized markets in H1 has disappeared. 

Given a rally driven by only a handful of names, relatively expensive valuations in large-cap growth and technology stocks, and the negative impact of credit tightening on company earnings, many market observers believe a recession and weaker earnings will compromise equites in 2024.  As we enter Q4, the narrative for the markets has become even more challenging to dissect, with various extreme cross-currents.  Investors will have to balance economic resilience with a higher-for-longer rate environment, while also considering the risk of a delayed recession. With stocks already priced for a very optimistic macro outcome, we continue to scrutinize the relative risk-reward of equities vs. bonds vs. cash.  

There are larger anxieties about the outlook for interest rates and the economy.  Higher yields lead to higher borrowing costs for businesses and consumers, keeping pressure on economic expansion.  Higher rates also boost the dollar which threaten companies with significant international operations.  Bridgewater’s Ray Dalio said he doesn’t want to own bonds and prefers cash, highlighting the difficulties investors face as global central banks try to manage inflation.  Indeed, cash’s risk-free +5% return seems alluring!

The U.S. 10-year Treasury yield is now making moves towards 4.7%. The 20-year just hit 5%. These moves are not happening in response to better economic data. They are happening globally. That’s what investors are getting nervous about, especially the real risk to the economy, including financial instability.

With inflation now closer to the Fed's target, further improvements in inflation will be more incremental. So we could be transitioning to a period of both slower growth and slower improvements in inflation. Equity markets may be somewhat range-bound in this transition period, especially considering that the soft landing has become much more of a consensus view; valuations are full; and there is less dry powder on the sidelines to drive markets higher. 

In stock rallies, as in comedy, timing is everything. For example, the chip maker Nvidia is the biggest AI winner so far, and its shares have more than tripled within a year. But it was down big in September. The challenge is to identify out which are the AI stocks before the herd catches on. This search extends well beyond traditional technology stocks. The next AI stock could be anywhere—pharmaceuticals, fin-techs, retailers, even appliances.

On the global front, we are more constructive about emerging markets outside of China, especially in large markets such as India and Japan. India is a direct beneficiary of what China has lost during zero-COVID. As supply chains continue to diversify away from China, a lot of companies embrace India.  The Japanese stock market also is beginning to look reasonable after being stagnant for many years. Other smaller emerging markets beckon, including Taiwan and South Korea, as well as in Vietnam,  the Philippines  and Indonesia, as supply chain re-shoring candidates outside of China.

Looking out into 2024, we believe equity markets can move somewhat higher from current levels as earnings growth resumes.  With uncertainty over the outlook for economic growth likely to persist, in conjunction with a flat yield curve, we believe high-quality stocks are well positioned, particularly those companies that have strong returns on invested capital, relatively stable operating margins, and healthy free cash flow yields. 

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Vengeance is mine; I will repay (Romans 12:19) …..  Happy investors are all alike; every unhappy investor is unhappy in his own way.

At the risk of overstating the obvious, investors are social animals and notoriously guilty of herding, especially during major market dislocations.  The ability to think independently, despite the comfort of the herd, is rare and elusive. Investing in speculative assets is an inherently social activity, and investors enjoy gambling, the banter of social media and the sense of belonging to a particular investing community. 

In the battle between and active and passive investing, the latter has been the clear winner over time.  Unlike other specific skill sets such as surgery, auto mechanics and playing a musical instrument, traders do not become better simply because they trade more.  This is because traders compete against other traders in real time, based on imperfect and fragmentary information.  They tend to benchmark themselves against a static reference point when they should frame the competition versus other traders, most likely institutional investors who enjoy the advantages of advanced data analytics and specialized research teams.  There exists an enormous amount of information that is not available - and we are not even aware of its absence.  

Retail investors have a well-established track record of destroying their own wealth. Studies have shown that individual traders somehow have the opposite of skill — they do worse than taking the proverbial random walk down Wall Street. Why? Investing is hard, and there is a lot of competition. There are thousands of actively managed mutual funds and other public investment vehicles. The ineptitude of individual investors is not for lack of trying. Perversely, the harder that individual investors try (by trading more), the more they lose.

Yet many investors truly believe that they can improve their performance by trading more often.  The more actively they trade, the better their performance.  Paradoxically, the best investors trade infrequently.  Since investor confidence correlates highly with recent performance, we let ourselves be lulled into a false sense of security. Winning streaks begets over-confidence while losing streaks bring on caution and pessimism. Anxiety causes us to sell our winners in order to “lock-in” gains while holding on to our losers in hopes of recovering our losses.  This approach seems to reflect a patient rationality but usually leads to worse outcomes.

Given all the mental mistakes demonstrated by behavioral finance, why do investors persist in repeating the same mistakes over and over again?  Perhaps the answer is that investing is not just about making a profit, but has a lot to do with more intangible desires.  Both amateur and professional investors enjoy the thrill of the chase, the fun of playing the game, and the sharing of their experiences about winners and losers.  Framing the pursuit of money in this way more accurately reflects the behavioral and cognitive patterns culturally embedded in our psyches.

This is why the most straightforward path to profitable long-term investing often seems the most difficult to follow:  diversification, buy-and-hold quality stocks for the long run, mindfulness to market disruptions, and not buying into bubbles or selling into crashes.  Investors who can keep their nerve maintain the strongest probability of navigating future financial storms. Accentuate a long time horizon, eliminate the negative factor of emotions, and position oneself for winning by not losing.  This will also mitigate the ultimate risk of longevity, wherein our financial resources become depleted before we finally discard our mortal coil.

 It is a funny thing about life;  if you refuse to accept anything but the best, you very often get it.

W. Somerset Maugham  

Life Lived Forwards….. We live in a world of myth masquerading as fact, a world of theory pretending to be truth and a fabric of hypotheses offering certainty. How does one lead and follow in this matrix of density and confusion?  As Kierkegaard has said, life can only be really understood backwards, but it must be lived forwards. This applies equally to investing decisions in the markets.  It becomes more and more evident that the correctness of trading decisions can never really be judged in real time because at no particular moment can one find the necessary resting place from which to understand it.  Yet the intrepid investor must keep going forward, relying on a mixture of historical analysis. individual skill and faith to achieve a comfortable return.  A dispassionate Heideggerian critic might dismiss this as “putting a radiant obstacle in the path of the obvious,” but that is the task of all serious active investors.   

As investing trends come in and out of fashion, it is difficult to navigate what is real and will power the future, and what is hype and will quickly fade. Trading stocks of companies that are in the thick of these trends can also be tricky, especially when trying to recognize value ahead of the broader market and appraising how any given technology will play out.  A short-term strategy can quickly leave a trader with a portfolio full of red at the end of a big run-up on stock prices, as was the case with most Robinhood-type accounts opened up in 2021-2022.

The S&P 500 is up 15.0% for 2023 YTD, and the Nasdaq Composite rose 31.7%. The first-half performance of the Nasdaq is the strongest for the index since 1983.  On the global front, virtually all international markets turned in a decent performance, as the MSCI World Index (+13.9%) and the EAFE (+8.8%) followed the U.S. uptrend.  

If you look at the S&P 500 or the Nasdaq YTD results, one might get an indication that things are looking quite rosy this year.  After a tough 2022, some rebound could be expected and welcomed despite what is expected to be a slowdown in the economy later in the year.  However, when looking under the surface, the participation in this market is incredibly narrow, reserved mostly for just the mega-cap tech names. For example, the seven largest tech stocks —  The Big Tech 7 including Nvidia, Microsoft, Alphabet, Amazon, Meta, Netflix and Tesla — are up a formidable 43% since January.  The biggest single driver was the hype around artificial intelligence or AI, a trend that can improve the productivity of many companies. Comprising 30% of the S&P 500, the Big Tech 7’s median gain is five times the S&P 500. Valuations look stretched, with a price-earnings multiple of 35 that’s 80% above the overall market.  A broader index of U.S.  equities such as the Russell 2000 (+6.9 % YTD) or the S&P MidCap (+7.5 % YTD) would be more representative of most diversified portfolios.

In equities, we view the U.S. as a potentially vulnerable regional market. Given a rally driven by only a handful of names, relatively expensive valuations in large-cap growth and technology stocks, and the negative impact of credit tightening on company earnings. We expect higher volatility in the months ahead. Alternatively, we are revisiting emerging market stocks (+3.5% YTD) - especially Japan - which should benefit from peaking US rates, higher commodity prices, and a weaker US dollar. 

Many market observers believe recession and weaker earnings will compromise equites in 2023. After an unexpectedly strong start to 2023, global growth is now below 2%.  We may not have to wait for the onset of big earnings downgrades to see lower equity prices. Low stock correlations, credit rating downgrades, and an acceleration of liquidity drain suggest valuations might get compromised before earnings do. 

While the concerns that are feeding into the individual investors’ ‘wall of worry’ - lingering inflation, higher interest rates and recession fears - are valid, the negative sentiment they have built up is, from a contrarian perspective, a potential catalyst for positive forward returns.  In other words there is support for stocks, as many potential buyers wait in the wings for current worries to subside.  Extremes in pessimism are bullish for near-term stock market returns, just as extreme investor optimism tends to be bearish for the near-term outlook.  

As we enter the second half of the year, the narrative for the markets has become even more challenging to dissect, with various extreme crosscurrents. On the one hand, the U.S. economy has held up better than expected, increasing the probability of a soft landing. On the other hand, the recent strength in the economic data means the Fed cannot afford to end its hiking cycle. Investors will have to balance economic resilience with a higher-for-longer rate environment, while also considering the risk of a delayed recession. With stocks already priced for a very optimistic macro-outcome, we continue to scrutinize the relative risk-reward of equities vs. bonds vs. cash. Our core portfolio remains intact although, at the margin, the focus remains on earning income, and identifying cheaper parts of the market that have lagged. 

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Love, Money & Success…..Passions and emotions are the most important variables in investing. What money means and how it fits into our daily routine is the central question of modern adulthood.  Understanding one’s own mental and behavioral idiosyncrasies can bolster long-term investment results more than a library of how-to finance manuals.  Psychological, behavioral and neuroscience research all demonstrate how interpersonal relationship styles mirror the degree of stability and security in personal financial matters.  This does not require hours on a psychoanalyst’s couch, but it does demand honest self-reflection about one’s intimate relationships.  Concurrently, money is inextricably intertwined with love in our unconscious.  Getting and losing money activates the same pleasure and pain centers in our brain as falling in love and undergoing heartbreak.

Our interpersonal attachment style functions on a spectrum from secure to insecure, and it is often refracted through the lens of financial concerns.  If you are needy and anxious about love, money can serve as a surrogate.  What we learn from our parents and our upbringing shapes our specific money attachment style.  Concerns about safety, control, status, power, rejection and failure are typically established early in life and remain difficult to modify.  It is so ingrained that most people are unaware of their own predilections.

Money typically ranks with sex as the main taboo topics in our culture.  Anxiety, insecurity and shame infuse our reluctance to talk freely about both our intimate relationships and our relationships with money.  How does past significant relationships and memorable money experiences influence current behavior?  What are the psychic costs imposed upon us in an unrelenting pecuniary culture? Even the most confounding actions become logical when historical contexts are uncovered.  However, even these epiphanies are not curative.  Insight facilitates change but sustained behavioral patterns need to be regularly reinforced.  Stress and a lifetime of dysfunctional habits inevitably leads to backsliding.  But that’s all part of the process: to recognize and articulate salutary thinking and behaviors, and consciously choosing a better path.   Freud, over a century ago, summarized the route towards therapeutic wellness and enduring change:  remembering, repeating and working through.  Only then can we construct a new paradigm wherein the pursuit of wealth is based upon a viable economics of happiness.

I became insane, with long intervals of horrible sanity.

Edgar Allen Poe

The Pit and the Pendulum….. I was sick - sick unto death with that long agony.  And when they at last unbound me and I was allowed to sit, I felt that my senses were leaving me.  Those awful words - that dread sentence of death - were the last words of meaning that had reached my ears.

Thus begins perhaps the most riveting horror and torture story in American literature.  

It may be overly melodramatic to characterize the past year as torture.  The markets have struggled in a back-and-forth between hope and dread.  Investors have been subject to an extremely data-dependent, binary, weekly equity environment with interest rates regularly repricing. It is no wonder that funds have been reallocated to Treasury bills or short-duration investment-grade credit.  The fear that the Fed will leave interest rates higher for longer hangs over stocks and may ultimately cause a more painful recession.

Equities ended Q1 2023 in a mixed, choppy fashion but finally concluded in a positive sigh of relief.  The S&P 500 rebounded +6.2% in Q1, while the NASDAQ surged +16.8% after 2022’s drubbing.  On the global front, virtually all international markets turned in a decent performance, as the MSCI World Index (+7.3%), the EAFE (+7.7%) and Emerging Markets (+3.5%) mirrored similar constructive sentiments.  Given the unexpectedly positive Q1 results, why do we still hold such morose market skepticism? 

Recent bank failures have sparked concerns about financial stability, leading to massive moves in the rates markets. Despite the banking turmoil and recent stress in financial markets as a whole, the Fed did signal that it is near the end of its hiking cycle.  Until now, the fear has been that the consumer will eventually rein in spending, sparking a recession. But the troubles in the financial system triggered speculation about a “Lehman moment” or making other parallels to the 2008–09 global financial crisis. Indeed, cash has been rewarded in a backdrop of rising rates and higher volatility.  Yet, equities have been surprisingly resilient during this period of banking stress, although the outlook over the next several months looks challenging due to lagged effects of Fed rate hikes and likely incremental tightening in credit availability. 

A bear market rally for stocks emerged in Q1; and there are further potential cyclical and secular drivers for equity prices on the horizon.  Drivers include more accommodative monetary policy as inflation slows; a more stable starting point for consumer balance sheets; pent-up demand in investment and in certain parts of consumer services; and a global growth recovery led by economies that have lagged since the pandemic.   

That notwithstanding, the global economy remains tumultuous, battered by inflation, war and an energy crisis.  Paradoxically, the U.S. still enjoys a relatively strong economy and a tight labor market.  Regulators have tried to find the right balance.  Investors are now compelled to reevaluate how to steer through technological, financial and political change, making larger macro-investment decisions.  Even as the investment world becomes ever more complex, requiring more sophisticated statistical analysis, we are still more swayed than ever by single-point anecdotal evidence, typically generated by our ubiquitous social media.  This tends to drive us towards more simplistic, primitive types of reactions.  For us, the main criterion for individual company stock selection is sustainability — of competitive advantage, business model, pricing power, cost efficiency, and growth. It is essential to identify the best franchises, not necessarily the most undervalued stocks. 

As for asset allocation, we maintain our defensive posture at an average cash level of 35%.  We  still favor equities, and remain agnostic about bonds. Cash on the sidelines is earning a robust 5% return while we await a stabilization in risk markets.  Analysts generally forecast stocks will go sideways, weighed down by more rate hikes and a potential recession.  It is important to note that the positive Q1 S&P 500 and NASDAQ performance was mostly attributable to a handful of mega-cap tech stocks, while many stocks remain range bound.

Investing inevitably generates anxiety, but it needs to be the right kind of anxiety.  Looking ahead, it still feels eerie after all these years.  The challenge is to remain focused enough, disciplined enough to navigate and shape these uncertainties.  If not, one may be consigned to not only investment mediocrity, or worse…..wherein one “shall be nameless for evermore.”

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Why War?…..As the war in Ukraine grinds on into its second grueling year, the tragedy of the largest conflict in Europe since WWII puts into stark relief all our other concerns regarding the economics of human activity or the ordinary business of life. In a market economy, human emotions are exchangeable commodities, subjected to the vicissitudes of our instincts.

However, as I obsessively follow the developments of this post-modern medieval war where appalling casualties in trench warfare are sacrificed for the sake of gaining or losing a small amount of earth, I was driven to reread a notable essay by Freud entitled Why War?  Published in 1932 in prescient anticipation of the impending Armageddon that was soon to engulf the continent, it offers sobering insights into why conflicts of interest between men are usually settled through violence.  Freud hypothesized that human instincts are governed by a fundamental duality:  the Platonic Eros, which seeks love and union; while alternatively, this edifying desire is offset by the aggressive or destructive instinct which seeks to destroy and kill.

The rapacity and lust for power demonstrated by the Russian state evokes our sense of disillusionment at the brutality of so-called modern society which has unleashed the primitive instincts that civilization was intended to restrain.  However, the profound disillusionment regarding the uncivilized behavior of those in this war are unjustified because they were based on an illusion that never accurately reflected human nature.  In truth human beings have not sunk so low as we feared, for they had never risen so high as we believed.  Why national units or ethnicities should detest and de-humanize one another (even when they are at peace) is merely the by-product of our most primitive, oldest and crudest mental states.

The species that is man was, and is, a very violent being, more cruel than other animals.  The history of mankind is filled with murder.  Man kills as a matter of course, and when unleashed is free from the instinct which restrains other animals from devouring their own species.  In peaceful modern society, killing is generally forbidden, but in our private minds we daily deport all who stand in our way or who have offended or injured us to some hideous demise.  How far has our conventionally civilized attitudes toward aggression and death really evolved from this primitive consciousness? 

From the moment modern weapons were introduced, intellectual superiority began to replace brute muscular strength; but the purpose of the fight through aggressive force remained unchanged.  We seek to crush our opponents with every available resource.  Yet even the victor must reckon with his defeated opponent’s insatiable thirst for revenge.  For both the triumphant and the defeated, the only enduring source of security is the permanent organization and maintenance of laws and safeguards that spurs a community of interests and emotional ties between members of different tribes and ethnicities.  

In the end, wars will only be prevented if mankind unites in setting up an effective supra-national or central authority which can mediate and moderate the numerous and unceasing outbursts of instinctual aggression that is ubiquitous in human affairs. We are now living in times of extraordinary change and uncertainty.  Technology’s quantum advances threaten our very existence on this planet.  When the unthinkable happens, how will we struggle to manage the chaos.  Devastating wars have happened before, and it is likely to happen again. Hence, the supreme irony is that in order to strive for everlasting peace, we must concurrently be prepared for preemptive war.  So as Freud grimly advised: “If you would endure life, be prepared for death.”

The past is never dead.  It’s not even past.

William Faulkner 

The Courage of Hopelessness…..What if the light at the end of the tunnel is the headlight of an oncoming train (more on this later)?  On Wall St., Mr. Market symbolizes a world populated by both lemmings and contrarians.  On one day, all the lemmings stampede towards the cliff together.  On another day, bad news in the real world manifests themselves in rising stock prices.  A massive corporate layoff signals a company is lowering its cost structure and its stock price rises. A strong jobs or GDP report means the Fed will keep raising interest rates and the market sells off.  How does a rational long-term investor navigate this schizoid, hysterical universe that operates in accordance with its own cryptic logic? 

Uncertainty abounds as a long list of market anxieties weigh upon investor sentiment.  The sources of instability range from the lingering pandemic, inflation, rising interest rates, energy crisis, supply chain bottlenecks and war.

Equities ended 2022 with its worst performance since 2008.   Despite a bear market rally in October and November, stocks continued their downward trend in December, with the S&P 500 closing down 19.8% for the year while the technology-laden NASDAQ crashed 33.1%.  The sell-off has been remarkably broad, with every sector except energy and commodities down big this year.  The technology sector suffered its worst setback since the 2000-2001 dot.com collapse, with the NASDAQ down four consecutive quarters in a row, the first such sustained fall since that earlier woeful period.  On the global front, virtually all international markets declined, as the MSCI World Index (-19.4%), the EAFE (-16.1%) and Emerging Markets (-22.4%) all mirrored current anxieties. 

Global equities lost a record $18 trillion in 2022 amid nearly 300 interest rate hikes from central banks around the world.The Federal Reserve is maintaining a hawkish position on interest rates and recession fears abound.   Bonds have endured a historic rout, having their worst year since 1949, down -13.0%. This has been the worst annual performance for bonds in the modern era.  

Are there any reasons for investors to be opportunistic?  Although economists warn of an impending recession, the strong U.S. labor market suggest that the Fed could cool inflation in a relatively orderly way, resulting in a hoped for soft landing.  It is still too early to prognosticate that the macro environment is improving. There is much evidence of rock-bottom consumer confidence.  We are not likely to see a market bottom until there is a clear signal that inflation has peaked and the Fed begins to adopt a more accommodating posture. However, the market is heavily oversold, and any glimmer of a soft landing may spark a sudden comeback in equity pricing.  Stock prices are always much more volatile than the asset values that underpin them. It is this dichotomy between investor perceptions and economic reality that creates the opportunities for knowledgeable investors with a long-term perspective.

At the strategic level, we maintain our  defensive posture at a level we believe appropriate given the heightened uncertainties, warranting an average cash level of 35%.  With short-term rates rising rapidly, cash on the sidelines is earning a respectable return while we await a stabilization in risk markets.  In fact, one can get 4%-5% on a risk-free 1-year CD, 1-Year Treasury Note or money market account these days. If we're heading into a recession, expected stock market returns may struggle to reach even the low single digits.   Analysts generally forecast stocks will go sideways, weighed down by more rate hikes and a potential recession.

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Triumph of the Therapeutic…..A hilarious though trite joke about psychoanalysis goes like this:  Question:  How many psychoanalysts does it take to change a light bulb?  Answer:  Only one, but only if the light bulb really wants to change!

Changing one’s thinking or behavior, no matter how admittedly dysfunctional or self-destructive, often meets with an internal resistance so strong that even well-meaning friends and advisors are disinclined to pursue the matter.  Why is genuine sustained change, even when cognitively acknowledged by the patient to be desirable, so difficult to attain?  Sage observers of human nature - ranging from psychologists, scientists and philosophers  -  have offered various theories to address this perpetual conundrum. Collectively, the ostensible experts have contributed to the debate but, alas, provide no clear solutions.  Perhaps the weight of inertia, the need for escapism, and the very human reflex to avoid difficult or painful remedies are the likely culprits for this behavioral impasse.

What, then, is the first step towards effecting real change in individual behavior and mental habits?  In many cases, even the most pessimistic diagnosis of individual myriad resistances to necessary change ends with sedulous optimism:  “The situation may not be quite as bad as feared,” or other bromides such as “There’s a light at the end of the tunnel,”  or “It’s always darkest before the dawn.”  But what if the most compelling way to effectuate fundamental change (when all prior efforts have failed) is when we fully admit that the situation is hopeless, that there is imminent disaster, or that one has “hit bottom?”  Is the courage to acknowledge hopelessness as the final catalyst for behavioral and mental change merely a counter-intuitive provocation? 

What, you may ask, does this have to do with investing?  In my decades of experience in this arena, I am often struck by the similarities and cross-applications between money management and behavioral management. Both endeavors involve intensely personal and often private subjective concerns that dramatically affect final outcomes. In my analytic practice, the twin taboo topics of money troubles and dysfunctional intimate relationships often rank as the main drivers that send patients into a search for therapeutic solace and insight.  The very fact that these  kind of sordid problems are hard to talk about with outsiders, are also the same reasons why they are hard to confront honestly with oneself. 

2022 was a particularly appropriate year to reflect soberly upon the need to have a reset on investing behavior.  For many younger investors, it was their first encounter with the carnage of a bear market.  The denouement of a long bull market and the spectacular collapse of the technology sector, emerging markets and crypto-currencies  all illuminated the toxic cocktail of widespread investor greed, stupidity and hubris that is a part of the hype-machine of Wall St. and  celebrity-driven social media. Redolent of the 2004 classic memoir American Sucker which captured the mesmerizing account of those years of dot-com madness, novice investors and tech gurus briefly enjoyed a second act.  Bear markets always humiliate ignorant crowd-driven investors. We witnessed the 2021-2022 spectacle of meme stocks, NFTs (non-fungible tokens), SPACs (special-purpose acquisition companies), and the mother of all instant corporate meltdowns in the $32 billion crypto-currency FTX bankruptcy.  Not only were most neophyte investors stripped of their cash and their fantasies, even world-class financial firms, venture capitalists and hedge funds proved once again that sophisticated investors are also susceptible to stupidity and hubris.  As the cyclical hype machine and hysteria winds down, along with depressed market prices, let us be reminded that these emotional responses drive volatility and that all this will happen again….. and again. In a market economy, human emotions are exchangeable commodities.  The stretches of the past stored up in the investor psyche only seem empty; they are burdened with the present.  

If you’re not willing to react with equanimity to a market price decline of 50% 

two or three times a century, you’re not fit to be a common shareholder

and you deserve the mediocre results you’re going to get.

Charlie Munger 2012

A Guide for the Non-Perplexed…..The close of Q3 couldn’t have come any sooner for beaten-up stock markets. It has been a terrible month, quarter and year for equities. The Federal Reserve’s policy makers made it clear they’re serious about raising rates until price increases cool down, sending bond yields surging. The economic turmoil in the UK and the nuclear-tinged anxiety over Russia’s war in Ukraine simply added fuel to the fire. Earnings season is around the corner, too, which may add even more pressure to markets that have already fallen to their YTD 2022 lows.

Equity investors received a sobering reality check in Q3, with the major averages having fallen in six of the last seven weeks.  Despite a bear market rally in July, stocks continued their downward trend. September lived up to its reputation as historically terrible for stocks. The S&P 500 fell 9.3% in its worst month since March 2020 during the onset of the Covid-19 pandemic.  The Federal Reserve is maintaining a hawkish position on interest rates and recession fears abound. Soaring bond yields and a strong U.S. dollar have reset valuations and earnings expectations for nearly every sector.  Despite falling prices, many stocks are still expensive, and valuations remain relatively high.  The sell-off has been remarkably broad, with every sector except energy down big this year.  On the global front, virtually all international markets declined, as the MSCI World Index (-26.4%), the EAFE (-29.9%) and Emerging Markets (-28.9%) all mirrored current anxieties.  Equities are on pace for its biggest annual drop since 2008. 

Market analysis all starts with the central banks. Basically, we’ve never experienced central banks all raising interest rates by this amount at the same time…in recorded history. The Fed was one of 10 banks that significantly hiked rates, and more than a dozen rate increases are planned through October. These simultaneous rate hikes could have a disastrous effect on the global economy due to tightening financial conditions too much, too quickly.  

Bonds have endured a historic rout, having their worst year since 1949; and spiking yields (which move inversely to prices) could have a major ripple effect across markets, including making stocks appear more unappealing.  Bonds, which typically provide lower but more stable returns for investors, have had a horrendous nine months, down -14.6%. This has been the worst 9-month performance for bonds in the modern era.  Since bonds are particularly sensitive to economic conditions, this is an even more worrying sign about the state of the economy.

Concurrently, currencies are extremely volatile.  The pound plunged to a record low after Britain released its much-scorned budget, and Japan moved to prop up the yen for the first time since 1998. Meanwhile, the US dollar continues to soar as a safe haven in these ominous times which, in turn, is putting downward pressure on most emerging market stocks.

Although a growing chorus of economists is warning that the odds of a recession have increased amid a historic inversion of the yield curve and signaled its policy would be more aggressive than previously anticipated, the strong U.S. labor market suggest that the Fed could cool inflation in a relatively orderly way, resulting in a hoped for soft landing.  It is still too early to prognosticate that the macro environment is improving. There is much evidence of rock-bottom consumer confidence, and the biggest stock-market wealth destruction (in absolute terms) that we may have possibly ever witnessed.  We are not likely to see a market bottom until there is a clear signal that inflation has peaked and the Fed begins to adopt a more accommodating posture. However, the market is heavily oversold, and any glimmer of a soft landing may spark a sudden comeback in equity pricing.

At the strategic level, we increased our  defensive posture to a level we believe appropriate given the heightened uncertainties, warranting an average cash level of 35%.  With short-term rates rising, cash on the sidelines is at least earning a higher return while we await a stabilization in risk markets. 

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Surplus-Enjoyment….. The history of investing is the history of excess, either narcissistic exuberance or doomsday misery.  Whatever is in vogue at the moment, there must always be more; there is never enough.  It seems like we need a surplus of whatever we currently desire in order to truly enjoy what we already have.  This counter-intuitive psychic position is what the Lacanian analyst Slavoj Zizek - a contemporary philosopher with a global cultish following - has coined as surplus-enjoyment (or in Lacan’s French parlance “jouissance”).  Arguably what is surplus to our needs is, by its very definition, superfluous and insubstantial.  But within the perverted nature of human desire and greed, without this surplus, we would not be able to truly enjoy what we profess to want and need.  Apparently,  the function of a surplus is to help us identify what is the optimal amount.  

The metapsychological reifications of Lacan’s notion of jouissance and its derivative -  surplus-enjoyment -  are, in turn, modeled on Marx’s classic concept of surplus-value.  In the context of a capitalistic investment process with its focus on extracting surplus-value, one encounters the paradox of human desire.  We presume that a desire for continual profits is structured in a straightforward way, striving towards some conventional goal, and finding satisfaction in its achievement.  However, this predictable dialectic then encounters the ironic paradox inherent in our libidinal economy:  regardless of whatever we achieve, we always want something else… and then more.  Consider the banal example of many women’s rapacious love of shoes.  So long as discretionary income and storage space permits, the woman’s shoe closet will expand to include a proliferation of designer brands, styles and colors, until such a surplus accrues that eventually incremental acquisitions start to taper off.  Many other examples can be cited in our hedonistic, hyper-charged consumerist culture.  Since we are compelled to pursue the surplus that eludes every object, such a metonymy of desire results in an impossibility.

In the investment world, a strong profitable performance in the past year sets up similar expectations for the current year.  Two consecutive years of out-performance raises the threshold even higher.  Three years of a bull market reproduces its own exuberant expectations in an ever expansive form….. and so on; until finally one day the market crashes.  Isn’t this scenario precisely what we have experienced from 2019 - 2022?  In our most recent investment paradigm, high-flying technology stocks served as this era’s “Nifty Fifty.”  This extreme imbalance and the inherent  contradictions of an unfettered auction-style market always leads to volatility and excess. 

Is there any escape from the vicious cycle of surplus enjoyment, or are we forever doomed to simply want more?  In classic works such as Small is Beautiful (Economics as if People Mattered) and A Guide for the Perplexed, the German-born British economist E. F. Schumacher points to a way out of this dystopia.   Recognizing the insidious culture of enjoyment we live in can provide the first steps in transcending the impasse, to avoid being the artificer of one’s own misfortune.

Surplus-enjoyment is a metaphor for other realms in our lives, either in the context of our material possessions, our social constellations, our daily behavioral routines or our emotional investments.  In each case, the cumulative iterations we go through to  - acquire more things, accelerate our distractions, or assume incremental commitments - all ineluctably  take a toll on us.  Do they enhance our lives, or do they irretrievably deplete our spirit?  When we want or pursue too much, do we lose our focus, do we fall prey to the illusion that “more” brings more satisfaction, more meaning?  Or do we succumb to complacency, mindlessness and sheer exhaustion?

There is a simple lesson here for profitable, long-term investing. Charlie Munger’s maxim to stay the course and accept with equanimity the vicissitudes of the market is admirable, albeit  difficult for the average investor to emulate.  That notwithstanding, anyone with significant assets must recognize that investing cannot be a passive activity.   Either directly or via a trusted financial advisor, investing is a serious business.  For the active investor, act with a clear focus and objective, limit the number of discrete investments to a manageable level and make sure you understand the thesis for each major position.  Once a portfolio has been established, monitor it carefully and make adjustments as appropriate.  The markets can change at a startling pace and it is necessary to both accommodate and anticipate these changes.  Above all, maintain a long-term perspective.  How long?  I suggest the following epigram from Sun Tzu:  “If you wait by the river long enough, the bodies of your enemies will float by.”  

Never interrupt your enemy when he's making a mistake. 

 - Napoleon 

Escape From Stupidity ….. An independent market research provider recently opined that “there is an uncomfortably high 10% chance of a civilization-ending global nuclear war over the next 12 months. If Vladimir Putin comes to the conclusion that he has no future, he may well decide nobody else should have a future either…. Despite the risk of nuclear war, it makes sense to stay constructive on stocks over the next 12 months. If an ICBM is heading your way, the size and composition of your portfolio becomes irrelevant.”  With tongue-held-firmly-in-cheek, it concludes that "from a purely financial perspective, you should largely ignore existential risk, even if you do care about it greatly from a personal perspective.”

Q1-2022 has mercifully come to an end, marked by wild trading, dizzying volatility and hints of an outbreak of WW III.  As if a persistent pandemic, rising interest rates and surging inflation were not enough to wreck investor sentiment, the Russian invasion of Ukraine has riveted focus on a precarious geopolitical Armageddon.  Meanwhile, China - the world’s second largest economy - is being hit with a Covid resurgence that is once more rattling the global supply chain.  For investors, these are the most treacherous times since the 2007-2009 financial crisis.  However, for investors with dry powder and a long-term perspective, fear and volatility may yet be used to their advantage.

Q1-2022 marked the first down quarter since the onset of the Covid pandemic.  Both the S&P 500 and DJIA declined nearly 5% while the NASDAQ fell nearly 10%.  However, the sting of these losses were lessened by a stock rebound in late March which lifted the major indices from correction territory for the broad indices, and a short-lived bear market for the tech-laden NASDAQ.

Moreover, bondholders are going to be in for some nasty surprises when they check their first-quarter statements.  In aggregate, bonds are down about 6% over the past three months--one of the worst quarters since the 1980s.  Investors have been fleeing bonds for months. Municipal bonds -which have an especially risk-averse investor base - have seen historic outflows and posted their worst quarter since 1994, down 5.8%. Investors have also been fleeing high-yield debt, down 5.5% in Q1. 

With bonds down and cash losing real value because of inflation, the stock market and "real assets" like real estate often provide more upside. Commodities have done extremely well recently - up 24% in Q1 - but are complex investments for the long run. The S&P 500 has been impressively resilient thus far, with a drop of less than 5% in Q1. As bond losses deepen, investors may re-allocate more funds into equities.

At the strategic level, we increased our defensive posture to a level we believe appropriate given the heightened uncertainties resulting from macro-economic events of Q1. Continuing pressures  on the global supply chain, rampant inflation, tightening monetary policy and the Ukraine situation warrants a higher than average cash level.

On the global front during Q1 2022, virtually all international markets were covered in red, as both the EAFE (-7.0%) and the MSCI Emerging Markets (-7.3%) mirrored current anxieties.  The  MSCI China index fell -17.%%, further exacerbating its massive decline of -22.5% in 2021.  The geopolitical risks of investing in China has grown after the financial isolation of Russia.  The regime’s domestic repression and control over China’s most successful companies, particularly in the technology space, is choking them off from international financial markets and jeopardizing killing the engine that drove China’s economic miracle.  The only major market to enjoy gains in Q1 was Brazil (+14.5%) which is heavily reliant on commodities pricing.

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Remembering, Repeating and Working Through ….. The word “stupidity” is typically used as a pejorative, as an insult.  But what if we take this thought seriously and propose stupidity as a valid concept, a tendency inherent in the human mind?  When one ascribes stupidity to a stranger or to people in general, it is a form of arrogance expressing contempt. But when we advise a friend or someone we care about that they are being stupid, it is more an expression of concern, a warning to discontinue a particular path of thought or action.  In this context, stupidity is transformed - not as an absence of thinking - but as a previously unrecognized form of defense.

Using a more nuanced register, stupidity is not ignorance; instead it describes a state of being struck dumb or stupefied.  We become stupid when we fail to take responsibility for our ignorance or recklessness, and reflexively blame the situation on some other agent.  Passively embracing our ignorance and thoughtlessness is the failure that truly constitutes falling into a state of stupidity.

The way to escape from stupidity is what psychoanalyst Jared Russell suggests is the emergence of the affect of shame.  When I become ashamed of my stupidity, I am already engaged in the process of overcoming it.  To be truly stupid is to be unashamed of one’s stupidity, to relinquish the fight for intelligent, mature thought.

The stock market is fun to chat about, both for neophytes and professional investors; but the reality is that it’s too complex for most people - even highly intelligent ones - to fully understand.  Acknowledging our shortcomings, it is useful to recognize that the history of investing - and specifically the history of the stock market - is the history of forgetting.  The repetition compulsion for investors results in new editions of old and fixed experience patterns.  In every investment cycle, investors follow a cycle of forgetting and remembering.  The compulsion to repeat fixed patterns of thought and behavior is a lesson that each generation of new investors must learn again each time.

The guiding principal of prudent investing is to recognize the various sources of risk: businesses vulnerable to technological change, narrow moats that invite competitors, leveraged balance sheets, imprudent managements, and countries with political systems that don’t respect property rights.  Measuring a full spectrum of resilience is essential to an assessment of a portfolio’s capacity to withstand crisis and other compounding shocks that result in permanent wealth destruction.

Despite the lessons learned from previous debacles, investors are constantly being seduced, and often succumb, to a global marketplace organized around exploiting the stupidity and fecklessness of mass consumers.  They are bombarded with the unremitting cacophony generated by an algorithm-driven ecosystem, driven by a ravenous and omnipresent social media machinery.  The intelligent investor must devote a lot of energy and discipline to maintain focus and performance.  Otherwise, just the natural entropy in the macro-economy will cause many to lost the battle for investment survival.

History is a mysterious approach. Every spiral of its way 

leads us both into profounder perversion and more fundamental reversal.   

 -Martin Buber

In Search of Lost Time….. Summer has come and passed. Stocks are going into Q4 on an uneasy note, confronted by a long anticipated correction that may have already started.  This bull market has largely discounted nearly all the worry signs in 2021, although many hedge fund managers, traders and analysts have been flagging a correction or a sizable retreat for months. September was the worst performing month since March 2020 — as the Nasdaq slid 5.6%, S&P 500 declined 4.7%, and the Dow Jones fell 4.2%. Volatility has resurfaced in risk assets following a sharp jump in Treasury yields. Headwinds from the delta variant along with growing uncertainty in China (bad debts, slowing economic momentum) and Washington (debt ceiling, infrastructure, and taxes) are also weighing on risk appetites. The land mines for the market are increasing, and they are taking their toll, as there is a slow-motion deterioration in numerous sectors of the market.

Anxiety about a looming correction has been building for months, based on a long rally, confusion around monetary policy, Covid-19, inflation, the job market, and slowing economic growth. It's hard to blame investors for their lack of enthusiasm. They're surrounded by uncertainties. The debt ceiling remains an issue. Meanwhile, $4.5 trillion dollars worth of spending bills are the kind of issues that keep investors on the sidelines. Bond yields continue their ascent. Yet, for all the worries, stocks are still doing relatively well. YTD, the S&P 500 is still up 14.7%, with the NASDAQ +12.1% and the Dow +10.6%. Internationally, the MSCI World Index and EAFE Index fell back -0.5% and -1.0% in Q3, respectively. The MSCI Emerging Markets Index - heavily weighted towards China - is now -3.0% YTD, as continuing US-China tensions and Beijing’s broadening regulations over the domestic technology sector create headwinds that dampen investor sentiment.

We expect conditions to remain volatile, with limited upside for stocks for the balance of 2021. Looking ahead to 2022, the stop-and-start reopening of the economy will be the primary theme in the ensuing quarters.  The broadening vaccine rollout and booster programs should unleash pent up demand returning to real goods, lifting consumption due to record net worth and low debt-servicing costs. As global COVID-19 infection rates drop, the world economy is set to bounce back. We think this “reflation” phase of the recovery will be characterized by high growth, rising inflation, low interest rates, and persistent volatility. 

Against this turbulent equity backdrop, the 10-year Treasury yield has moved to the lower end of its recent trading range, hovering around 1.5%. As has been the case in 2020-21, it has been much easier to invest for income in the broader equity markets versus the credit markets.  Among “yield assets,” MLPs and REITs continue to offer attractive income. The high yield bond sector (+4.6% YTD), buoyed by the record volume in leveraged financings and M&A transactions, remains the only major fixed income sector to show meaningful gains in 2021.

On the global front, during 2021 the China market has exerted a disproportionately large impact on global portfolio performance and overall investor sentiment. To understand what’s going on, one must accept that China is a state capitalist system wherein the state runs capitalism to serve the interests of the regime. Policymakers are largely indifferent to the sensitivities of the capital markets. What we have been witnessing in recent months are not some technical corrections but a political intrusion on major businesses in China by the central government. It is a regulatory crackdown by a government which is setting new financial rules for its own benefit. In fact, investors in the global capital markets have a subordinated position in the system. 

China’s technology giants are the growth and innovation engines of its economy—40% of the economy is from the digital economy, the highest share in the world. People underestimate how much of a technology-oriented economy China has become. The risks of regulation are greater this time because China is so dependent on technology. We are in the midst of a regulatory cycle and these tend to last a year or so, if the past is any guide. 

Despite the turbulent political climate, net flows of overseas investment into China surged to a record high of $443 billion in the first half of 2021. The massive capital inflows reflect attractive returns provided by yuan-denominated assets amid the currency’s appreciation, and foreign investors’ growing confidence in China’s recovery from the Covid pandemic as some other major economies continued to suffer.

Stepping back, both the American and Chinese systems and markets have opportunities and risks, and will compete with each other and diversify each other. Hence they both should be considered as integral components of a global portfolio. China is still the second-largest economy in the world. A year ago, many investors who were overweight China now have beat a panicky retreat.  Longer term, the prudent path is typically between these two extremes. To not have an asset allocation to such a large economy is not a view that long-term global investors should advocate. Stated simply, one needs be very careful, at least for the next few months. It’s not in Beijing’s interest to kill the big internet companies, but in the near-term, it may be saferto allocate funds to other geographic sectors rather than look for the bottoms of the big Chinese technology companies (e.g. Tencent, Alibaba, Meituan, JD) that have had an amazing run in the last 3 years. The trend of digitization in emerging markets is here to stay. Companies like Sea in Southeast Asia and Mercado Libre in South America are both rising stars in their respective regions. The same digitization trends are evidentin India, Southeast Asia and Eastern Europe but are at an earlier stage of the curve than China.

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Remembrance of Things Past….. In light of passing time and knowledge, the cumulative cascade of facts, ideas and changing prices are disseminated in the marketplace. This kaleidoscope of shifting perceptions and price valuations functions like a cosmic wheel that distributes and redistributes wealth throughout the economy. An investor’s life, lived out in the markets, can thus be understood as a succession of divergent challenges. But without the benefit of hindsight, its course and meaning will often seem refractory to simple reasoning or our powers of anticipation.

Remembrance is an act of translation, a process of filtering meaning and significance that eludes our grasp in the moment. At a meta-self-conscious level, I am obsessed with time. There’s never enough of it, especially with the ones you cherish. And maybe one way to have more of it is to live in multiple worlds every day, to create whole new timelines and dimensions. As a categorical imperative, nothing is more addictive than an immersive reminiscence of the past, but such an addiction can threaten to subordinate both present and future. As for a more constructive form of remembrance, I am referring to intelligent, rational memory retrieval, not some kind of mystic epiphany. A detailed documentation of progress can help us identify what drives specific desired outcomes. Yet, for all the decisions one might make about life’s course, they often make sense only after the fact.

The financial mind seeks an environment that can satisfy two conflicting drives: in the context of the markets, money means everything; but in the larger life of the mind, money means very little. Within each of us, it is the capacity to shift from one perspective to another - from the financial to the psychological to the spiritual - which enables us to transcend our circumscribed worlds. Thus, the mind of the market is in synchronization with the individual mind when it is open to both economic success and failure. To change is really only to come closer to the essence of one’s impermanence. Like the mindful individual investor, the market accumulates not only the capital gains of its successes but also its failures, capitalized in wisdom and experience. 

“My life improved immeasurably when I was able to find a balance between living in the past, 

remembering the past, thinking about the past, and thinking about the future.”

 -Eckhart Tolle

The Power of Now….. The markets concluded a volatile Q1 with respectable gains, shrugging off a variety of worrisome undercurrents. For 2021 Q1, the Dow Jones Industrial Average and the S&P 500 rose 7.8% and 5.8%, respectively. The tech-heavy NASDAQ, after a stupendous +43.7% 2020 performance, lagged with a more tepid +2.8% increase. Internationally, the MSCI World Index and EAFE Index gained +5.4.0% and +3.4% in Q1, respectively. Among major overseas markets, China’s Shanghai Composite dipped -0.9%, as growing US-China tensions and Beijing’s broadening regulations over the domestic technology sector created headwinds that dampened investor enthusiasm. Meanwhile, Japan’s continued its rebound, with the Nikkei up 8.8% for Q1.

In Q1, stock prices swung in a messy internal rotation as investors weighed signals that the U.S. economy is positioned for a rapid return to re-opening post-pandemic. This has been counter-balanced against concerns about rising bond yields, and the extremely high valuations of momentum growth stocks that fueled much of the 2020 trades. Beneath a relatively calm surface manifested by the major equity indices, there have been large moves in individual stocks and sectors. The DJIA, with its cyclical tilt to financials and industrials and its price-weighted calculation, fared the best in Q1. In comparison, investors backed away from the tech darlings that dominated the markets in 2020. Higher bond yields have been a major headwind to technology companies, challenging their current valuations when sustained profitability is still in the intermediate term future. Compounding this anxiety is a strengthening dollar, growing geopolitical US-China tensions, and the dreaded return of inflation. Rising Treasury yields led to declines in most fixed-income sectors, with the lone exception of high yield bonds (+0.9%) which tend to trend more in correlation with moves in the equity markets.

Equities already reflect much of the positive news. The average stock in the S&P 500 trades at 22x multiple of  2021 projected earnings. This high valuation could mean limited upside for stocks unless earnings rise more than expected. That is especially true because yields on government debt are rising, making bonds more appealing as an alternative. While we expect conditions to remain volatile, the most recent developments on three of the main market drivers - stimulus, pandemic news, and inflation data - point to further equity upside. This windfall comes on top of existing signs of pent-up demand from U.S. consumers. We remain constructive on equities, even in the face of a highly unstable macro-environment. 

Looking ahead to the balance of 2021, the stop-and-start reopening of the economy will be the primary theme in the upcoming quarters.. The accelerating vaccine rollout will unleash pent up demand returning to real goods, lifting consumption due to record net worth and low debt-servicing costs. As global COVID-19 infection rates drop, the world economy is set to bounce back. We think this “reflation” phase of the recovery will be characterized by high growth, rising inflation, low interest rates, and persistent volatility. 

Against this backdrop, we recommend that investors position for reflation, refocus on the hunt for yield, and try to use volatility to invest and protect. Looking further ahead, the world is continuing to become more digital and more sustainable, and economic power is shifting from West to East. With that in mind, we recommended at the end of 2020 to seek opportunities in Asia and position for structural growth. Over the past 20 years, the Asian economy has grown fivefold, with China accounting for the bulk of that increase in GDP. Yet strategically, many investors, particularly those outside of Asia, still significantly under-allocate to the region. In today’s environment, it is key to seek opportunities in Asia. We advocate adding to Asian equities strategically. Within Asia, one of our most preferred equity markets is China, which offers strong earnings and a better liquidity outlook. Asia is also home to some of the most compelling growth opportunities in the world, offering exposure to disruptive themes across 5G, greentech, e-commerce, and fintech, all of which are especially led by companies in China. 

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Zen and the Art of Investment Management….. The temporal dimension is crucial in how we experience the task of investing, and is often determinative of our short-term and long-term decision-making. If there is an excess of preoccupation with either the past or the future, we become unable to focus our energies on the immediate present. Living in the past results in regrets and second-guessing, dwelling on losses and missed opportunities. An obsession with the future brings on fear, anxiety and delay.

Experienced investment management means an adherence to bedrock principles of balance and diversification: getting clients through market drops, portfolio rebalancing and harvesting losses. It’s about maintaining a longer-term perspective and identifying undervalued sectors over the next five-year horizon. A fundamental question that all investors should ask themselves has long been posted on our website home page (by Adam Smith, the pen name of the late George  Goodman) in his book The Money Game: If you don't know who you are, the stock market is an expensive place to find out.

But the principles of investing are often more art than science. Through multiple reiterations of facts, information, theories and hypotheses, we end up with more indeterminate, relative truths rather than any single, absolute truth. What is crucial is that one should be superbly methodical, persistent, regular and meticulous. Investing is also a balance between skill and chance. The decision-making process constantly involves risk and probabilities. It is an environment where imperfect information is rife with ambiguity, and many possible variables can weigh on the outcome. Many amateur investors are drawn to the process because it provides a false illusion of agency and control. Often the ones who proclaim the most confidence are the ones least aware of their own ignorance. They think they are investing when in reality they are merely gambling.

Short-term traders tend to equate activity with productivity. Often the best tactic is to not do anything; but that stance should be a conscious choice, not a result of inertia or paralysis. What is important is that the decision-making process is a conscious one, based on reason and experience. Conversely, fear and anxiety are also valid emotions that should be respected, especially if that fear is coming from a place of knowledge. Anxiety is the psyche’s signal to the body to try to avoid a negative outcome. Successful investors trust their own cognitive processes, and possess abundant humility that they may be wrong because the investment world is unforgiving and constantly changing.

In the marketplace, there exists an ongoing struggle of elegiac poignancy between the present and the future, which challenges our conventional view of the past, present and future. In his emblematic book of the the 1970s, Zen and the Art of Motorcycle Maintenance, Robert Pirsig talked about the ancient Greek view of time wherein the future sneaks up from behind us while the past recedes in front of us as far as the eye can see. We can only project the future from our past, which dominates everything in sight. 

This Heideggerian being-in-the-market recalls for the active investor the necessary ability to look into the future and grasp the three interwoven dimensions of time: the present, the past, and the future. The financial markets are, by its nature, forward looking. But in the act of investing, the future becomes the present, even as the present recedes into the past.