A colleague recently challenged our team with a brain teaser, a fun exercise that reminded me of my long-held enjoyment of such problems. Looking to occupy some time on a summer road trip, I posed the same challenge to my daughters. It served its dual purpose of absorbing precious minutes in the car and developing critical thinking skills. It also was an interesting observation of the emotional swings of children, who first became pessimistic ("we're never going to solve this"), then followed shortly after by exuberance ("let's do another!") after a taste of success.
Child-like mood swings also occur in the public markets, with 2022 serving as a prime example. After a six-month period in which investors experienced historical drawdowns in stocks and bonds, the market trends that dominated the year's first half abruptly flipped:
- The S&P 500 gained 9.2%, growth stocks comfortably outperformed value stocks, and returns for small caps exceeded large caps.
- The pattern in the bond market was the same, with rates declining and high yield outperforming investment grade bonds.
The first-half sell-off may seem justified by a confluence of adverse events that included international conflict, rising prices, and slowing economic growth. But markets, like children, can become overly emotional in the short run and reach extreme levels of pessimism, only to swiftly reverse course.
During these periods, a disciplined approach to rebalancing can help weather the storm. For example, through our investment process, we’ve sought to:
- Increase exposure to disrupted equity markets and trim relative winners in complements (such as various categories of alternative investments);
- Subsequently, moderate equity positioning during the recent rally.
Forecasting the market's mood in the coming months is a riddle, but we expect continued volatility until there is improved clarity on the paths of inflation and economic growth. We are confident, however, that having a plan and sticking to it will increase the odds of successfully navigating the inevitable shifts in the market – and children’s – moods
