On Markets

Markets as Emotional Systems

Markets are not rational. They're not irrational either. They're emotional systems driven by millions of people making decisions based on incomplete information, fear, greed, and narrative. Understanding that is the starting point.

Most people come to markets with a story. The economy is strong so stocks will go up. Inflation is rising so bonds will fall. A war started so everything drops. Sometimes the story plays out. Often, markets have a way of doing exactly what makes the most people wrong at the worst time.

The Prediction Problem

Don't try to predict where markets are going. The answer based on 100 years of data is simple. In the long term, they go up. In the short term, no one knows!

Nobody can predict the future. Some investors can win against the market. A few can beat it consistently over years. But I hold another counterintuitive view. Beating the market is meaningless.

Everything else is noise. This is true whether you're running a billion-dollar aggressive hedge fund or saving quietly into a pension. The benchmark that matters isn't the S&P 500 or some index. It's whether the portfolio is doing what it was designed to do for the person it was built for.

A portfolio that returned 40% but exposed the client to currency risk? If that wiped out half the gains when they needed the money, that's a failure. A retiree forced to sell assets at the worst time because the portfolio wasn't structured for distributions? Failure. A simple portfolio that returned 6% but delivered steady income exactly when it was needed? That's success.

Time in the market beats timing the market. The industry obsesses over relative performance. I care about absolute alignment with purpose.

Studies have tracked thousands of market predictions from dozens of prominent forecasters over more than a decade. The average accuracy? Around 47%. Worse than a coin flip.

This isn't because these people are stupid. Many of them are brilliant. It's because markets price in information faster than most individuals can process it, and the things that actually move markets, a pandemic, a bank collapse, a policy surprise, are by definition unpredictable.

When something terrible happens but the facts are known, markets can price it in, companies can plan, capital can be allocated, and growth can resume. Uncertainty freezes everything. Certainty, even ugly certainty, allows planning. Planning allows optimization. Optimization allows investment. Investment drives growth.

Understanding that connection is a big step in understanding how markets actually work.

The financial media needs predictions to fill airtime. People want certainty because uncertainty is uncomfortable. But building a portfolio around a forecast is absurd.

Risk needs to be managed to the point where the forecasters being wrong doesn't destroy you. What is the worst thing that can happen? How comfortable am I from that margin of safety? And honestly, do I even have the ability to understand the risk I'm taking?

Take something simple. You're saving to buy a house in three years. You have the money sitting in cash. Feels safe. But inflation is eating 3-5% a year, and real estate prices are climbing. So your "safe" cash is actually losing purchasing power against the goal. You move it to equities to keep up. Now you've got market risk on money you need at a specific date. Both positions have real risk. The question isn't which one feels safer. It's how to structure the risk so you have the best chance to meet the actual goal, and what you can absorb if things go wrong.

What Markets Actually Do

If you zoom out far enough, equity markets go up. This is not optimism, it's historical data. Companies earn profits, reinvest, grow, and compound. Over any 20-year rolling period in the S&P 500 since 1926, there has never been a negative return. Not once. There can always be an exception. But statistics are on the long-term investor's side.

It's worth understanding why. Growth isn't magic. Economists have studied its origins for centuries.

Adam Smith, the father of modern economics, explained it in 1776. When people specialize in what they're good at and trade with each other, everyone produces more.

David Ricardo, a British economist and one of the most influential thinkers in classical economics, took it further in 1817. Even if one country is better at everything, both sides gain by focusing on what they do relatively best. This insight, comparative advantage, still explains why global trade works. It's not abstract theory, around 40% of S&P 500 company revenues come from outside the United States. The largest companies in the world are built on the back of Ricardo's idea, whether they know it or not.

The fundamentals haven't changed. Economies grow because populations grow, because technology improves how we produce things, because capital accumulates and gets reinvested, and because human beings keep finding ways to do more with less.

On top of that, markets benefit from constant new capital entering the system. This is a relatively recent phenomenon. For most of history, stock markets were the domain of wealthy individuals and speculators. That began to change after World War II, when employer-sponsored pension plans expanded rapidly across the US and Europe. The Internal Revenue Act of 1942 gave tax incentives to employer pension contributions, and by the late 1960s, roughly half the American private-sector workforce was covered. Then in 1974, the ERISA Act created the framework for modern pension regulation, and in the 1980s, 401(k) plans began channeling millions of ordinary workers' savings directly into equities every month.

Today, pension funds, sovereign wealth funds, insurance companies, and endowments push institutional money into markets on a schedule, regardless of headlines. Tens of billions of dollars enter US markets alone each month, and the same pattern holds across most free markets. This structural demand for equities didn't exist two generations ago. It's a tailwind that compounds over decades.

But that long-term line hides enormous pain along the way. The market lost 86% between 1929 and 1932. It went nowhere for 16 years from 1966 to 1982. The dot-com crash wiped out 49%. The 2008 financial crisis took 57%. Covid crashed markets 34% in 23 days.

Every single one of those recovered. Every single one felt like the end of the world while it was happening, and in the ups and downs that followed, usually for years to come. You might remember some of them. Investment teams remember them well. That's the tension at the heart of investing. The long-term trend is your friend, but you have to survive the short term to get there.

This is one of the most important questions in portfolio construction and management. How does a person, an institution, a fund achieve its goals, even when markets rattle?

Part of the answer is stress testing. The idea is straightforward. You take a portfolio and run it through historical worst-case scenarios. What would have happened in 2008? In the dot-com crash? During a rapid rate hike cycle? If the answer is "the client would have been forced to sell," the portfolio isn't built right. Better to discover that in a spreadsheet than in a crisis.

But stress testing is mechanical. More important is clarity and preparation around goals. Consider how the best university endowments operate. Yale's endowment, famously managed under David Swensen's philosophy, didn't panic in downturns because its spending rules were designed to smooth out volatility over years. The fund needs to distribute roughly 5% annually, forever. So the portfolio was structured around that reality, with enough liquidity to meet near-term obligations and enough growth assets to preserve purchasing power across generations.

When markets dropped 40%, Yale didn't sell. They could afford not to, because the structure was built for exactly that scenario. Under Swensen's 36-year tenure, Yale consistently met its distribution obligations, grew the endowment from $1.3 billion to over $40 billion, funded financial aid expansions, campus development, and faculty recruitment, through multiple crashes, recessions, and crises. Not because he predicted markets better. Because the structure was right, the goals were clear, and the discipline held.

The same principle applies at any scale. A retiree who knows their next three years of living expenses sit in short-term bonds can ride out a crash without selling a single equity position. A family saving for a child's education in ten years can tolerate volatility today because the timeline allows it. Clarity about when you need the money and what the portfolio is supposed to do, that's what keeps people invested long enough for the long term to actually work.

"But I Don't Have Goals"

Everyone has goals. Whether you have $1 or $1 billion.

A 25-year-old with $500 in a savings account has a goal, even if she hasn't named it yet. Maybe it's not touching that money so it grows. Maybe it's having a safety net so she can take a risk on a new job. That's a goal. A couple in their 40s with a house and some retirement savings? Their goal might be making sure they don't run out of money at 80, or helping their kids without hurting themselves. A business owner sitting on excess cash? His goal is making that cash work harder than inflation without putting the business at risk.

Nobody walks around with "no goals." They just haven't defined them clearly enough to build around. The secret isn't having complicated goals. It's understanding the ones you already have, understanding yourself, how much uncertainty you can live with, how you react when things go wrong, and marrying that with an understanding of risk, markets, and assets.

That's where portfolio construction begins. Not with a product. Not with a model. With you.

Mean Reversion and Extremes

Markets overshoot. Always. They overshoot on the way up and they overshoot on the way down. This is mean reversion, the tendency for returns, valuations, and sentiment to swing past the average and eventually come back.

The Shiller CAPE ratio, a widely used measure of market valuation, has averaged around 17 since 1871. It hit 44 before the dot-com crash. It dropped to 13 in 2009. As of early 2025, it's sitting in the mid-30s.

This doesn't tell you when to buy or sell. Expensive markets can stay expensive for years. Cheap markets can get cheaper. But it tells you something about the range of probable outcomes over the next decade. High starting valuations have historically meant lower forward returns. Not always, but often enough that it matters.

It's also worth understanding what pushes multiples higher over time. Inflation and economic growth naturally drive valuations upward. A company earning twice what it earned a decade ago should be worth more, and the market reflects that. The long-term upward drift in valuations isn't irrational, it's partly a reflection of real growth in the economy underneath.

But when markets overshoot to the downside, when fear takes over and valuations compress sharply, that's when something powerful happens. Great companies become available at great prices. This is the first step in active portfolio management done right. Recognizing when the market is giving you a genuine opportunity, not because you predicted the crash, but because you understand what things are worth and you have the structure to act.

This is also the most important step. Getting the big calls right, what to own, at what price, in what proportion, matters more than any amount of trading or tinkering. It's the foundation everything else is built on.

But here's the honest truth. For the vast majority of people living normal lives, this kind of active management isn't necessary. For 99% of the population, the cost of hiring an active advisor to try to exploit these moments isn't worth it compared to simply doing nothing, buying a diversified portfolio and holding it. The math is clear. Most active managers underperform their benchmarks over time, and the fees erode whatever edge might have existed. Doing nothing, done properly, is a remarkably powerful strategy.

Active management makes sense for a narrow set of situations, complex wealth, multi-jurisdictional tax planning, concentrated positions, illiquid holdings, family dynamics. For everyone else, the best advice is often the simplest. Buy broadly, keep costs low, and don't touch it.

A Note on Non-Equity Markets

Everything above focuses on public equities, stocks with prices that update every second of every trading day. But many investors hold assets in markets that don't work that way. Real estate. Private equity. Venture capital. Private credit. These are enormous markets, and they deserve honest attention.

To put it in perspective, global public equities are worth roughly $115 trillion. Government and corporate bonds, about $117 trillion. Private markets, private equity, private credit, infrastructure, private real estate funds, around $14 trillion and growing fast. But the single largest asset class on earth is real estate. All of it, residential, commercial, agricultural, totals roughly $393 trillion. More than equities and bonds combined.

They just don't look that way because they don't have continuous price discovery. A stock drops 30% and you see it on your screen in real time. A private equity fund drops 30% in underlying value and you might not find out for six months, when the next quarterly report arrives. A property loses 20% of its market value and you won't know until someone tries to sell it or a new appraisal comes in.

This creates a dangerous illusion of stability. Investors look at their private holdings and see smooth, steady returns while their stock portfolio swings wildly. They conclude the private assets are "safer." They're not. The risk is the same or greater, you just can't see it in real time.

Worse, the inability to see the price also means the inability to properly assess the risk. In public markets, volatility is uncomfortable but it gives you information. You know exactly where you stand at all times. In private markets, you're often flying blind between valuation dates. And when you do need liquidity, when life happens, when plans change, when cash is needed, these assets can't be sold quickly, or can only be sold at a steep discount.

This doesn't mean private markets are bad. They can play an important role in a portfolio, particularly for investors with long time horizons and genuine tolerance for illiquidity. But the idea that they're a smoother, safer alternative to stocks is one of the most persistent and dangerous myths in investing.

The Cost of Panic

The biggest risk for most investors isn't a crash. It's what they do during a crash.

J.P. Morgan's research shows that if you missed just the 10 best days in the S&P 500 between 2003 and 2023, your annualized return dropped from 9.8% to 5.6%. Miss the 20 best days and it dropped to 2.9%. Miss 30 and you lost money.

Here's the catch. The best days almost always happen during the worst periods. Six of the ten best days in the last 20 years occurred within two weeks of the ten worst days. Selling in a panic means you almost certainly miss the recovery.

This is why structure matters more than timing. If the portfolio is built right, with enough liquidity to ride through downturns and enough allocation to capture recoveries, the temptation to panic becomes manageable.

Market Environments

I don't classify markets as "good" or "bad." I think about environments. What is the current interest rate regime? Where are we in the credit cycle? Is liquidity expanding or contracting? What are valuations relative to history?

These aren't predictions. They're conditions. The same way you check the weather before deciding what to wear, not to control whether it rains.

A portfolio designed for all weather, with positions that serve specific roles across environments, doesn't need to predict anything. It needs to be built honestly and reviewed regularly.

Markets will do what they do. They'll surprise, frustrate, and occasionally terrify. That's not a flaw in the system, that's the system. The price of long-term returns is short-term discomfort.

The job isn't to outsmart the market. It's to build something that holds up across whatever comes, and to have the discipline to let it work.