What a difference a year makes. One year ago, markets were licking their wounds having fallen high double digits, beset by worries of an impending recession to be triggered as interest rates were raised to kill inflation. The most prestigious purveyors of investment advice were squealing in delight as they coached continued caution, as further downside was sure to follow. The raging fire of investor pessimism was fueled further by constant trumpeting of bad news by a media desperate to feed the endless cycle of ‘breaking bad’. It was a true investor’s buffet - everything was on sale!
The Wisdom of Crowds
The concept of the ‘wisdom of crowds’ hinges on three conditions:
1.Social Capital Diversity: a wise crowd benefits from diverse viewpoints.
2.Cognitive Diversity: there should be a rich tapestry of thoughts and debates on various issues.
3.Values Diversity: a productive society agrees on basic values and social mores.
Stock market behaviour can be a bit like a dinner party—you want a mix of guests. Optimists, pessimists, dreamers, and realists. When everyone starts singing the same tune, it’s either a really good party or a sign that something’s out of balance. The madness of crowds. Where we were, where we are, and where we may be heading.
The Set Up
The end of 2022 saw investors ravingly bearish and thus prices were in the dumpster. Fear and dejection had the upper hand, and the only greed evident was that better values were lower yet. As 2023 progressed, investors were corralled into a more constructive mind as prices advanced - as they usually do when fear becomes too dominant. The investing inteligencia begrudgingly spun the ‘wheel of fortune’ and trotted out successively less pessimistic swings of the bat to maintain the lustre of sophistication in their models. They have paid tribute to the long-held truism that bull markets climb walls of worry. Voila! Markets produced shockingly good results with the final months seeing bears jumping from rooftops into the pools of honey.
As 2023 rolled to a close and investors rushed to ‘catch-up’, they chased after anything and everything that had not gone up. I call this dumpster diving. It’s tempting to join the party. But, you see, in my 38 years of navigating the investment waters, I’ve learned that the shoals of investing are always present; they are only hidden by the rise and fall of the tide. I’ve learned that when everyone agrees that trash is cash, it’s time to get worried. The party is fun for a while, but eventually someone calls the cops.
This is where things get tricky, or who let the dogs out?
Investors may become overly confident about positive outcomes at the precise time that uncertainty and the range of outcomes is perhaps becoming less certain. The stool that supports the wisdom of crowds may be losing a leg.
We are thrilled that 2023 was a year that produced strong results. Were we lucky or were we wise? Short periods of time like a year do not provide enough data to make a strong argument one way or the other, but we played the odds. With valuations so depressed, being aggressively optimistic was likely a safe course of action. We pounced.
Today, we are dealt a new hand, and it is not because it is January 1, 2024. The investor base is increasingly positively disposed and a few more cups of juice could tip into downright giddy behaviour.
Just because a lot of people scream the same thing, don’t make it so.
Since late October ALL the biggest stocks in America increased 14.5% but, more impressively, the “also ran” stocks are up about 25%. All this gnashing of teeth about how only seven stocks have made this spectacular market advance are rapidly melting into a boiling cauldron of ignorance. Ignore the chattering masses, they are picking selected facts to support a view not supported by all the facts!
If we sound confident, please be assured we are not. When walking in a snowstorm you need to watch every step—aware of the beauty and the risk of slipping.
I have scars.
The greatest killer of investment results is over-confidence, and we hold ourselves as able as any to suffer from such bouts of stupidity. We realize that we must make decisions with a great deal of uncertainty, and for periods of times crowds are right. We will consider that the consensus now building is that a good economic outcome over the next few years is possible. It is possible! We will continue to seek opinions contrary to ours. We will consider with open minds, the good, the bad and the ugly. But we will always stick with quality, factually measured.
We remain on heightened watch, alert to the fact that as prices rise—reflecting increased optimism—risk of disappointment and thus short-term negative results rises. 2024 will be the year that Davis Rea looks upon things with a much more discriminating eye, not fearful just enlightened by history.
We remain very confident in the longer-term outlook for the companies in your portfolio. Our compass will always be guided with a fundamental, long-term business-owner approach that reduces the randomness of short-term outcomes and plays to the strengths of the businesses you own. We do not know what the next year will bring, but please know that we are actively alert that the range of outcomes is as wide as ever.