Q1 Market Commentary - On Our Best Behavior.

I grew up in a family that prioritized mental health. Both of my parents were captivated by the intersection of feelings and behaviors, instilling in me a curiosity about this dynamic in myself and others.  

Much financial literature assumes logical decision-making based solely on facts. However, in real life, we often grapple with irrationality, especially when something holds significant importance. These irrationalities, known as behavioral biases, can heavily influence our actions during extreme market swings.

Take Conservative Bias, for instance, which involves clinging to original viewpoints without incorporating new information. At the start of the year, the Fed predicted three quarter point interest rate cuts during 2024. During the first quarter, however, solid GDP growth, strong employment, and inflation showed signs of stickiness. A failure to consider that new information would be Conservative bias.

The market did incorporate that new information. It recognized that interest rates may not decline as soon as hoped. This put downward pricing pressure on bonds. The Bloomberg US Aggregate Bond Index lost -0.78% in the 1^st quarter.

Self-Control bias (lack of self-control) is also noticeable, evident in the tendency to abandon long-term strategies for lack of discipline. The MSCI ACWI® net Total Return Index gained 8.20% in the 1^st quarter while the S&P 500 Total Return Index gained 10.56% over the same period. The sharp rise in the technology sector, as well as expectations around generative AI, pushed some technology holdings to all-time highs. During strong, upward, sector-concentrated moves, there is a temptation to abandon diversification and put all eggs in one very shiny basket – behavior potentially driven by Self-Control bias.

Interestingly, the first quarter saw a divergence among major technology companies, with names like Microsoft and NVIDIA doing well while others like Apple and Tesla struggled. This shift is crucial to monitor due to the significant benchmark weights of companies like Apple and Tesla.

Here are some other examples of behavioral bias:

- Confirmation bias is the tendency to look for or only notice information that confirms our beliefs. I think this one is self-explanatory.
- Hindsight bias is the tendency to recall a situation as being easy to predict or reasonable to expect. This can lead to assertions that predictions were more accurate than they were in the moment.
- Loss-aversion bias is the preference to avoid losses more than achieve gains. When the market is flying high, loss aversion can present itself as fear of entering the market too high or desire to sell riskier assets earlier than advisable to avoid the chance of a pull-back.
- Overconfidence bias is the tendency to place unwarranted confidence in our abilities. Sharp market rises like we have seen over the last 6 months can really feed the ego, sometimes allowing overestimation of skill.
- Regret-Aversion Bias is a “do nothing” tendency prompted by worries that the decision will turn out poorly. If you haven’t struggled with this bias over your sidelined cash, you are super-human.

There is no better illustration that we are better together as when navigating our own behavioral biases. I am thankful to be working at a place that takes these biases seriously. We are committed to discipline and thoughtful process, and we work as a team to counter our individual biases. Even when we are looking to brag about ourselves, we go back and look at our written decisions to see if we got the call right or were lucky.

I think our emotions are an important part of the investment experience. By remaining aware of their impact, we can strengthen our connections with each other and avoid potential pitfalls.

So, next time I jokingly express distrust for a bull market, remind me not to let my loss-aversion get the best of me. While I'll maintain my skepticism, we can also embrace the market and enjoy the lift together.

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The S&P 500 Index is a market capitalization-weighted stock index. It is comprised of about 500 stocks of the largest capitalization companies that are traded on U.S. stock exchanges.
The MSCI ACWI Net Index measures the performance of large and mid-cap companies across 23 Developed Markets and 27 Emerging Markets. The MSCI ACWI® Net Index subtracts foreign taxes applicable to US citizens.
The Bloomberg US Aggregate Bond Index measures the return of investment grade debt across the US market.
All returns are reported assuming that interest, capital gains, and dividends are reinvested.

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