Being objective to avoid biases and blind spots, understanding market history, and paying attention to cogent trends are three important aspects of managing portfolios. That’s because though picking stocks well, undeniably helps portfolios, a far greater determinant of success (especially over longer periods of time) is asset allocation. Furthermore, though many have success at stock picking when capital is cheap and the economic environment is characterized by extremely accommodative fiscal policy, when this changes and conditions tighten, naïve investors tend to be vastly outperformed by those who truly understand not only the fundamentals of the companies they buy but the fundamentals of the sector in which those companies compete. It’s a well-known fact, in the world of professional investing, that in an early market cycle environment where capital is cheap, skill is much less a necessity to have success picking stocks. Through a full market cycle things get more difficult. As the father of value investing Ben Graham once said- “In the short run, the market is a voting machine but in the long run it is a weighing machine.” This reality has consequences of course, for those who are on the wrong side of the scale. 

We’re seeing a bit that play out right now. Everything is cyclical when it comes to markets. Even hated asset classes have their day in the sun. Commodities have been the worst performing asset class for the last decade but are up almost 70% since April of 2020. Last year Large Cap Growth stocks destroyed value stocks but are being handily outperformed this year. Last year long duration bonds performed very well, and this year not so much. Last year IPO’s did well but this year many are struggling out of the gate. Peloton, Zoom, renewable energy stocks, health care and cryptocurrencies are also having a difficult time maintaining gains.

Diversification is obviously a word that gets used a lot when it comes to proper portfolio construction, and thankfully diversified portfolios are holding up decently this year, according to the financial press. That said, diversification alone is not the holy grail of portfolio design, it is just one component. Managing portfolios optimally requires a strong investment discipline and a defined process but also requires objectivity and an understanding of how different asset classes perform throughout the market cycle. Even if a portfolio is not “balanced” by definition of the fixed income to equity ratio it holds, every portfolio should be managed with balance and objectivity. Being too rigid or too flexible can lead to unwanted results. Adapting to market conditions is best if it’s not too reactionary in nature. Chasing returns usually ends up being an exercise in chasing your own tail as the market cycle evolves. And so, when some of my “DIY” investor friends call to lament their recent challenges with their stock picks I sympathize. As the saying goes “you can’t know, what you don’t know.” The pattern of learning the hard way, that investing isn’t nearly as easy in the mid and late market cycle is one I’ve seen play out several times now in my career and I have no-doubt I’ll it see play-out again in the future.