The 2023 stock market may well have earned a permanent spot in market history.
The market has returned some 26%, exceeding its historical annual gain of about 9%. Thoughtful investors expected a different outcome, with the risks of investing outweighing the perceived rewards for most of the year. And yes, many such investors still exist, even if they are often overshadowed by telegenic pundits and tyros with active social-media accounts.
In the future, when investors debate risks and investment strategies, 2023 is destined to be cited as a case study when seemingly insurmountable risks succumbed to significant gains. The war between Russia and Ukraine posed a geopolitical threat that some feared could spark World War III. Markets shrugged it off.
The Federal Reserve’s aggressive interest-rate increases made bonds an attractive alternative to stocks, and yet rates didn’t rise high enough to trigger a recession or a migration out of equities. Higher rates pushed commercial real estate into crisis, but office buildings didn’t implode and weaken the economy and debt market—at least not yet.
Hamas, which the U.S. government declared a foreign terrorist organization in 1997, attacked Israel and killed more than 1,200 people on Oct. 7. Fears of a wider war in the Middle East remain, but that infamously unstable region has so far managed to dodge one.
We learned that investors in the stock and options markets can be too smart for their own good. Many were positioned for catastrophe, only to see the unruly market mob make more money.
Many of them will now behave more aggressively because the
S&P 500 index’s
performance exceeded their own portfolio gains. They want to make up for lost time and money. We remain amazed by this disconnect between risk and reward.
After the different crises over the past 25 years, 2023 provided evidence of how investor behavior has changed after the market has overcome those episodes. We have come to believe that many investors rent returns and own risks.
They play a winning hand for a year or more, but they ultimately give back some or all of their gains to thoughtful investors who understand that investment success is not defined by a year or two of high gains but years of consistent returns and managing risk. The indexes are false gods that often cause people to march greedily into overripe investments, and then panic when the momentum ultimately ebbs.
In other words, for most investors, gains appear as fact, even if they’re unrealized, and risk doesn’t exist—until it does.
Sooner or later, investors who have seen their portfolios surge in value because of luck and market momentum will encounter a harsh market fact. Something always happens—and it is generally not something that many people expected—that rises up and sweeps away the unrealized gains.
When that occurs, Main Street will learn a tough lesson: Unrealized multiyear gains are violently reclaimed by the pros. When that happens, the undisciplined and overconfident will feel like tourists who have returned from a great trip, only to get into a bad accident on the way to the airport.
We have spent much of 2023 thinking of an insight that was shared with us when the Internet bubble burst. Back then, the head of one of the most powerful bank trading desks on Wall Street quipped on a particularly brutal day that the market hurts most people most of the time.
In other words, stocks may trend higher over time, but few people are disciplined enough to sit tight in a well-curated portfolio of blue-chip stocks. Instead, they are hostages to their own emotional swings, and that inevitably hurts them.
Remember that when you look through the prism of your 2023 portfolio toward 2024.
Email: editors@barrons.com
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