The Rational Investor
By Karl Rogers, Chief Investment Officer
Although our last memo was published on March 28th, the frequency of these notes is governed by two guiding principles:
Write only when we have something meaningful to say.
Increase communication when volatility rises.
The recent market turbulence justifies breaking the usual cadence.
In this memo we discuss macroeconomic developments, the implications of the recent tariff announcements and the resulting capital market moves to provide insight into how we interpret and navigate this period of uncertainty. Our objective is to act like a rational investor, when irrational behaviour is most tempting.
Rational Investors
Economists often assume rational behaviour in their models - yet time and time again real world behaviour doesn’t comply. I first appreciated this during induction week at Trinity College Dublin while studying for my MSc in Finance. Our class was offered a €10 prize to guess a number between 0 and 100 — with the winner being the one whose guess was closest to the average of all entries. For a student, that was big money - the price of two pints at the time.
I assumed in a room full of MSc Finance students at a top academic institution everyone would be logical and rational and guess the obvious number: 50. Assuming everyone would pick 50 (the rational choice), my game-plan was to hedge this number slightly and opt for 49. Then guesses started coming in like 7, 25 and 73. I couldn’t believe everyone didn’t guess 50 - the rational number. As it turned out, if I’d have guessed 50, those 2 pints would have been mine.
This was my first real exposure to irrational behaviour in a financial setting. If this group of finance students, who statistically should have a better understanding of probability and biases, act this way then the wider population should be equally, if not more, random and less rational when real money is at stake. As behavioural biases exist and persist, the best investors acknowledge their existence, recognise them in others and themselves, and work to avoid them within their portfolio decisions.
Investor Psychology
The most important and persistent driver of any market cycle’s direction, velocity and length is human psychology. Emotions often dictate market behaviour. This explains why capital markets can exhibit more volatility than corporate revenues, which in turn swing more than long-term productivity. Depending on where we are on the spectrum between fear/greed or optimism/pessimism, emotions can take over, driving market action and momentum in whichever direction the market is going. This emotional influence often leads to market overextensions.
Emotions tend to dominate when significant market events occur, particularly when uncertainty or volatility rises. In these moments, investors seek explanations at to what is happening and what the outcome will be.
As a side note, my previous memo highlighted that the market drops witnessed were not ‘surprising’ to the market given the low levels of VIX, reaching the 30 mark before moving back towards 20. On Friday, April 4th, 2025, the VIX jumped to 45, doubling from its level prior to the tariff’s announcement and reaching its highest point since the pandemic. The move was less about the existence of tariffs and more about three things:
The magnitude of the tariffs
The blanket nature of the implementation
The uncertainty of what comes next
One of the key takeaways from this memo should be the importance of not placing undue weight on predictions or forecasts, even if they are in the media’s headlines.
History Doesn’t Repeat Itself but Often Rhymes
One of the most common questions we hear from clients during periods of market turmoil (particularly during Covid-19) is: “But isn’t this time different?”
This question is grounded by the fact that the downturn was caused by a global pandemic. An event which wasn’t forecast by anyone. The appropriate response to that client question comes from a quote by Mark Twain, “History doesn’t repeat itself, but often rhymes”. While each market downturn is different, the emotional reactions that drive market behaviour are remarkably consistent, leading to similar cycles over time.
The previous market downturns were all different, reinforcing the quote that history doesn’t repeat itself. For example:
The 2008 Global Financial Crisis, was financially driven in nature due to leverage and unfit credit underwriting;
The 2020 market downturn was caused by an exogenous shock – a global pandemic that forced economies into sudden and widespread shutdowns, halting productivity almost overnight;
The most recent market decline was driven by government intervention through President Trump’s initiation of a broad-based trade war.
While the causes of these market downturns are distinct, the emotions and behavioural responses of market participants are consistent, creating the “rhyme” that drives market cycles. It’s easy to get caught up in the moment, believing each market downturn is unique and all-encompassing. Similarly, periods of growth and euphoria feel all-encompassing and never ending. When you take a step back and look at the bigger picture, these movements are just the natural rhythm of long-term cycles - the inevitable peaks and troughs that shape markets over time.
Macro Forecasts
It’s worth revisiting macro forecasts in the wake of President Trump’s tariffs announcement. It’s been proven time and time again that investors should not place too much weight on macro forecasts. In reality, that doesn’t stop investors from seeking out opinions to try and predict the outcomes. Investors instinctively seek patterns in data, even when none exist. This tendency, known as randomness bias, reflects the human mind’s discomfort with uncertainty. The result is behaviour and decision-making shaped not by signal, but by the illusion of order in random noise.
The “superior investor”, coined by Oaktree’s Howard Marks, describes an investor who consistently beats the average market performance. The superior investor observes current market movements and narratives, not because the market is telling them what will happen but because they understand what other market participants expect to happen. This is an important nuance and is relevant, not because market participants know what will happen, but rather it provides insight into the current investment psychology of market participants which helps the superior investor understand where we are in the market cycle and in turn use this information to help them decide on how to position their investment portfolio. Consider the two trading days when the S&P 500 fell by 10%. Following President Trump’s tariff’s announcement, bond yields fell sharply. However, his trade tariff announcement could easily and logically have driven yields in either direction:
Inflationary View: These tariffs are inflationary and therefore rates should go up as Central Banks will need to raise interest rates to battle the increased inflation. This relationship was the cause and effect of the why interest rates soared from the zero-lower bound in 2022,
Recessionary View: The costs associated with the tariffs will be the driver of a difficult corporate period increasing the likelihood of a recession and therefore yields would likely drop as Central Banks would drop rates from current levels to combat the recession.
Both views and opinions are entirely logical and grounded in fundamental theory. The same event - last week’s tariff announcement - could justifiably have had the financial media writing a headline based on bonds moving in the opposite way. Two important insights on this point:
Financial headlines will attempt to assign a reason for a move in the markets. It will seem like that reason is why the market moved the way it did, but these headlines are usually retrospective and are a hypothesis as opposed to fact. In this case, both the inflationary and recessionary scenarios in relation to interest rates hold legitimate and a rational view as to where yields should go. The move down in yields also could have been random. If so, randomness bias is in focus again.
Whether the inflationary or recessionary views proves to be correct remains to be seen. For now, the superior investor is focused on understanding the current investment psychology to identify which narrative and view is prevailing.
The Low Likelihood of Accurate Forecasting
If you’re to take away one key insight from this memo it should be that the price movements witnessed in the markets on Thursday and Friday are not what the market believes will happen but what the market expects to happen. The superior investor analyses macroeconomic variables to assess where we are in the market cycle to guide investment portfolio positioning across the spectrum from defensive to aggressive. In contrast, the ‘average investor’ uses the market movements to align their portfolio based on current outcomes rather than anticipating future shifts. This approach often results in performance that mirrors the market and produces average returns, by definition.
When considering the value of a market forecast, its primary purpose is to analyse current market events to understand where we are headed, over what time horizon, and how that trajectory might unfold. For a forecast to be useful it would need to accurately predict a number factors, many of which are uncertain.
The outlook today based on the most recent information is not one that paints a pretty picture - increased costs, deglobalisation, higher inflation and increased uncertainty. The standard forecast method of extrapolation requires a prediction for many variables including whether countries retaliate to the announced tariffs, if so which countries, what is that retaliation, what is the US’s response to any such retaliation and how far are both sides willing to go. Predicting this correctly, requires an understanding of President Trump’s end game objective. In my previous memo, I mentioned that President Trump may not be opposed to a shallow recession if it forced the Federal Reserve to reduce interest rates, which has historically boosted public equities, helped the real estate sector and reduced the US national debt burden. Following President Trump’s April 4th which s tweet: “CUT INTEREST RATES JEROME, AND STOP PLAYING POLITICS”, it seems increasingly likely that this is part of his strategy.
How long will it take to fully understand President Trump’s end goal in relation to the tariffs and how long these policy-driven constraints will be in place affecting the real economy, remains unclear. This market shock is driven by government intervention and just like any regulatory-driven program it carries ‘red pen’ risk : the reality that a single signature can instantly reverse or escalate the current trajectory. President Trump could remove the tariffs as soon as tomorrow or they could be left in place for months or years. The longer the policies stay in place the more likely that the current extrapolated fears for the economy will be realised.
Accurately forecasting the outcome of the recent tariff announcement requires predicting all the above variables correctly - a reminder of the difficult of the task at hand in trying to build successful forecasts.
Taking Objective Stock of the Situation
We are aware of the understandable panic and fear investors are feeling since the announcement on Thursday. When panic takes over, positions are sold, and recoveries are missed. This pattern of behaviour is the main reasons retail investors consistently underperform the general market. Now is a time for patience and perspective. Let the dust settle. As the situation unfolds, the path forward will gradually become clearer. In the meantime, take stock of where your portfolio sits on the defensive/aggressive spectrum. With uncertainty at elevated levels, making changes to your portfolio now is akin to shooting in the dark.
Rarely is the worst-case scenario witnessed. Investors tend to take in recent significant market movements and extrapolate similar levels into the foreseeable future; this leads us to expect the reality will be the worst possible outcome. This is a natural behavioural process; I vividly remember that fear that took over from my days as a trader on the electricity markets. When a spread started showing a large negative number, my instinct was to calculate how bad this hour’s loss was going to be and then multiply that by how many more hours I had that position for. The possible and expected result was always overwhelming. However, the actual result ultimately never ended up near that number. This emotion-driven extrapolation process was the reason that many of my happiest days returning home from the trading floor were those where my losses did not end up being as bad as expected, while some of my most frustrating days were the days I achieved above average profitable days as I regretted not going bigger and having an even greater day. In an attempt to mitigate these emotions, I ended up building a mathematically driven position sizing process.
We are currently in a higher volatility and lower growth environment where return levels witnessed over the previous 10 yrs-15 yrs (the best 15-year on record) are unlikely to be repeated in the near future.
Peaks and troughs are part of the cycle. When in the heat of the battle, it’s hard to see the longer-term picture. That’s why its importance to take note of market attractiveness over a full cycle to put into perspective where we are.
Finally, a point I touched on in my previous memo: when markets conditions change, so too do the main drivers of your portfolio. If an investor is in materially different conditions today compared to yesterday, that investor shouldn’t be surprised to see that yesterday’s winners are not today’s winners.
This commentary is provided for investor insight only and does not constitute investment, legal or tax advice. It is based on current market conditions, which are subject to change without notice. Past performance is not indicative of future results.
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