May Insights: Good Judgment

Good Judgment

My wife and I went to Scotland for our honeymoon. One evening in a pub in Edinburgh, we noticed a plaque on the wall beside our table with a quote I will never forget: “Good judgment comes from experience. Experience comes from poor judgment.”

John Maynard Keynes is remembered primarily as an economist. In many ways he was the father of macroeconomics, or the study of the larger economy from the top-down. He died in 1946, but to this day his theories on how government policy can shape the economy still hold weight with many economists: the Keynesian and neo-Keynesian schools of economics. Less known, however, is that Keynes was also a legendary investor. From 1921 until his death, Keynes ran the endowment at King’s College, Cambridge. His theory on balancing risks is largely credited with creating what we now refer to as the hedge fund.

One of the things I have always admired about Keynes was his ability to change his mind. A great example was in his investing career. When he first started investing, he felt, as many investors still do today, that having insight into the larger economy should give him an advantage, and he arguably had more insight than almost anyone else of his generation. He quickly and painfully learned that his knowledge of economics was not of great use when investing. He did much better when he invested from the bottom-up, getting to know the companies in whose stock he invested.

He quickly abandoned trying to invest based on economic trends and instead invested in a concentrated portfolio of stocks in which he felt he had some knowledge. While his portfolio remained concentrated, he paid close attention to managing risk. I have written about Keynes as an investor in the past, but the recent market activity brings this to mind.

We, like many others, have spent a great deal of time discussing tariffs and their negative impacts on the economy. I look forward to the day when we can stop talking about tariffs. We have also made the point, hopefully, that investment decisions should not be based on speculation of what final trade policy will be when the dust settles; Prudent investing is done from the bottom-up.

If one of the most famous economists of all time could not profit from top-down economic forecasts, then how in the world could the average investor do any better? It is far easier to analyze a company and determine whether it is a good business worth investing in than to try to figure out what economic growth will be in a year and what that means for investing today. This may sound counter to what Wall Street focuses on, but investors need to remember that Wall Street is in the transaction business. At the end of the day, Wall Street cares little about whether those transactions are sells or buys, and it really doesn’t care if they are profitable for the investor. It simply cares about the number of transactions.

Political and economic headlines change much more rapidly than the actual business of companies in whose stocks we invest. That rapid change leads to rapid transactions. Wise investors know better. The market has bounced back, partly because the tariff rhetoric has softened, but mostly because companies have reported earnings and those earnings are good. With 72 percent of companies in the S&P 500 having reported, earnings per share has grown 12.8 in the first quarter. This is after 14 percent earnings growth in the fourth quarter of 2024. We began the year with a very expensive S&P 500, but between the market correction and back-to-back double-digit earnings growth announcements, those valuations have come down more quickly than most would have thought possible. This has led the market to bounce back from the April selloff.

Will the rally continue, or will it fizzle? I don’t know, and the truth is no one else knows either. They may tell you otherwise, and they might sound very confident while doing so. I know, because 25 years ago I was one of those very confident prognosticators. Today I have the better judgment that comes from experience, and yes, much of that comes from poor judgment.

Experience has taught me, as it taught Keynes and countless others before, that knowing what you own and managing risk are the keys to long-term investing success. Prudent investing is done from the bottom-up, and from that perspective, things look pretty good.