It's a Bubble: Part Six – Underperformance?

It's a Bubble: Part Six – Underperformance?

For the past five weeks, we’ve been unpacking a statement from a few months ago:

"For both predetermined quantitative and qualitative reasons, we believe that we are in the late stages of a longer-term stock market rally; and are in the beginning stages of a stock market bubble. When this happens, our portfolio mandate switches us to play what Poker players would call a very 'nit' game. In other words, all of our programs become very … tactically tight. Smaller position sizes."

In the previous installments, we covered the quantitative and qualitative factors driving our view that the market is in bubble territory. We discussed extreme valuations, significant price deviations, increasing upside volatility, and a wave of euphoria that has gripped retail investors.

In the last article, we touched on performance and what "good" performance really looks like in the long haul. But there's more to be said about this concept of “underperformance” — particularly during short-term bubbles.

Underperformance Doesn't Mean Defeat

It can be easy to view any short-term period of underperformance as failure. This tendency is amplified in bull markets when certain strategies, particularly those that are more conservative, may lag behind the broader indices. This might lead some to question the effectiveness of those strategies. However, it’s essential to understand that short-term underperformance does not necessarily equate to long-term underperrformance.

Take, for instance, Warren Buffett’s Berkshire Hathaway during the late 1990s. From 1998 to 2000, Berkshire underperformed the S&P 500 Index significantly.

For newer investors looking at that period, Buffett might have appeared to have lost his edge, especially as technology stocks soared, and investors piled into what they believed was an unstoppable new economy. It was easy for new and aspring traders to claim “underperformance”.

However, when we zoom out and look at Berkshire Hathaway’s performance over the longer term, that period of underperformance becomes less significant. In fact, Buffett’s cautious approach — his ‘nit game’ — allowed him to avoid much of the fallout from the bursting of the dot-com bubble in 2000-2000.

A Lesson from Berkshire Hathaway: 1998-2005

As we all know, Buffett didn’t chase the mania. He stuck to his mandate, focusing on value investing and avoiding overpriced tech stocks with no earnings. And when the bubble burst in 2000, Berkshire Hathaway’s performance began to shine again. While the S&P 500 suffered significant declines, Berkshire weathered the storm and continued to generate strong returns in the years following the crash.

The lesson here is simple: short-term underperformance during a bubble can often precede long-term outperformance. Buffett wasn’t concerned with keeping pace with a bubble-driven rally. His mandate was to avoid excessive risk, protect capital, and invest in companies with strong fundamentals. And in the long run, that strategy paid off.

The Patience of Long-Term Outperformance

Let’s circle back to what we discussed last week: patience.

In our own portfolios, we take a similar approach. As we’ve discussed over the last few weeks, the market is showing signs of extreme valuations, upside deviations, and euphoria. In environments like this, it’s crucial to remain disciplined and conservative. Our mandate dictates smaller position sizes and a more cautious approach to managing risk — much like Buffett’s during the late 1990s.

And Berkshire Hathaway's example is not the only example of this phenomenon. For Futures traders, you can see clear evidence of this same principle of “underperformance in the short-term, outperforming in the long-term” with Bill Dunn's performance from 2005 to 2008.

Today, we find ourselves in a similar situation. While the S&P 500 continues to push higher, driven by a handful of high-flying tech stocks, the risks are mounting. Our conservative approach — much like Berkshire Hathaway’s in the late 1990s — is designed to preserve capital and avoid chasing short-term gains that may disappear when the bubble bursts.

In the long run, the key to successful investing isn’t about outperforming in every market cycle. It’s about playing the long game, managing risk, and positioning for sustainable returns over time.

Conclusion

To wrap up, periods of underperformance are not only inevitable but sometimes necessary when managing a portfolio through a bubble. Warren Buffett’s experience from 1998 to 2000 illustrates that short-term underperformance during a bubble doesn’t mean a strategy has failed. In fact, it can often be a sign of prudence.

Our approach remains patient, tactical, and cautious.

And as always — until next time, stay safe … and trade well.

Dan 
GTC Traders