The Thin Line
Guest post by Ted Lamade, Managing Director at The Carnegie Institution for Science
During my final semester of graduate school I took a class titled, “Leadership Ride: Lessons from Gettysburg”.
The objective was simple — to study the Civil War’s most decisive battle and apply the lessons from it to business and investing in the current day.
Not in the least bit.
In the first few weeks of the class, we explored why strategies leading up to and during the battle evolved. We also compared how tactics were carried out and what differentiated generals like Robert E. Lee from George Meade, Richard Ewell from Joshua Chamberlain, and John Buford from James Longstreet. We then dove deeper into where mistakes were made, opportunities seized, and gains taken or lost.
After ten classes on campus, the “Ride” concluded with a two-day tour of the battlefield, which included spending time at places like Seminary Ridge, Little Round Top, Devil’s Den, and the Peach Orchard.
At the end of our second day at Gettysburg, we found ourselves atop Cemetery Ridge, which represented the Union Army’s critical defensive position and where the battle ultimately came to an end.
On this chilly afternoon in mid-April, our guide turned to us and asked a seemingly simple question,
“Who thinks they know what ultimately determined the outcome of this critical battle in early July 1863?”
As you might expect from a class of eager MBAs, nearly everyone had an answer — communication breakdowns, failures to take strategic positions, inferior resources on the Confederate’s side, the Union army’s ability to maintain the high ground, and even the weather, to name a few.
While our guide acknowledged that these factors certainly contributed to the battle’s ultimate outcome, he told us he was looking for more. He then peered down at Seminary Ridge, which served as the launching point for the infamous Pickett’s Charge, and asked us several pointed questions (it felt like the hymn from Ken Burns’ “The Civil War” documentary should have been playing in the background as he spoke):
· Why did the Civil War’s most esteemed general — Robert E. Lee — believe his forces could march up this ridge through open space into well-entrenched Union forces while facing a barrage of bullets?
· How could a nearly flawless general make such an obvious mistake?
· How did someone who had won decisive battles at Manassas, Fredericksburg, and Chancellorsville against much larger Union armies make such a fatal decision?
· Why would someone renowned for creative and tactical maneuvering make a decision that seemingly contained neither?
· Why did someone with Lee’s temperament and experience make a decision that would ultimately damage the Confederates’ optionality, flexibility, and ability to win the battle, and eventually the war?
The guide then paused, looked back at us, and gave us a chance to respond.
The class sat in silence for a few seconds, until one of my classmates replied from the back of the pack with one simple word:
Our guide asked her to elaborate, to which she replied,
“Lee’s prior success sowed the seeds for his failure at Gettysburg because it blinded him to the potential risks. It had mistakenly convinced him that his army was invincible.”
She was right. The fact that Lee had won so many battles under incredibly challenging circumstances with far fewer troops and resources seemed to have clouded his judgment, impaired his ability to both manage and control risk, and convinced him that victory was a preordained conclusion.
What Lee succumbed to at Gettysburg is not unique though. In fact, it is something countless people have experienced throughout history. Look no further than the collapse of the British, Austrian-Hungarian, and Roman Empires. Or in business, examples include Bear Stearns under Jimmy Cayne, General Electric under Jack Welch, Chesapeake Energy under Aubrey McClendon, and most recently WeWork under Adam Neumann.
Simply put, success breeds confidence. The longer this success lasts, the more a leader’s confidence grows.
The tricky part is that this increase in confidence is initially a positive because it is what enables a leader to take risks, expand, and grow. However, if success is sustained for long enough, an increase in confidence can morph from an advantage into a significant disadvantage.
The fact is confidence operates on a thin line. Possess too little and you will never take enough risk. Possess too much and you will inevitably take imprudent risks. This is why, as with most things in life, having the right balance is critical.
This is top of mind these days because it feels like overconfidence has become pervasive.
After dodging Ebola, SARS, and other outbreaks, people became overconfident that we could continue to evade pandemics. As a result, preventative measures were removed or neglected. We all know how this played out.
After decades of relative peace on a global scale following the end of the Cold War (namely a world without significant conflicts between major nation states), many grew confident that this was the natural state of affairs. Then hot wars broke out in Eastern Europe and the Middle East, while tensions with China continue to simmer.
For many years, Americans grew to believe that the surest path to economic prosperity came through obtaining a college degree. The trouble is few incorporated the cost of that degree into the equation.
Most recently, a fifteen-year bull market that brushed off a global pandemic and materially higher interest rates has convinced many investors that the economy is headed for a “soft landing” and that this bull market is here to stay. As a result, risk seeking behavior is slowly returning, credit is loosening, M&A activity is picking up, and rates are falling.
So, what does this mean?
It means that like Robert E. Lee staring up at Cemetery Ridge, investors face an important risk management decision today.
Sure, the consensus may be right. This bull market may continue. The hottest segments of the market could march higher. Things that have worked in the past decade could continue into the next. The most confident managers could overcome the odds once again. After all, it is plausible that Lee’s forces could have overtaken the Union forces atop Cemetery Ridge if Union general George Meade hadn’t repositioned his forces and a few other things had gone the Confederates’ way. We only know now with hindsight that they didn’t.
However, the trouble is that if these things do not happen, the consequences could be material given the current level of valuations and a lack of liquidity in many portfolios.
So what is an investor to do?
They can take another path. A path that can feel lonely at times, the “Road Not Taken” as Robert Frost would say.
This is a path that forces an investor to assess both the situation and themselves. It forces them to ask questions like —
What is my true objective? To beat the market at all times? To outpace my peers? To risk it all to seize the hill? Or is it to secure the financial footing for my institution, my client, my family?
How will I react in the event of a reversal? Will I have the fortitude to stay the course? Or will I react poorly? Even if I have the fortitude, do I even have the liquidity needed to do so?
Don’t get me wrong. Choosing this path does not mean waving the white flag in surrender. It also does not mean completely overhauling your risk tolerance or dramatically reducing equity exposure and running for the safety of fixed income all at once. What it simply means is re-calibrating your confidence level.
If Robert E. Lee had looked up at Cemetery Ridge and decided that the risk/reward was not in his favor, what would he have chosen to do next? Would he have retreated into Virginia? Would he have maintained his forces in Pennsylvania? Would he have chosen to attack another point in the Union front?
No one will ever know. However, it is safe to assume that the Civil War’s fate would not have been determined on that day. In fact, had Lee chosen a different path, Gettysburg may have been lost in the annals of history.
This said, one of the class’s key lessons was that like war, investing can be characterized as an act of survival and that success is often contingent on an investor’s ability to simply persist and endure through cycles. As a result, making sure a portfolio is positioned to do so should always be a priority.
Personally, I have found that confidence in investing is an endless struggle to find your balance. At some points, the markets will make you feel like a genius, while at other points they will make you feel anything but. However, one thing I know for sure is that every time I have crossed that thin line into the realm of overconfidence, I have been humbled shortly thereafter. As a result, the longer I do this, the more I realize that these are the moments when I need steer myself back towards that thin line and find my balance.
Two roads diverged in a wood, and I, I took the one less traveled by and that has made all the difference.