Considering the Stockdale Paradox

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I was in high school during the 1973-1974 economic recession. OPEC, crazy inflation, demoralizing market crashes (a drop of 45% in the US, 73% in the UK, and 83% in Hong Kong), a prime lending rate of 20%—none of that mattered to me at the time.*

Of course, I went on to study that crash in college and have looked back on it for insights throughout my career. For example, during the 27 years after the 1974 bottom, there was only one market decline of over 20%, and that occurred over three months in 1987. Now we’ve experienced three more of them in the past 20 years (okay, almost, January-March 2020 was down 19.6%).

Severe declines like these have always been built into our expectations of future market behavior. I’ve personally studied and experienced a wide range of alternatives to the “stay the course and rebalance” approach we advocate and practice at Equius Partners, as have others at the firm.

As many of you know from previous articles, I once made a major career shift to join a firm that offered a “tactical” asset allocation system that worked—until it didn’t. I’ve also closely followed the research and career of another prominent tactical asset allocator who subsequently adopted a factor-based approach similar to ours. And I’ve observed from a distance much less credible market timing schemes that very quickly crashed and burned. So what is one to do in the midst of this current market and economic debacle?

Park long-term assets in a money market fund until we feel “safe” again (i.e., time the market)?

Put our money in bonds at a time when interest rates are at historic lows (and an increase in rates will result in falling bond prices)?

Invest in municipal bonds when states—almost across the board—are in fiscal crisis due to underfunded pensions and other obligations?

Shift assets to “alternative” investments such as high-priced hedge funds like so many did after the 2008-2009 decline (and regretted it after 11 years of a strong up market)? 

The answers are no, no, no, and no. As a wise man once said, “Those who do not remember the past are condemned to repeat it.” 

So what is the answer? 

How about faith, patience, and perseverance? 

I was recently made aware of something called the Stockdale Paradox, which is named after Admiral James Stockdale, a highly decorated naval officer during the Vietnam War. 

Admiral Stockdale was the highest-ranking prisoner of war during that conflict and endured seven and a half years of deprivation and repeated torture in the notorious Hanoi Hilton prison camp. For those interested, his memoir is titled In Love and War: The Story of a Family’s Ordeal and Sacrifice During the Vietnam Years. 

Jim Collins, the author of Good to Great, had the chance to interview Admiral Stockdale on the campus of Stanford University some years ago. He had read Stockdale’s book and remembered this. 

Wait a minute, I’m getting depressed reading this book, and I know the end of the story. I know he gets out. I know he reunites with his family. I know he becomes a national hero. And I even know that we’re going to have lunch on the beautiful Stanford campus on Monday. 

How did he not let those oppressive circumstances beat him down? How did he not get depressed? And I asked him. 

He said, “Well, you have to understand, it was never depressing. Because despite all those circumstances, I never ever wavered in my absolute faith that not only would I prevail—get out of this—but I would also prevail by turning it into the defining event of my life that would make me a stronger and better person. Not only that, Jim, you realize I’m the lucky one.” 

I said, “No, I don’t.” 

He said, “Yes, because I know the answer to how I would do and you never will.” 

A little later in the conversation, after I’d absorbed that and said nothing for about five minutes because I was just stunned, I asked him who didn’t make it out of those systemic circumstances as well as he had. 

He said, “Oh, it’s easy. I can tell you who didn’t make it out. It was the optimists.” 

And I said, “I’m really confused, Admiral Stockdale.” 

He said, “The optimists. Yes. They were the ones who always said, ‘We’re going to be out by Christmas.’ Christmas would come and it would go. And there would be another Christmas. And they died of a broken heart.” 

Then he grabbed me by the shoulders and said, “This is what I learned from those years in the prison camp, where all those constraints just were oppressive. You must never ever ever confuse, on the one hand, the need for absolute, unwavering faith that you can prevail despite those constraints with, on the other hand, the need for the discipline to begin by confronting the brutal facts, whatever they are. We’re not getting out of here by Christmas.” 

The Stockdale Paradox is an important lesson to those who have lost jobs due to the novel coronavirus pandemic and the stock market crash in March. I faced similar circumstances in 1990, when the firm I worked for (that tactical asset allocator mentioned earlier) closed its San Francisco office due to a severe loss of clients nationwide.** After a difficult period of readjustment, TAM Asset Management was born and eventually grew into Equius Partners. 

Whenever I’ve been prompted to reflect on that period of my life and career—a time of very un-comfortable uncertainty—I’ve credited confidence in my experience and fact-based knowledge and a stubborn perseverance (unwavering faith?) as the qualities that most helped me succeed. 

It was not, on reflection, unbridled optimism that got me through. In fact, I never ever set goals for new clients. I was offering a very novel approach to long-term investing, based on a body of research and science most investors were not aware of, while working in an industry that was very hostile to what I was both exposing and promoting. 

Short-term goals not met would have been very discouraging, to the point I may have quit trying. 

Sound like stock investing generally? 

In 27 years of Asset Class articles, you will not find short-term predictions of market declines or recoveries—or economic forecasts of any kind. But you will find confidence in an amazing economic system that still encourages and rewards entrepreneurism, a unique respect for modern financial science, and a perseverance (i.e., enforced discipline) that allows you to prosper in these circumstances. 

“Knowledge,” “confidence,” and “discipline”—these are words mounted on our office wall and beliefs etched in the mind of every Equius employee. 

Yes, it does require a certain amount of faith that our economy and stock market will recover again given societal forces seemingly aligned against it, but we’re confident this faith will be well rewarded over time. 

Admiral Stockdale’s experience and wisdom should inspire us all as we face our own unique challenges in life and in investing. 


*I was pleasantly distracted by a beautiful young lady; still am, 47 years later.

**An institutional consultant who was also “asked to leave” with the closing of the office became a founder of GoPro and at the time of its public offering in 2016 became very rich. Alas, I was not part of that deal.

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Past performance is not a guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. There is no guarantee an investing strategy will be successful. Investing involves risks, including possible loss of principal. Diversification does not eliminate the risk of market loss.

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