A strong year in the domestic stock market - like we saw in 2013 - can create overconfidence in investors, which, in turn, leads them to make a number of predictable errors in judgment.

For the past thirty years investors could allocate a portion of their portfolio to investment grade bonds and regard that money as safe. Wealth preservation was easy buy a ladder of Treasuries or triple-A rated corporates and go back to bed. That perceived safety was a direct result of a continuing, if not steady, decline in interest rates.

The Cirque du Ben will soon be leaving town for good. Some have cheered while others have watched in horror waiting for the disaster, but all were treated to a high wire act unlike any other Fed chairman has ever performed. Fed chairmen are often defined by the consequences of the previous performer. Bernanke had a couple of tough acts to follow in Volcker and Greenspan. Volcker had to guide an economy out of stagflation while Greenspan presided over 9/11, two recessions, and a full market crash in 1987. By the end of his his show, Greenspan had an oversized influence on policy.

So goes comedian Louis CKs bit about hitting middle age. Not old enough for anyone to care that youre old. Not young enough for anyone to be proud of you or impressed. And as we head into the backstretch of this economic cycle, that same cynicism and resignation seems to be settling right in. The glory days of riding the upward slope when almost everything was screamingly cheap in 2009 are behind us.

Risk-averse is often used as a description of a rational investor. However, aversion is not a logical desire to minimize. Aversion is fear and disgust. When we avert our eyes, we look away. The term risk-aversion, in fact, gets right to the heart of the behavioral side of finance. We are afraid of losing money and perhaps even more powerfully, we are afraid of the embarrassment that comes from being a loser.

For a long time investors have been told the only free lunch is diversification. In a hurry to buy into the mythical free lunch investors jumped in without asking enough questions, like what is diversification. Instead everyone hurried to fill buckets and cover the style boxes with about as much thought as someone filling out a March Madness office bracket.

The Treasury has doled out approximately $10.5 billion on excess bank reserves over the last four years. The emergency Fed policy of paying 25 basis points on excess reserves was enacted on October 6, 2008 to incentivize banks to hold them in the midst of the financial crisis. It worked. But the policy also introduced another headwind to velocity of money.

Frontier markets are not going to wait 30 years to take the global economy by storm. The parallels drawn between Africa today and 1980s China are apt, but the pace of the emerging market life cycle is likely to be accelerated by technology, investment, demographics, and other factors. The lack of a one-child policy leads to more favorable demographics. Africas workforce will be the worlds largest by 2040, surpassing both China and India. The payment-with-infrastructure investment approach favored by China can mean better transportation, utilities, and communication for whole communities.

There is almost always a gap between price and value. Over the next few years price volatility is likely to be the source of the gap as sentiment waffles from overly exuberant to downright pessimistic. In the era of the 24-hour news cycle, high frequency trading, and an ever shortening investor attention span, prices move fast. Markets are emotional creatures and have a tendency to boom and bust. There have been occasions when underlying changes of value have gone unrecognized for sustained periods, and the gap was not primarily a function of price volatility.

On Mar 1, Lazlo Birinyi called for the S&P500 to hit 1700 in 2012 (an increase of 35%). The 24% rise in the S&P500 between Oct 4 and Feb 29 has prompted many to review their outlook for the year. Their euphoric revisions are propelled by some tailwinds: lean company financials with high operating leverage; emerging markets consumer demand; improving jobs reports; low interest rates, and high cash balances. Many of these factors contributed to Galways relatively positive outlook. However, one lesson we have learned over the years is to start getting nervous when everyone agrees with you.

The Roubiniesque blues felt globally due to a lack of confidence is not isolated to just the marginally attached and does have merit. As the economy restructured manufacturing workers in the 1980s only had a 65% reemployment rate. We feel the past few years have marked another restructuring in US the economy. Again it will likely mean unemployment will remain high as many workers may not make the transition. This time around the reemployment rate for housing related jobs and financial services will likely remain very subdued.

The US has a confidence crisis, not a growth crisis. Jobs are being created. Consumers spending rose 6.9%. Corporate profits went up 16%. Financial leverage is low, operational leverage is high. Even with the rise in government debt, public debt service is at its lowest since the mid 80s. And all this during the year we survived a major nuclear crisis in Japan, the first-ever Treasury downgrade, revolutions in North Africa and the Middle East, several hundred thousand government layoffs, gridlock in Washington, and the effective bankruptcy of Greece.

The back half of the year has seen a dramatic rise in volatility that has shaken investor confidence in the market itself. Markets have routinely seen wild swings in the futures market prior to the open in New York, before the European close, and in the last hour of trading in the US. This pattern has been an almost daily occurrence and at times seems to have no connection to actual fundamental information. The mystery of this market behavior leaves investors wishing cousin Eddie emptying his chemical toilet was the biggest source of irritation this Christmas.

Determination of fact can be a science but discerning meaning is an art. For example, we recently spoke one-on-one with a fund manager who we have a long history with. He in no uncertain terms told us to steer clear of his asset class for now and even made other suggestions. A week later, on the general shareholder call, the manager listed all the reasons why the asset class did well year to date, which was the truth-but not the whole truth.The audience did not alter the facts but it sure impacted the message. Investors need to go beyond the facts and find the substance.

One region has five of the twelve fastest economies in the world, including the fastest at a growth rate of over 20% this year. This region has grown faster than the OECD countries and its consumer sector is growing 2 3 times faster than the developed worlds. A study by the Harvard Business Review in 2009 reported that publicly traded companies average return on capital was 67% higher than comparable countries in China, India, Indonesia, and Vietnam. Investors have been blissfully ignorant of Africa for decades, but the opportunity cost of ignorance is increasing.

An all-or-nothing mindset has taken hold of Washington. The days when a Ronald Reagan and a Tip ONeil would hash out a compromise used to be called leadership. Neither gave up their core beliefs but that did not impair the building on common ground. Compromise is now perceived as weakness. Since the rise of cable news and other noise-creating outlets the extremes on each side of our political spectrum have become emboldened, leaving the middle a lonely place. The increase in partisanship is not just a matter of rhetoric. It can be seen clearly in how Congressmen are voting.

The analysis performed by S&P was flawed. They made a $2 trillion mistake. S&P stated the mistake was not material and had no impact on the rating. Simultaneously they inserted a change in their assumption on the Bush tax cuts. For two years the assumption was the impact of the cuts was $900 billion over 10 years. Now reversing the cuts is worth $4 trillion over 10 years. This very significant change being revealed only after their mistake was pointed out is interesting. Guess $900 billion is not big enough to allow you to so clearly dismiss a $2 trillion mistake but perhaps $4 trillion is.

Alan Simpson was talking to Eliot Spitzer on CNN?s In the Arena about balancing the national budget when he said ?show me your favorite sacred cow and shoot it.? He?s attained notoriety for his criticism of Social Security. But when asked to list some cows to slaughter, he went on to describe how the tax loopholes and subsidies for various fuels in his home state of Wyoming (where he served as a US Senator for 18 years) need to be closed. That ability to go beyond our own personal bias and focus on the greater good is something investors should keep in mind when viewing markets.

The news of late indicates we are indeed in the midst of an economic slow patch (as we were this same time last year). This cyclical pause occurs in the context of a secular de-leveraging here in the US, which results in a healthy albeit modest expansion. The lack of job creation in the most recent BLS report and a general longing for ?better days? has left many nostalgic for the good old days. The problem is the old days were just awful. Many of the gripes today really are nothing new. The great wealth disparity between rich and poor is an example.

Using Mr. O?Neill?s own metric, the market?s shrug on April 18th indicates that the ongoing value of S&P?s business has dropped rather dramatically. Continued investor confidence in the credibility and reliability of its ratings is in question, at best. On April 18th, 2011, S& P did something that no credit rating agency had ever done: it released a negative outlook on US debt. The reaction of the market to this historic news was anything but historic. Insurance on Treasuries barely budged up to less than half of its all time high at the trough of the credit crisis.

Last summer we began discussing how the structure of the market should stabilize, and we highlighted this opinion in our December newsletter. Before the ink was dry on that letter, markets were confronted with a continental flood in Australia. Since then, Middle East uprisings and the removal of multidecade entrenched dictators, the ongoing soap opera known as the European Union debt crisis, surging oil prices, and the devastation of the thirdlargest global economy by a tsunami and continuing radioactive meltdown. Other than those events, and a new US military front, it?s been a quiet year.

The Canadian Leslie Nielsen was a great example of the most American of qualities, the ability to re-invent and innovate. That same ability to re-invent and innovate will be critical to America?s economic future. We have headwinds working against innovation, from insufficient visas to attract the best global talent, to a backlogged patent office, and R&D tax credit structures that are now falling behind other countries?. This plays to our historic strengths if we can once again re-invent our economy, this time into a productivity exporter rather than just an importing consumer.