For me, the first two months of the Covid-19 State of Emergency dragged by.  Days felt like weeks.  Weeks, like months. 

And then something changed – slowly but surely.  The ground beneath me felt more solid.  My ability to predict what might happen over the course of one day began to improve.  I described it as getting into more of a “groove”.  

Not groove as in “groovy man” – the 1960’s colloquialism. Groove – as in a routine.

Maybe that’s why financial markets started to skyrocket upward almost as quickly as they had fallen.  I wasn’t the only one feeling more grounded.  There was a shift in the developed world’s state of mind as one-by-one people began to feel less panic and more hope for the future.  

The direction of the stock market is highly correlated with how optimistic society feels about the future, and vice versa.  By the 3rd week in March the case was being made that the situation was dire, and potentially apocalyptic.

From the progress on a vaccine or treatment standpoint, most of the market recovery since then occurred before the announcement of a (legitimate) major medical breakthrough.  That’s because optimistic-minded investors assumed treatments would be found in 2020/21 and factored that into their investment decisions. Trillions in government stimulus on an unprecedented scale didn’t hurt either.

Advising through uncertainty

At my firm, we don’t make short-term market predictions, but many ask to anyway. We understand the desire to know the future.  We want to be on the list of people that get asked for an opinion.  It’s an opportunity to describe the prediction trap and have a conversation about a range of possible outcomes and the pros and cons of each.

Here are some additional future events we are asked to predict::

  • The direction of Interest rates
  • Oil and gold prices
  • Real estate prices
  • Tax policy
  • Election results
  • Mortality rates
  • Unemployment rates
  • Global economic growth

Knowing the future in advance is impossible.  Here are two of a range of methods we use to develop our advice instead.

1.  We think in terms of probabilities. 

For example, what is the probability of equity markets being higher or lower 1, 3, 5 or 10 years from now?  What is the likelihood that interest rates will increase or decrease?  

And if our assumption is incorrect, what could go wrong?  Is it worth mitigating that risk and, if so, at what cost?

2.  We don’t rely on the media for insights and neither should you.  

Here’s just one example from Reuters, June 21st, 2020:

U.S. stock futures - tweet from Reuters

And from the Financial Post the next morning:

Stock futures - Financial Post tweet

How should an investor respond to the reality of news as entertainment?

1. Stop wasting time reading this stuff.  Or at least, avoid basing your investment decisions on the last market commentary you read. (We read them on our clients’ behalf.  That’s part of our professional responsibility).

2. Understand the difference between individual security risk and market risk. 

Idiosyncratic risk – The inherent factors that can negatively impact individual securities or a very specific group of assets.  Indeed, you can lose all of your investment in a single security (stock/bond) if the company goes bankrupt.  Here is a summary of some of the U.S. company bankruptcies and what triggered them.

Investors who owned one or more of these stocks, and didn’t sell before they went bankrupt, lost their entire investment.  

Hence, the importance of diversification.  Owning a basket of stocks through a mutual fund or ETF reduces single security risk.  If one of the companies in the basket fails or runs into insurmountable obstacles, the entire portfolio remains intact and only slightly impaired.  

Market risk – The possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets in which they are involved.  Also known as “systemic risk” it cannot be eliminated through diversification, though it can be hedged against in many ways.

3. Acknowledge the complexity.  Globalization has created a web of relationships, dependencies, moral responsibilities, and power imbalances that play out in our daily lives.  “If this, then that”, is an over-simplified approach.

4. Focus on your personal risks and opportunities.  That’s what we do.  Here is a list of some factors that we consider when aligning market realities and opportunities to client needs and circumstances:

Pre-retirees

  • Job security
  • Future income prospects
  • Special needs of children now and in the future
  • Credit worthiness
  • Past investment behavior
  • Differences in risk tolerance between couples
  • Saving capacity
  • Company pension plan or not
  • Future housing needs/costs
  • Net worth position
  • Tax position

Retirees (some overlap)

  • Expected longevity
  • Health status
  • Portfolio withdrawal rate 
  • Tax position
  • Estate aspirations
  • Special needs of children now and in the future 
  • Credit worthiness
  • Past investment behavior
  • Differences in risk tolerance between couples
  • Future housing and healthcare needs/costs
  • Net worth position

The Bottom Line

Our recommendations are based on what we see as most probable, while recognizing the frailties of predictions.  As a result, we avoid big bets.  Our approach isn’t for everyone and that’s ok.   There are at least as many investment strategies as there are types of apple trees (7500 for the curious) .  You are bound to find one that aligns with your personal world view. Before you do so, consider familiarizing your self with the power of confirmation bias.

Consider focusing your energy on what you CAN influence that will contribute to your financial goals (income generation, spending levels/effectiveness, tax efficiency, and health and wellness, to name just a few).

The last six months have been a rollercoaster for investors.  In March 2020, there were so many possible paths forward.  Although extreme outcomes can happen, financial decisions guided by a balanced point of view (where we land on most subjects), leads to a prudent, well-considered approach to dealing with uncertainty.  It’s one of the reasons we publish a weekly Good News of the Week blog that includes practical and philosophical paths to a meaningful and fulfilling life.  I encourage you to subscribe.

Rona

Meeting you at the intersection of money and life.

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.