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Under Pressure

“Pressure pushing down on me
Pressing down on you, no man ask for
Under pressure that burns a building down
Splits a family in two
Puts people on streets”

- David Bowie, Under Pressure
 


We are in the middle of a market panic. The virus has ripped through the fabric of markets and society with a ferocity that very few of us saw coming. I was dead wrong about the severity of the effect that the virus would have on markets.

Dead.  Wrong. 

Yes, I thought it had the potential to be bad and I wrote about that in previous posts.  No, I didn’t think it could be “move the market 5-10% each day” bad. 

No one did.

Some called for a correction, no one called for a panic.

In the interest of full disclosure, below is an excerpt from an e-mail I sent to a close friend of mine on February 16th (which feels like a lifetime ago). His question was simple: should I sell everything and go to cash? Here is my response:

“I don’t necessarily believe that this virus marks the end of it all.  Given its heavy toll on China, I guess the biggest risk in my mind is the idea of supply chain disruption and the potential for a domino effect from that.  Could it happen?  Sure…but it’s not a foregone conclusion.  There are pretty large tax consequences to what you’re doing; based on what you indicated last week, I think markets would have to fall around 25-30% or so just to break even on the tax expense. Bottom line: given your concerns, you should definitely lower risk but, as I’ve said before, it’s unlikely I would ever advocate for an ‘all out’ or ‘all in’ strategy regardless of valuations.”  
 

Given what’s transpired since then, I’ve never been so wrong, so fast.

 

In her book Thinking In Bets: Making Smarter Decisions When You Don’t Have All The Facts, legendary poker player Annie Duke writes a lot about the concept of “resulting”. Resulting is an inherent bias that most of us have whereby we judge the quality of a decision based on the outcome. Using the above example, I advocated against selling the entirety of a portfolio and going to cash one month ago. That looks really dumb now since markets are down 35% or so from their highs. Most would say that was bad advice.

But was it?

Say I go out tonight and have a few drinks at a local bar (that’s not possible since all of the bars in LA are closed due to the greatest health crisis in a generation, but it’s a nice thought). I then have a few more. And maybe a few more after that. I top off my night of heavy drinking by getting in my car and driving home, arriving safely in my inebriated state.

Now say that instead of my night out on the town, I decide to stay in and order some takeout. While driving to the restaurant, I get into an accident and total my car in the process.

Which of the two scenarios involved worse decision-making: driving drunk or driving sober?

Which of the two involved the worse outcome?
 
 
Going “all in” or “all out” on markets has historically been a risky endeavor. It involves timing and, ultimately, a huge amount of risk in both directions. Getting it right involves a vast amount of luck and an even larger amount of patience if you’re wrong. That’s hard for most people to do, which is why diversification works as well as it does. It’s hard to pitch that story now though since “all out” has worked so well lately.

It’s extraordinarily difficult to make decisions when you’re either stressed or don’t have a complete set of facts. We’re all suffering from both of those things right now.

We’re seeing a partial shutdown of the global economy. People are being mandated at this point to not go out and spend money. Mandated! That’s really scary and we have no way of knowing what the second and third order effects of that will be -- but we know they won’t be good. Businesses are closing their doors but we’re not sure for how long. There is no way to model the revenue loss if you don’t know how long the revenue is going away for… or if it’s ever coming back.

Since we have no way of knowing any of the above, having a plan and a systematic way of making decisions has never been more important than it is today. 

Go back to basics and consider three critical factors:

Do you have enough cash in your portfolio to weather further volatility? What if markets don’t rebound at all for a year? 3 years? 5 years? 10 years?

Are your bonds serving their intended purpose?  Everything has worked for the last decade so high yield masqueraded as fixed income even though it’s really just equity with a kicker. Go through your bonds with a fine-toothed comb and make sure your quality and duration are right-sized.

Do you have enough risk exposure to account for future growth?  I know it sounds crazy right now but risky assets like equities or real estate will likely return more than fixed income over the long haul even though they’re getting killed right now. Most investors need at least some exposure in their portfolio even though it’s painful to endure at the moment.

I’ll end this missive with an unabashed commercial:

At Trace, we’re really good at helping people evaluate questions like the three posed above.  We don’t have a crystal ball, but we have a deep expertise in understanding markets, a systematic approach to making decisions, and a way of communicating that information that will make sense to you.
 
Get in touch today.