True Risk

As the Titanic steamed through the North Atlantic they had crew members constantly scanning the horizon for icebergs. On the sides of the ship, in the wheel house, in the crow’s nest, men spent hours looking for giant chunks of ice that posed a risk to the 2,224 souls on board. As we all know, there was one iceberg they didn’t spot, one that came out of the darkness, one that doomed the luxury liner to become the most famous disaster of all time (did you know Rose says “Jack” 80 times in the movie? Really bugs me for some reason). In my 2020 Outlook to our clients I reminded them that the icebergs Titanic’s lookouts couldn’t see were the one’s that represented true risk. That same thought process is relevant to the market and your investments. I read countless outlooks to start the year talking about the Election, Manufacturing weakness, debt, interest rates, earnings, etc which are all known icebergs. Did a single strategist write about a viral outbreak originating in the 6th largest city in China posing a threat to a tentative global economic recovery? Of course not, but that’s TRUE risk.

Let me put my semi-retired trader hat back on and walk you thru what’s happening right now. A novel virus is expanding its reach thru a city of 11mm people while simultaneously working its way around the globe. We know that China’s economy has been slowing but the market hoped a Phase 1 Trade deal would put it back on track, now that hope might be gone (you gotta read this crazy Twitter thread by my friend Denise Pellegrini of BBRG. Chaos Theory in action). The Iowa caucuses are in a week and the latest polls show Bernie Sanders in the lead. If he wins next Monday and gains momentum in NH the market will need to start discounting the chances that he not only wins the democratic nomination but the Presidency (policies are what the market cares about, not an individual). Finally, let’s face it, we were a bit overbought and overloved, we haven’t had a 1% move since October. Those kind of stretches can happen in a bull market (I wrote about it here) but the flip side is that corrections can come out of nowhere and catch us all off guard. There’s a reason the phrase “stairs up, elevator down” exists.

Ok, so, we know what the market is concerned about right now, what should we do about it? Here’s the thing: when a bridge builder builds a bridge and expects the maximum downward force on it to be 5 tons, she’ll build it to handle 10 tons. When a modern airliner is built its wings are flexed further than any turbulence could possibly flex them. If true risk in the market is something we’ll never see then the best we can do is build our portfolios to withstand a worst case scenario. The longest drawdown in history for an all stock portfolio is 13 years (for the popular 60/40 variant it’s 11 years). Can you handle that? If not then maybe it’s time to re-examine what you’re holding, possibly add more ballast to your portfolio (bonds/cash). There isn’t a single person on the planet that can predict the future, especially with respect to markets and the economy. Preparation is, and always will be, paramount to your well-being.

I’m going to end with just one link tonight, the Oscar winning short film by Kobe Bryant. 

Dear Basketball