Staying ready for uncertainty
By Joel Dresang
The April issue of Milwaukee Magazine arrived with a letter from the publisher. She warned that items in the edition were “very out of sync with the current reality of canceled events and temporary restaurant closures.”
I took it as another example of the swift and sweeping upheaval from the COVID-19 virus. Editors had planned the magazine’s coverage three months in advance; staff finished preparing the issue four weeks before I received it. But for all their plans and preparation, no one had counted on the pandemic.
“There’s Almost No Chance of a Recession This Year, Experts Say,” Barron’s declared for its January roundtable of “some of Wall Street’s best minds.”
A week later, CNBC proclaimed, “Wealthy investors see nothing that will stop this relentless bull market.”
The April issue of Kiplinger’s Personal Finance includes an article titled, “What Kills Bull Markets: We don’t think this record run is over yet—but we’re watching these signs.”
Kiplinger’s noted mostly favorable conditions among factors that historically doom stocks. It also cited an economist’s warning that if the coronavirus outbreak became a global pandemic, resulting slowdowns “could cripple global economic growth.”
Several pages earlier, though, another economist said the coronavirus shouldn’t throw off his forecast of 2% GDP growth for the U.S. this year.
Now I read such prognostications with the smug 20/20 hindsight I feel when I see the historic headline, “Dewey Defeats Truman.” Yet, to be fair, the speed and scope of disruption from COVID-19 has been stupefying.
Like news editors, investors can plan and prepare with the best information available at the time, but they cannot foresee every possible cataclysm. I routinely hear Bob Landaas explain the importance of accounting for the unforeseen.
“The hard part about markets is that it’s the unexpected that typically takes markets down,” Bob said in a Money Talk Video. “So, we can obsess about known risk, but in my experience, it’s the unknowns—the proverbial meteor from outer space—that blindside investors and take stock prices lower.”
Of course, investors cannot plan for a specific unknown, but there are ways to prepare broadly for unexpected meteors from outer space. The preparation involves asset allocation and is based on the findings of Harry Markowitz, the Nobel laureate whose lifework he has called “the economics of uncertainty.”
Born in Chicago just before the Great Depression, the self-described nerd studied physics and philosophy on his own as a teenager and graduated in just two years from the University of Chicago. Given a choice of academic fields to pursue, Markowitz picked the intersection of mathematics and finance.
“I soon gravitated to the theory of rational decision making under uncertainty or economics of uncertainty,” Markowitz said in an interview. “So, this is the path by which I got to where I am.”
Nearly 60 years ago, Markowitz began applying theoretical math to long-term investing. He reasoned that investors could play the expected risks and rewards of one asset against another to try to optimize the combined assets’ performance while minimizing risk on balance.
“It’s about all these different pieces working together,” Kyle Tetting explained in a Money Talk Video. “And that’s really where the benefit comes for investors and where we can add some value is in picking these different things that kind of all work together, so that as some of them are moving one direction, others are moving the other. So, we can really reduce the risk of a portfolio without completely sacrificing returns. That really allows us to maximize the returns relative to the level of risk we’re taking.”
Properly allocated assets position bonds in a portfolio as a counterbalance against stocks and as a relatively safe reserve from which investors can withdraw money.
“Most clients have a significant portion of their investments in bonds,” Bob noted in a recent article. “Bonds serve many roles but primarily function as a source of funds during a bear market.”
Balance can help buy time for long-term investors during short-term sell-offs. It also acknowledges that investors always face uncertainty. Investors who can concede that need to plan for the unknown are practicing what’s known as humility.
“Even though we know what might happen in the future in the markets and in the economy, we’re never certain as to what precisely is going to happen,” Art Rothschild said in a Money Talk Video about humility. “So, it’s a discipline that causes us to prepare better for alternative outcomes so we’re ready for anything.”
The magazines I read and the news I consume are mere sources of infotainment. I can afford for them to be out of sync on occasion as long as they correct themselves in a timely manner. (Kiplinger’s has a special coronavirus report in its May issue, which was published in mid-March.)
My investment portfolio is less forgiving. That is where I want to be ready for anything—even unknown meteors from outer space. That is where I benefit from humility and balance and the asset allocation research of Markowitz, the father of Modern Portfolio Theory and the master of economic uncertainty.
Joel Dresang is vice president-communications at Landaas & Company.
Keeping balance in unnerving times, by Bob Landaas
A note on coronavirus volatility, by Kyle Tetting
Correlation: A balancing tool, a Money Talk Video with Kyle Tetting
The importance of humility in investing, a Money Talk Video with Art Rothschild
(initially posted May 1, 2020)
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