There’s nothing like a pandemic scare to reveal a person’s true self. So, it’s been fascinating to see how the fear of infection is affecting friends and colleagues in different ways. Sitting at the ‘que sera’ end of the spectrum, I was taken aback by a colleague who last week cancelled a proposed trip to Madrid and then told me straight-faced about the ‘go bag’ he has had packed and ready ever since the south London riots a few years ago.
Of course, one man’s paranoia is another’s prudent preparation. And he may have the last laugh when I am scrabbling around for dried pasta in a few weeks’ time. What this unexpected hot-desk conversation made me consider, however, was the disconnect between the increasing vulnerability to black swan events of the interconnected world we have created and the illusion of control that governs our behaviour.
The heightened risks of a globalised world of dependent supply chains and drop-of-a-hat intercontinental travel have become investors’ primary concern as the coronavirus outbreak shifts from a public health to a global economic crisis. No-one is now in any doubt that the outbreak and, especially, the measures taken to contain and delay the spread of the disease will have a significant impact on growth this year. The only questions now are how deep and how long.
What is more interesting is the mismatch between the fragility of the world we have built in the past couple of generations and our belief that we can manage or mitigate the impact of throwing grit into the cogs of that finely-tuned machine.
The illusion of control is a well-documented characteristic of investor psychology, nicely illustrated in James Montier’s epic study of the subject, Behavioural Investing. He cites a study in which one group was asked to pick their own lottery ticket numbers while another was assigned numbers randomly. When asked the price they would accept to surrender their tickets, those who chose their own numbers wanted $9 on average while those assigned numbers would settle for just $2.
Ever since the days of the Greenspan Put in the 1990s, and in the era of extreme monetary policy since the financial crisis, we have vested the illusion of control in central banks, especially the Federal Reserve. This is why last week’s rejection by the market of the Fed’s emergency rate cut was so unsettling. It was the financial equivalent of a super-bug laughing in the face of the magical power of anti-biotics.
We used to be better at accepting the unpredictability and cruelty of things. Death was not something to be managed away but an unavoidable consequence of life itself. This greater realism may explain the curious absence of literature on the economic and social impact of Spanish flu, the viral outbreak that killed as many as 50 million in the wake of the First World War. Compare that grudging acceptance of the Grim Reaper to the hysteria that has greeted 3,000 deaths so far from Covid-19.
Perhaps this apparent over-reaction reflects a realisation of how complacent we have become about playing God over the global economy and markets. From the Bank of England’s lifeboat to the Fed’s intervention after the collapse of Long-Term Capital Management, from bank bailouts to Draghi’s ‘whatever it takes’ speech, we have developed a blind faith in the authorities riding to the rescue.
It is possible that the increasingly obvious impact of climate change and the sudden arrival of coronavirus could mark a watershed in both our attitude to risk and our expectations about what the future can realistically offer us economically and as investors. But it remains to be seen whether we will view international travel or the desirability of far flung supply chains and just-in-time manufacturing differently in future. Or whether we will simply breathe a sigh of relief when infections start to subside and go back to business as usual.
As investors, however, a heightened appreciation of the inherent unpredictability of the world around us is a good thing and long overdue.
We cannot control either the spread of coronavirus or the market’s reaction to it. But we can learn something from my nervous colleague; there are relatively simple things we can do to protect ourselves and our portfolios.
First, we can accept what we can’t control. We don’t know what will happen in the short run to our investments, but we do know that in the long run the stock market is the best place for our patient capital. We also know that some investments will do better than others and behave in different ways. We can, therefore take a long view, embrace the opportunity to buy significant dips and be well-diversified.
Second, we can know ourselves. If you can’t sleep at night because the stock market has fallen by 10pc in a week then maybe the stock market is not for you. Accept that the price you will pay for an absence of short-term volatility may well be an absence of long-term returns. Cash will protect you from the ups and downs of the market, but I would be very surprised if in 20 years’ time you were glad you cashed out in 2020.
Third, we can pack that financial ‘go bag’. Give yourself a cushion (enough to pay for, say, a year’s basic outgoings) to cover off the unlikely possibility that the worst does happen. Knowing that’s in place, you will be more relaxed about taking the sensible market risks that will serve you well in the much more likely case that it doesn’t.
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