And Now War
March, 2022
Introduction: Grim Times Need Context.
And now we add conventional land war in Europe to the list of impossibilities of the past few years. It is stunning to consider the litany of grave crises we’ve encountered in the recent past, most of which in some way persist. There is plenty to worry about. For investors, the headlines can draw our attention to the very short-term as we fret over what this all could lead us into. It is a natural human reaction to crisis to immediately conceive of the worst possible outcomes: how many of us have already imagined the direct route from the awfulness in Kyiv to the apocalypse of World War Three?
Today we find ourselves faced with many problems whose outcomes could be catastrophic. We are right to be deeply frightened and appalled by these challenges. War. Pandemic. Inflation. Disparity across many dimensions. All of this made worse as we seem to have lost our capacity for constructive public discourse. Grim times indeed.
It is a good time to remember the words of the Rev. Dr. Martin Luther King, Jr. that the arc of the moral universe is long, but it bends towards justice. There is much to this statement. It speaks of hopefulness and resilience, these from a man who we can presume knew quite a bit about each. In times such as these, it is helpful to add expansive and historical context to our histrionic immediate fears. I find human history more remarkable for its resilience, durability, and progress, than for its coincident injustices and brutality.
Also, this is helpful thinking for investors because it can focus us on long-term trends and remind us to be wary of emotional decision making. In times of great economic and geopolitical crisis, we can feel compelled to act. But making reactionary decisions rarely ends well. Too often, whatever news you are reacting to has been “priced in” to your investments, so your buys or sells are already too late. It is far better to try to identify and understand the trends that will have major impact over the long-term. Align your allocations and investment selections around these, and then don’t tinker. Easy to say, harder to do.
Current Events
Of course the short-term matters. In the short-term we see traces of what future might lie ahead. But the future we actually end up with is rarely the one we envisioned. It is probably best to think in terms of likelihood of potential outcomes rather than personal biases or worst-case fears.
War. I doubt I could add anything new to the volumes being written about this terrible predicament. From the narrow viewpoint of an investor, it is clear that stocks right now follow the trajectory of this war. Indexes would likely react badly to a big expansion in this conflict. But if this devolves into a protracted quagmire of occupation and insurrection, then the impact on global stocks is likely to become a nuanced array of winners and losers. I am not qualified to make any predictions about Ukraine, but I have read that the quagmire scenario may be the highest probability at this time.
Pandemic. It is ending but is not over. As we turn from pandemic to endemic, we continue to move into the recovery phase of this long global disruption. The pandemic has caused a great deal of adjustment and transformation. Lasting changes have come to much of our society, economy, workplaces, etc. As in the aftermath of war, there will be varied winners and losers as companies and investors figure out how to operate and grow in this changed landscape. Recovery benefits us all, but while some sectors are poised to thrive, others must undergo major transformation if they don’t want to become obsolete.
Inflation. The war in Ukraine and the resulting sanctions serve as a setback to pre-existing inflationary pressures. There was a window not long ago where forces like the snarled global supply chain, commodity prices, labor market dislocation, etc. seemed they might soon ease. Wage increases may be impossible to roll back, but many other factors may still ease in a matter of several months or so. And one or two years would still probably fit a definition of “transitory” if we weren’t such a nation of complainers and armchair quarterbacks.
For Investors, the Long-Term Matters More.
What trends are likely to play out over the coming decades that will completely transform our economy and society, and offer generational opportunities for investors who position correctly?
Secular Shift in Interest Rates. This is perhaps one of the most underappreciated trends we have before us. As much talk as there is about interest rates today, there is little said about the context. Rates have been in a long-term secular decline since the early 1980s. In 1982, then Fed Chairman Paul Volker famously jacked up interest rates to choke off inflation. This caused a recession, but tamed prices. Rates were much higher then: mortgages were as high as 18%. Since then, rates have been in a slow structural decline, with periods of short-term cyclical fluctuation. These declines served as a tail wind for the economy and for stocks. And with the Fed funds rate now at zero, and with inflation growing, we are likely entering a new era. The potential impact for the economy, corporate earnings, and stocks is not at all clear. Investors will have to pay close attention as we undergo this shift in monetary regime. Will rates stay relatively low and will policy makers be effective at managing the balance between rates, inflation, growth, and employment? Or will rates slowly rise and if so, what sectors and investments might benefit from that type of potential economic headwind? I fear the days of simply buying the dip with a broad-based index fund may already be behind us. And bond investing can become fraught in this environment and noncorrelated alternatives could thrive.
Climate Change. Like the pandemic, climate change doesn’t really care if you believe in it. There could be much to learn and debate about magnitude, timing, specific impact, and the like, but directionally it seems clear that this is happening. As horrifying as this might seem, for investors this presents dramatic opportunities as money flows to solutions and accommodations. Investors will have to be careful as money flows out of industries that appear to face decline. For example, the energy sector seemed an obvious place to divest from until the recent Ukraine war derailed or at least postponed that thesis.
Demographics. Another trend that receives too little attention is the topic of changing demographics in the US and in other developed countries. Declining birthrates, aging population, changing of majority/minority status, economic disparity, mortality rates, and so on are trends that are difficult to address and change. These trends can seem very personal because they relate to how we see ourselves, our communities, and the country we imagine that we know. But these trends aren’t personal. They may be inevitable. And how different groups deal with them, resist them, or use them as guidance for growth and opportunity will have profound impact.
Technological Advances. Technology stocks are coming down to earth after years of high valuations. While this is probably a healthy reset of pricing and leadership, it almost certainly does not indicate a decline in technological advancement. In the years and decades ahead, technology is set to continue to evolve and transform most economic sectors. For example, healthcare, transportation, energy, communications, entertainment, food production, etc. may become almost unrecognizably transformed, presenting opportunities for investors.
Investment Performance: Remember Three Things
It is likely that investors will have to become more granular in the way they manage their portfolios. Some investors may find that individual stock picking yields strong results. But this approach is probably too risky for most. Others may evolve to a process of tilting their portfolio among sectors, styles, and asset classes in a deeper version of rebalancing. And hot investment fads, a traditional staple of Wall Street hype, will probably continue to tempt us with sure fire solutions. While many factors contribute, we’d be wise to remember the three items that most influence portfolio performance:
Asset Allocation. Think of this as top-level diversification. How much should you allocate into cash, stocks, bonds, real estate, and other alternative types of investments? Of course this depends upon things like your risk tolerance and time horizon. And it hasn’t mattered so much in recent years, as growth has concentrated into the tech sector, especially large tech like Amazon, Apple, Google, Tesla, and Netflix. If large tech is no longer the growth leader, then it will be very important to have your wealth spread across many asset classes and types so that you will have money in front of future leaders and be able to isolate or minimize losses. For example, the recent rotation from growth to value was widely predicted. But in late 2021, fewer predicted the current outperformance of energy stocks and commodities.
Investment Selection. Once you’ve defined your top-level strategy, it is important to populate the slices of your allocation pie chart with high quality investment choices. There are many unbiased third-party tools to help with this process. And while index funds have traditionally served as an efficient means of allocating to large cap stocks or sectors, their effectiveness in the conditions I’ve described above may become reduced. There are important active approaches for other allocations (like international, emerging markets, small caps, bonds, and alternative investments). What you’d ideally hope for is that the investments you own do a good job at what they’re supposed to do within their respective slices of the pie. You’d like each member of your team to do an excellent job playing their own position.
Investor Behavior. This is where it gets dicey. Humans have emotions and emotions can investors to make bad decisions. It’s what Maynard Keynes called “animal spirits” and is the reason why they say that investments often outperform investors. When everything looks terrible, investors tend to have a lot of fear and mistrust. When our accounts trend downward, we often want to do something about it. Problem is rough times can lead investors astray. Doing nothing (or actually adding to your investments) can seem counterintuitive during selloffs. But the best investments are often made during times of turmoil. When we consider a long-term chart of market history, it’s obvious in retrospect when to invest and when to sell. But in reality periods of decline, though prices become cheaper, investors are often too fearful to invest.
Conclusion
It seems we have entered into a time of broad restructuring and change. The complexities and crises of today result from the progression of various interconnected and interdependent threads and trends. Dominant models and assumptions are evolving, not necessarily being cast aside so much as transforming into something different built upon what went before. What worked in the past may now yield only meager results. In these times, if we have the peace of mind to allow it, let’s focus on curiosity and inquiry so that we can understand what is happening and where this all might lead. For my part, I prefer to listen more closely to the analyses of sober and thoughtful experts over the rantings of sanctimonious conspiracists. And I do believe in the hopeful resilience in the arc of a moral universe.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Stock investing involves risk including loss of principal. Asset allocation does not ensure a profit or protect against a loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
The data included is developed from sources believed to be providing accurate information.