Over the course of the last couple of weeks the world suffered a market crash that left investors lost for words. As market participants one of our duties is to study the many ways that market failure can occur, and prepare ourselves accordingly. We learn about complex financial instruments, and how to use them, and we learn about the mistakes that we are capable of making as people. Clearly our preparation wasn’t enough. Moreover, we are at risk of continuing to make the same mistakes again if we fail to evaluate the current market circumstances adequately.
This week alone I received 20+ messages from my friends, family, and peers, asking what they should do regarding their investments, holdings and cash assets, and what to invest in right now. Those working in financial services will probably relate and have – too – been asked the same, or a similar, set of questions. The purpose of this post, or open letter, is not to answer these questions, nor provide any sort of forecast. Instead, I hope this serves the purpose of helping people appreciate the gravity of the implications of COVID-19 on both markets and on everyday life, while directing their interest and attention to what matter the most. Hopefully, you will be able to answer your own questions by the end of this letter.
I would like to preface this outlook with two messages. First of all, please do not view this as investment advice. Each individuals financial needs are different, and there is no “one size fits all” venue in which you should park your capital, especially now. Secondly, I urge everyone to closely follow the instructions of your local government authorities with regards to the developments of COVID-19, and take this crisis seriously. This is a problem that afflicts everyone.
To start off, what we’re facing now is a crisis of demand. The single most important mechanism within the global financial markets is the individual market participant. It doesn’t matter whether you interpret participants in the classical economic sense or with modern pragmatism – we are in the midst of a participant crisis. A sick person is not capable of participating within the market in the same ways as a healthy person, nor is one sick person simply a marginal absentee to the market. A sick person burdens other participants of the market, just like an injured soldier will slow down a platoon: someone has to carry them.
This is an attitude that we must take into consideration. A lot of the times we become very disconnected from the humanity of economics and financial markets. This isn’t an argument of consumer rationality, we discarded that a long time ago and replaced it with heuristics and biases that we labeled as effects and phenomena. It is a saving grace that in the last 10 years we have slowly started to understand the importance of ethics through the likes of the ESG criterion. What I am asking for is that you view this crisis, and the actions of governments, businesses, and individuals, with ethics in mind, not just quantitatively.
I am not saying that it is unethical to think of money right now. Frankly, we should all be thinking and planning our finances right now. However, should you hope to grasp an inkling of what is occurring in the financial markets, you need to start evaluating the present circumstances differently.
In the midst of this financial meltdown we saw a shift in the profile of global systematic risk. Preconceived notions of “safe haven” assets, and traditional portfolio hedging tools were all subject to the same downside risk. Gold, everyone’s favorite recession-proof hedge, tanked. Contrarian cryptocurrency investors saw assets like Bitcoin and Ethereum drop in excess of 30%. In an extremely unlikely and unpredictable turn of events we also saw bond prices fall -rather than rise – as equity indices around the world sold off. Watching on the screen – markets continued to trigger limit-downs and trading halts, and stepping outside I saw my friends lose their jobs, businesses close down, and people stockpile food. For the first time I was able to put a real face to what would normally be just numbers. It prompted me to take the crisis not only seriously, but personally. I became pro-active in sharing information regarding the outbreak of COVID-19 when I found out my own friends, still in their last years of medical school, were deployed to hospitals across Europe to help patients.
From reviewing market price-action, and in speaking with other traders, risk managers, and financial professionals, I was able to reach a conclusion as to what happened in the market that caused such an unusual cohesion in systematic risk, beyond simply blaming an absence of demand. What we saw was a mass-redemption, a liquidity crunch backed by the same panic that drove countless people to stockpile toilet paper and line up in front of ATMs, coupled with an almost immediate drop in consumer demand. While we didn’t necessarily see consumers flock to banks in demand of their savings, we saw banks and funds suddenly re-evaluate their positions while risk premiums rose faster than a controlled liquidation could be implemented. In other words, funds sold equity at increasingly low valuations, while those who were late found risk management too expensive and were stuck holding the bag. At the same time alternative investment managers struggled to find utility in safe-havens (gold is only as good as fiat is bad, and cryptocurrency still lacks both stability and actual use-case). Government bonds represented some liquidity, but remained questionable under effects of potentially new and aggressive movements on behalf of central banks, while corporate credit was, and remains, in purgatory as investors aim to gauge which companies will be subject to a bailout. I have come to question where I stand in terms of the imposed economic policy, too. I find it difficult to identify with the dirigiste nor laissez-faire schools of thought. I believe that this is an argument best saved for another time, maybe when we all have a bit more capacity to entertain it. Low interest rates may provide relief to indebted business, but is not a catalyst for demand.
While this isn’t reassuring, but the fear the we are seeing in the market is ok. Often we view fear in the markets as something that is to be ashamed of, however I begin to view as a good thing. Owing to the fact that we are all caught in a period of uncertainty, we see that the market, in all it’s illiquidity and irregularities, has never been more efficient than it is now.
So when you put into question the effect that this crisis has on your portfolio, ask yourself what affect the crisis has on you, on your neighbour, and on your friends and family. If you’re still lining up to buy toilet paper, firing your staff, or are unfortunately ill – if you’re scared, so is the market. However, if you see your community implementing changes, if there is clarity and direction then we and the market will start to price-out uncertainty, and price-in possibility. That’s when it becomes the time to go long and deploy your capital! When the moment comes that we see doctors returning home, patients recovering, and schools re-opening – the price-action will follow proportionally across most asset classes. I won’t negate that there are already many assets trading at bargain-bin valuations, but right now it’s like trying to catch a falling knife. Sure, some of you that purchase select securities now will stand to profit significantly, but you will be assuming the risk of uncertainty.
So what can you do now? Well that depends on how much risk you are willing to assume, and frankly I’ve tolerated enough of it so far and will wait. Most importantly, I implore everyone to do their part to help us find clarity faster. If that means staying at home – stay at home, if it means buying groceries for your elderly neighbours – do so, and in my case – I will continue to represent the best interests of my own stakeholders, personal and business.
Overall, I remain optimistic. I believe we will be able to overcome this crisis, and it’s financial repercussions. After all, we’ve been through worse.
Once more unto the breach.