The outlook for global economic growth is plagued by uncertainty today. Just how far will the U.S. and China go in their efforts to win the current trade war? Will the U.K. arrive at a solution to the ongoing Brexit impasse? Will central banks around the globe continue their easy money policies?
At the industry level, it seems hard to pinpoint another time in history too when so many were witnessing deep, fundamental change. In payment systems, upstarts like Apple Pay are threatening to unseat well entrenched competitors like Visa and Mastercard (also see page 2). In healthcare, public policy initiatives aimed at controlling costs may undermine the basic business models of hospitals, drug distributors and pharmaceutical companies. In the media sector, the war to capture consumer “eyeballs” is forcing unprecedented consolidation and change.
In periods of perceived heightened risk, it is helpful to take a step back and consider the long view of history. Take a look at the chart below of the VIX. This investment index, a popular measure of expected stock market volatility, tends to rise when stocks are falling and shows when heightened jitters are creeping into the market. Over the past 20 years there have been at least 10 periods when the VIX spiked above 30. While most of us remember the 2008-2009 recession, many have forgotten the anxiety produced during the summer of 2011 (European Sovereign defaults and the downgrading of U.S. debt) or fall of 2015 (fears of slowing economic growth and falling oil prices). In behavioral finance, the tendency to place more emphasis on recent rather than old information is referred to as Recency Bias. As investors, this trait gets us into trouble when we assume that current conditions (bad or otherwise) will continue into the future. This, of course, may be true but it is not necessarily true.
Investors should also keep in mind the idea that they receive a return precisely because they are taking on risk and, all else being equal, the more risk you assume, the greater the potential return. Over short periods of time, the stock market’s gyrations are driven by the very human emotions of fear and greed. The result? If you are investing correctly, you are likely living in a constant state of dissatisfaction. If the market is up, you wish you had invested more in the market and if it is down, you will always think you have too much invested.
So, what is an investor to do in the face of such uncertainty? Investing is as much about understanding yourself as it is understanding the markets. Conduct an honest assessment of your own ability to tolerate risk by which I mean either temporary or permanent loss of capital. If principal preservation is more important to you than capital appreciation, your portfolio should hold a good slice of more stable things like bonds and cash. And don’t forget diversification within each asset class. At its heart, the concept of diversification is really an admission that we don’t know what the future holds. An adequately diversified portfolio will never keep pace with the market’s highest-flying sector like tech today, but it will never behave like the worst either.