You have to have some sympathy for those strategists working at asset managers and investment banks who spent the tail end of last year writing lengthy outlook pieces for 2020. Although the tomes produced always have an inbuilt redundancy; the onset and spread of coronavirus (COVID-19) has upended all forecasts in a particularly dramatic and rapid fashion.
For investors the staggeringly swift reshaping of the prevailing investment narrative should have served as a sharp reminder of the futility of short-term forecasts. The complex and adaptive nature of financial markets means that making predictions about the near future with any level of specificity is an utter folly.
Unfortunately, as investors hastily recalibrate their market expectations they have not become more circumspect about forecasting imponderables – quite the contrary. As the perceived risk has heightened there seems to be an increased production of speculative prognostications. Most asset managers are now producing their own viewpoints on the potential ramifications of the virus. There is puzzling need for detailed opinion pieces from financial market practitioners about an incredibly uncertain topic about which they have no specialist knowledge.
It is not only opinions that are sought after when the market environment becomes challenging, but actions also. In periods of tumult trading is required to show that these new risks are being addressed and accounted for. The biggest danger for investors is the temptation to engage in heroic trades; either removing risk entirely on basis that there will be severe economic and market ramifications from the virus; or conversely increasing risk substantially because the market has overreacted. The outcomes here are binary: one group will receive praise for their sagacity; the other will be seen as reactionary and injudicious. Both sides are merely guessing.
If investment decisions are being made related to the progression of the outbreak, it is worth considering the complexity of such predictions. It is far more than anticipating the spread of a virus (which in itself if an improbable feat); but the second and third order effects – the decisions politicians will make, how people in those countries will behave and, crucially, how investors will react. Even if we had perfect foresight of how the virus would evolve over the coming months, it would still be impossible to confidently predict the market and economic implications.
The new coronavirus outbreak inevitably creates a tail risk of severe economic dislocation and market weakness, but nobody can possibly have any confidence in the probabilities around such sharply negative outcomes occurring. The idea that we can correctly gauge whether financial markets are accurately ‘pricing’ such uncertainty is entirely spurious.
Although the coronavirus outbreak (and the reaction to it) has the potential to precipitate an economic slowdown, earnings recessions and severe market decline (from a purely financial perspective); being a long-term investor means continually facing such risks. It is simply that the virus is currently the most salient and available potential cause of such a scenario. We should have a portfolio that is commensurate with our willingness to withstand them; from both a financial and behavioural perspective.
Any communication related to this issue should be focused on the general principles of good investment behaviour during times of stress and volatility. Not specific commentary about a virus over which nobody has even a modicum of certainty over future developments.
Sensible investment rules such as diversification, rebalancing and adopting a long-term approach are only prudent because financial markets and human behaviour are so unpredictable. If we had greater confidence about the future they would be entirely unnecessary. Now is is not the time to abandon them.