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APRIL 2022

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Induced by Russia's tragic war on Ukraine, we find ourselves in a significant shift in the world's geopolitical order. 

As Howard Marks documents in his most recent essay, the offshoring of manufacturing to Asia has run afoul of well-documented and quite severe supply chain issues. Hovering over them is the growing realisation that China cannot be relied on to be a rational actor.

Finally, we find ourselves in the grip of the most severe inflation outbreak in 40 years, created primarily by an expansion of the money supply far beyond the economy's needs.

So what should we rational investors do?

No one can begin to predict how these situations will resolve themselves…much less when. Nor can anyone begin to imagine how the capital markets will adapt to said resolution(s). We are once again in a perfect Cloud of Unknowing.

It is also irrelevant to the investment policy of a long-term, goal-focused, plan-driven investor. And I say again: current events are perfectly irrelevant to the investment policy of the long-term investor in a globally diversified, Evidence-based portfolio.

What, after all, is the essence of successful long-term equity investing? Surely it is the continuing practice of rationality under uncertainty. But what does that even mean? To me it means basing our investment policy on our financial plan as distinctly opposed to a view of the economy and the markets. This is where rationality begins and ends.

Two years ago, we could not begin to imagine how lethal the pandemic was going to be, nor when (or even if) effective vaccines would become available in sufficient quantity. Today, we can't anticipate what Putin will do in Ukraine, nor how the back of this inflation will ultimately be broken.

Nothing has changed; we've just moved on to a different set of unknowables. Meanwhile our retirement dates are bearing down on us at the same pace. The amount of money we need to accumulate has if anything gone up with inflation. And the only hope we have in the world for a secure retirement and meaningful legacy is the premium return of equities, whose short- to intermediate-term ebbs and flows cannot be anticipated, much less timed.

What we can know amid all this uncertainty—and just about all we need to know—is that the great companies in the world are already adjusting to this reordering. Just look at the massive write-offs they're taking on their exposure to Russia. I'm guessing that they're in the tens if not the hundreds of billions. 

Meanwhile, there's abundant liquidity in the financial system. The consumer's balance sheet is as healthy as it's been in 40 years. Unemployment is cratering; indeed job openings are at record highs. Everyone who can work and wants to can find employment at rising wages. In every important respect this is the mirror opposite of the Global Financial Crisis, when banks had zero excess reserves and the consumer was leveraged to his eyeballs.

Today's crisis invariably becomes yesterday's news, and, not only will we not be worried about this stuff ten years from now, we likely won't even remember it. (Do you remember that the equity market went down nearly 20% over six months in 2011 because of a raging government debt crisis in Southern Europe, the threat of a U.S. government shutdown, and S&P downgrading the debt of the U.S. Treasury? No? Well, neither does anyone else. That's my point.)

It all comes down to acting vs. reacting: keeping your head down and continuing to fund your plan, looking neither to the right nor to the left. History not headlines. This is a glorious time to be a mainstream investor for the long haul—even if, just at this moment, it feels like we can't see a foot in front of our faces.

Exhaustion Is Not an Investment Policy

Kevin Wood

A global public health crisis.  A 30-year inflation spike—paced by soaring oil prices—that so far gives no indication of being “transitory.”

And now, Russia's invasion of Ukraine.

You might not be human if, after two years and counting of this kind of chaos, you didn't just want to sell all the long-term investments in your financial plan, get to the “safety” of cash, get some rest, and look again “when things settle down.”

You're exhausted. We all are. (That includes us) who want nothing more than to see you and your plan succeed.

But exhaustion isn't an investment policy. (And cash, in a seven percent inflation environment, certainly isn't “safe” by any definition.) Getting out of the market to make the pain/anxiety stop is an impulse, and a very powerful one. But it isn't a plan. And chances are you're not going to make it without a plan.

So let's think this through together.

First, let's realise that the tragic situation in Ukraine is essentially unrelated to the other nightmares we've endured recently, most notably those cited above: the pandemic, and the inflation spike. There may very well be a cumulative effect on our psyches—much akin to running the gauntlet—but objectively these are different occurences.

Next, let's embrace the fact that we don't know how this situation is going to be resolved. No one does. Thus we realise that what's called for here is that most elusive of human qualities: rationality under uncertainty.

If we can't look into the future—since there are no facts about it—we're forced to ask: what other terribly shocking events have we lived through, and what do they teach us about their effect on the long-term values of the world's most successful companies?

To me there've been four genuinely cataclysmic “Black Swan” events in the last third of a century or so, that seemed to come out of nowhere and shake the very financial foundations of this country, and even of the world. None of these is perfectly analogous to Russia/Ukraine—indeed, none is exactly like the others. But I think it might be useful to see where the S&P 500* was as each of these tsunamis hit, relative to where it is now.

*The S&P 500 is the world's flagship equity market and its movement is the best reflection of the global appetite for equities

As I write, the Index stands at 4,221—a bit more than ten percent below its all-time high in early January. The four earth-shattering events I'm thinking of are (in chronological order) the 1987 Crash, 9/11, the Lehman Brothers bankruptcy, and the onset of the COVID-19 pandemic.

  • The 1987 Crash—the largest one-day decline in stock prices ever—took place on Monday, October 19, 1987. The S&P 500 closed the previous Friday at 283.
  • On the night before the terrorist atrocities of September 11, 2001 the Index closed at 1,093.
  • It closed at 1,252 on the Friday before the Lehman Brothers bankruptcy filing in September 2008 set off the Global Financial Crisis.
  • Finally, the Index closed at 3,386 on February 19, 2020, just as the world was shutting down amid the pandemic.

These were all, each in its own unique way, trumpeted to the skies as The End of the World. In the event, they were not. Life went on. The economy healed, as did the markets. Superior companies continued to grow and innovate, increasing earnings and dividends over time.

Is Russia/Ukraine greater than/less than/about the same as any or all of these global shocks? We don't know yet. It's therefore very easy to say—without a shred of solid evidence—“This time is different,” and head for the exits. 

But the more you know about past crises—and how the great companies in the world absorbed them, regrouped and went on to new heights—the more you may be inclined to entertain the thesis that “This too shall pass.”

Remember always that it's not a market of stocks. It's a market of companies.    t: 01827 264 485
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