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Taking Stock - Man Overboard

Date: 14 March 2023

At the moment I am taking some time off in Devon, and so I’m currently sat writing this in a tiny cottage, with a wood burning stove (highly recommend!) in a lovely one-pub village called Ashprington. I will admit to not being the best at genuinely switching off and can often be found on holiday with my head stuck in my laptop - but I’m making a particular effort this time around to down tools, because this really is a beautiful part of the world. Also, the Wi-Fi is awful.

Despite my relative lack of contact with the outside world over the past few days, I do get the sense that investor fear is on the rise again. As human beings, we are absolutely conditioned to “fight the last war”. That is to say we attribute higher likelihoods of recent traumatic events occurring again and take preparations accordingly. So, when a relatively niche bank in California announces that without a rescue package, it is going to the wall – we see Lehman mark 2. This sort of thing is catnip to financial doomsayers who have largely spent the last decade being totally and utterly wrong, and who in many cases don’t even run money – but that’s a conversation for another day.

Now I'm not going to explain here why I think that the failure of Silicon Valley Bank (SVB) is unlikely to bring on the next global financial crisis. If you have a subscription, the Friday 10th March edition of the Financial Times' Unhedged column does a great job of that. By way of a summary, the relatively unique characteristics of SVB have left it far more exposed to rising interest rates than most regional banks, and certainly more so than the big, systemically important, banks. Therefore those institutions are in a far better place to weather the choppy waters that have sunk SVB. 

What I would say however is that investors have been waiting for some sign to show that rising interest rates are causing cracks within the financial infrastructure – and Silicon Valley Bank is far more a part of the conventional financial system than, for example, FTX. the cryptocurrency exchange founded by Frodo Baggins. As a “proper bank” SVB’s failure is more difficult to dismiss.

As I have said before in these pages, it pays to invest like an optimist. But it can also be helpful to have a “man overboard” plan in place during the good times*. Basically, the idea is to have a plan in place of the action that you will take the next time the market experiences a drawdown. This may be nothing more simple than “I will heed hundreds of years’ of market history, and sit on my hands” or “I will take what I know to be positive steps from a personal finance perspective, and invest more of my income” – but by at least putting some rules in place during periods of calm, you have a fighting chance of following a sensible course of action when emotions are running high.

Recently, I have found myself talking clients through this concept more regularly. To me it doesn’t feel like we have felt the full effects of rising interest rates on the economy, and by extension company earnings, just yet. My hunch is that there will be more turbulence in the equity market to come this year, not least because equity market drawdowns in excess of 10% happen more often than not during any given calendar year.

Graph showing intra-year declines verses calendar year capital returns

Given this point of view, am I selling everything within portfolios and hunkering down? No, because given what the data tells us (that asset prices are more likely to go up than down) – that would be irresponsible, and frankly egotistical on my part. I don’t manage money based on my hunches. But I am talking clients through their “man overboard” plans and we are taking steps in advance to mentally prepare ourselves for further disappointments.  Going back to the October lows would be a real heartbreaker for all of us, and anything we can do in advance to cushion the blow is helpful.

Provided your core asset allocation remains suitable in the context of your financial circumstances, making significant changes to your investment strategy on a regular basis will likely only be counter-productive. However, if the idea of a 10% or 20% drawdown from here and the projected impact on your portfolio feels too difficult to stomach, then the good news is that bonds pay us far more of a return than they did a couple of years ago. You can reduce your exposure to the equity market, and still earn a perfectly sensible (albeit negative when adjusted for inflation) return from bonds.

Bad things happen. But the anticipation of bad things can often be worse than the actual “bad thing” itself.  In any scary film, the build up to seeing the monster is far more frightening than the big unveil.  By having some kind of plan in place, we can be ready when it emerges from underneath the bed.

Have a great week.


*This is a concept I first heard about in the excellent Value After Hours podcast with Jake Taylor, Tobias Carlisle and Bill Brewster, which I would highly recommend if you really like to get into the weeds of stock selection and investment process. 

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