Thought of the Week



These are difficult times, not only from an economic and investment standpoint, but a community one as well. This societal strains and uncertainty over depth and time-frame of the current pandemic add to the volatility in financial assets. Keep in mind, though, as we’ve mentioned in prior notes, that these periodic shocks are far from abnormal. In fact, they’re healthy checks on risk-taking, and allow a reset of expectations and re-pricing of risk.

If it were easy to take risk and invest in stocks (or real estate, corporate debt, etc.), such as if they moved in a positive direction 100% of the time, everyone would be doing it. Everyone would own high-risk assets, likely all the time, and that constant buying pressure would buoy prices to such an elevated level that valuations based on underlying fundamentals would no longer be logical. This would ruin their positive expected returns for the future, and increase fragility to the point where, instead of remaining somewhat resilient, the smallest snowflake would trigger an avalanche. Rather, periodic smaller avalanches help the mountain retain its stability. But sometimes, if the conditions are right, avalanches can be stronger than expected, and even become so extreme, and investors so disenchanted, that risk assets become cheap again. The unamusing irony is that this becomes the time when no one wants the same asset at a discounted price that they once coveted at a much more expensive price only a month earlier.

It is important for investors to take a step back and view these events in proper context. It’s the risk in stocks, and the potential for these types of draw-downs and volatility, that keep markets efficient. If they were simple, and always consistent, riskier assets would act like short-term bonds, and likely not even keep pace with inflation or earn enough to reach other goals. The uncertainty creates the opportunity. (Although the reminders aren’t ever pleasant.)

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