Events in Greece, China’s massive market sell-off, and the temporary shutdown of the NYSE remind us that change and crisis shift the narrative of what today holds and the future portends. Investors may at first want to run for the exit, but the wiser choice may be to stand calmly and let the storm pass.
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If it seems as though we have focused on crises in Europe for years, that’s because we have. The seemingly endless impasses of Greece and its possible spillover effects on the rest of Europe and then, by extension, on the global financial system, have beset markets and investors for nearly six years.
The past month was yet another convoluted chapter, culminating in a referendum by Greek citizens who, by a margin of more than 60%, rejected their European creditors’ demands for further austerity. That vote was a significant development, but unfortunately for Greece especially, and the financial markets in general, it will not be the last word.
The slow-motion crisis is another opportunity to evaluate investments in the face of geopolitical instability. Greece is but one example of what happens continually in human affairs: change, both expected and unexpected, and crises small and large, which shift the narrative (or at least perspective) of what the present holds and the future portends. The world is always messier and less predictable than spreadsheets suggest, with their expected returns predicated on assumptions of bond yields and equity returns over the next five or ten years.
What to do with a crisis?
In every crisis, investors must answer one question first: Is this the Big One? Followed by: Is this the moment of the great unraveling? And further: Will this event trigger not only volatility but also a sharp deterioration, upending markets and prices so dramatically that no amount of prepositioning can inoculate against losses too severe to recoup in any reasonable amount of time?
If the answer to that first question is yes, then radical action is in order. In 2008—2009, we learned that there are few (if any) safe havens in a major crisis. And, that anything that can be bought and sold will be, at a steep discount. Even that dramatic financial sell-off, however, saw sharp reversals in the months after March 2009, and had you sold at the end of 2008 or during the first weeks of 2009, you would have suffered large losses and enjoyed none of the rebound. If you believe that a crisis of even greater order is on the horizon, however, then being invested in any financial instrument carries significant risks and heavy losses.
Voices in the financial world are always warning of the Big One. But the Big One rarely happens, and most of the time, it is a big mistake to heed those warnings. Opportunities are lost, and “inoculation” investments—i.e. gold bars—often turn out poorly, at best.
Of course, the Big One could be just around the corner. We only will know in retrospect. The next question to ask is whether it makes sense to prepare for it considering A) it may never come and B) the investment choices you make to protect yourself perform badly unless it does. How you answer these questions depends on your personal ability to manage the uncertainty and potential stress that come with a dislocating event. Remember, investment decisions born of the desire to protect against worst case scenarios will almost always do quite badly unless the events occur.
If the Big One isn’t on the immediate horizon, then the next series of questions has to do with the actual implications of the crisis du jour. Today it is Greece; a few months ago it was Ukraine. Prior to that, it was tension in the Middle East, from Iraq to Iran to ISIS, which may soon resurface. And before that it was the U.S. debt crisis of 2011. Unfortunately, each year there is always something, and there always will be.
Each of these junctures presented investors with a series of choices. The two most important are: Do you sell or trim exposure to financial markets and stay with “safe” investments such as U.S. Treasuries? Or do you increase exposure to investments that have been sold off in the stampede, since many of them are unlikely to be affected fundamentally?
To repeat, investments made at the heart of a crisis and designed to protect against further downside rarely perform well. Gold, bear-market funds, derivatives, (the simple act of buying puts)—none of these tend to outperform once the crisis passes. Most of the time, fear- and insurance-based investments need to be in place before the crisis hits to generate meaningful upside.
On the flip side, however, crises almost always cause a broad financial sell-off with implications for assets that have little fundamental exposure to the crisis. Many equities that experience volatility during a regional crisis become oversold either because of greater contagion concern or short-term traders and algorithms triggering selling pressure. Therein lies a genuine, albeit clichéd, buying opportunity.
The aftermaths of March 2009 and November 2011 (which was the last major global spasm triggered by the Greek crisis) demonstrate just how potent those buying opportunities are, and how significant the bounce-back can be for assets that sold off even though they had little direct connection. Today, countless American companies as well as global bond yields have experienced volatility despite no direct effect from Greece per se. Major American retailers, for instance, won’t see earnings affected by a Greek default, yet many saw price volatility. Investors who bought gold as insurance during the crises noted above, however, had considerable losses.
Never let a crisis go to waste
We all know the investing homilies: buy when others are selling; markets climb a wall of worry. But truth lies in such homespun wisdom. The caveat is that any one of these crises could trigger the Big One. And the further caveat is that Big Ones almost never happen, and when they do, most efforts to protect will fail.
But, market movements can be clumsy during moments of crisis and concern. The past weeks have seen not just Greece floundering, but also China’s rapid reversal of its equity markets, both of which have spooked investors worldwide. China is an admittedly larger issue and economy than Greece, but its equity markets are almost purely retail and do not involve foreign money. So even though tens of millions of Chinese investors are panicking, the implications for global markets should be minimal. Should be. But, indeed, many will take their cue from a purely local, retail, domestic Chinese event and apply it to a sell-off in equity and bond markets whose implications suggest little correlation.
Instead, there may be opportunities to build positions in areas that have been unduly hit. Or it may simply be a wave that passes, with one’s basic allocations remaining largely intact, and even adding new cash to them (unless those allocations were heavily focused on, say, Greece).
This basic wisdom has been repeated over and over: no crisis looks precisely like another, and we are all primed and alert about the ever-present potential for bad situations to spin out of control. Given the cost of attempting to prepare for the worst, however, and the opportunity cost of not calmly standing in the eye of the storm, that basic wisdom is unlikely to become common sense anytime soon, and bears repeating for some time to come.
Karabell is head of global strategy at Envestnet, a leading provider of wealth management technology and services to investment advisors.