Either/Or: How Should We Invest?

​A timeless example of opposing possibilities was illustrated by the philosopher Soren Kierkegaard in his book, Either/Or. According to Wikipedia, Kierkegaard's work "outlines a theory of human development in which consciousness progresses from an essentially hedonistic, aesthetic mode to one characterized by ethical imperatives arising from the maturing of human conscience." The point of the exercise was to help answer the question, "How should we live?"

Stark alternatives now also present themselves to investors. Having enjoyed a period of declining interest rates for nearly 35 years now, it has been easy for investors to realize excellent returns from capital markets without much effort. That world, however, is quickly evolving into a very different one characterized more by binary outcomes than by stable equilibria. Not only is this new landscape likely to be far less profitable for investors in general, it carries with it the ongoing risk of extremely negative outcomes. In such a fundamentally different environment, "How should we invest?"

With few clouds currently darkening the financial skies, investors might be forgiven for doubting this thesis. The US economy is moving along reasonably well, unemployment is extremely low, and rates are low but starting to normalize. In addition, it is certainly possible to read some positive economic implications from the president-elect's early statements.

As we have apprised readers for some time now, however, underlying investment risks have steadily been rising. High levels of debt across the globe not only serve as a brake on economic growth but also significantly increase the risk of "accidents". Aging demographics and slowing population growth further compound these risks by constraining the opportunities to "grow" out of the debt. Increased financialization combined with increased interconnectedness not only broadens the reach of breakdowns but also amplify the consequences when they do occur. In short, the investment landscape is best characterized by what Nassim Taleb describes as "fragile".

While none of this is especially new, what is new is that some of those underlying risks are beginning to bubble to the surface. As they do, problems that had been considered abstract and remote are becoming tangible and real.

One of those risks is with underfunded pension plans. The Economist reports on one particular case: "Bank runs, with depositors queuing round the block to get the cash, are a familiar occurrence in history. A run on a pension fund is virtually unprecedented. But that is what is happening in Dallas, where policemen and firefighters are pulling money out of their city's chronically underfunded plan, and Mike Rawlings, the mayor, is suing to stop them."