Planning a Response to an Unpredicatable Market


The important part of a traditional stock and bond portfolio is not its regular volatility, but its vulnerability to cataclysmic events.

My experience of interacting with financial gurus is that, like weather forecasters, though they can tell you how past patterns evolved and what the present day is likely to bring, they don’t control the weather and are regularly taken by surprise.

From the 1971 Bretton Woods Agreement break-down, to the 1997 Asian financial crisis, to the 2008 Great Recession and countless  debacles in-between, these are, according to smudgy glassed econometricians “once in a million year” events yet, occasions that pounce upon us with surprising regularity.  Still, so often the financial services industry at-large, when I ask important portfolio diversification questions to important people, looks remarkably like a hugely complex charade of betting on horses: Running to make sure they are staying sufficiently ahead of the present game so that by the time trouble strikes, they are several moves ahead.  All in the name of selling what will sell as there’s far too much pink-slip risk otherwise.

A Signpost Toward Judgment

All this makes me believe it is more than likely there are ills of assorted varieties fastened tightly upon our present investing culture. Most importantly, we shouldn’t be surprised when, from time to time, they wind up blowing up.

Investors demand equity-like returns and the financial industry caters. Remember that point-and-click equity investing and the like are a very recent invention; perhaps whispering a societal prerogative that subliminally says if it’s easy, it must be reliable and safe.  Our markets – like our culture – have quickly evolved from a disjointed fragmentation of phone calls and hand signals to a symphony of speed and synchronization.

I’m not suggesting that exchanges reintroduce the chalkboards to publish price. But we shouldn’t underestimate the connection between our external actions and formation of inner desires.  We need to slow down and reconsider who we are and what in the world are we doing.

Portfolio Diversification Demands Self-Deprivation

This is precisely what the German philosopher Kant, if he around to see it - may have dubbed our fast, easy, point-and-click market culture “sublime.”  The moment you purchase that high-flying tech stock, sell that call option, purchase that IPO on a whim – all those things are disillusionment, consummations not really to be wished for.  We’ve taken the waiting out of wanting – where we are the happiest not when we have it but, when we see the possibilities laid out in front of us.

Building a Portfolio to Flourish

Most traditional stock and bond portfolios collect a stable return when markets continue onto equilibrium yet risk enormous losses during unusually large moves.  These portfolios have and possibly can show years or decades of positive returns – ultimately containing a volatility that doesn’t expose the true risk inherent, until one catastrophic event shreds an investment portfolio to ribbons.

Liquid alternative investments (i.e. managed futures, global-macro, event-driven), on the contrary, by the nature of their strategy pays tiny costs of exposure to the market during directionless and/or states of equilibrium, while anticipating large profits during strong directional moves either up or down.  These funds will suffer – and can suffer for long periods – during seasons of macro tranquility without trend or volatility.

Be warned, it’s incredibly unwise to view these investments as a way to beat the market, rather view them as a real portfolio diversifier – an asset class that has a long history of stunningly low correlation to the rest of your portfolio.  Will it disappoint – yes and especially so if you are expecting equity like returns.  Have they fared poorly or gone into a long drawdown?  Yes and especially so during the period 2010-2013 – directly opposite of the equity market.  Can they be expensive?  Yes and especially so if you are looking for equity-like returns.  On the other hand, if the strategy is effective, expensive is very relative indeed.

Contrary to popular belief, stock market debacles don’t follow a reliable schedule, you can’t plan them.  However you can plan a response to them.  That is precisely why the emphasis in good organizations is always steeped in disciplined training and planning.  From my experience as a Divemaster, I can tell you that SCUBA instructors both train for disasters and practice reacting to them.  They understand that what happens in the minutes immediately afterward can change people’s lives and that mechanical response can be the difference between someone’s life and death.   Unfortunately, that’s a lesson many investors evidently never bothered to learn.