This Will End Badly

By: Matt Garrott

It’s clear that 2018 will not be a repeat of 2017.  Low volatility, a steady march up and to the right, and a general disregard for headline risk were last year’s calling cards.  2018 seems jittery by comparison, but is actually a more normal market.  Historically, drawdowns have been slower and deeper, but maybe this year’s sharp drops and rebounds reflect changes in technology or adaptation to a new information paradigm.  Regardless of the actual reasons for the return of volatility, experts assure us that “This will end badly.”

Of course it will end badly.  Otherwise it wouldn’t end, right?  On the other hand, the last few times it ended badly it didn’t really end at all, did it?  Phrases like this and “I’ve seen how this movie ends” are not helpful.  Doomsday clichés are a way to identify the unserious, the uninvested, and the charlatan.  Don’t mistake it for actual insight.  They are just words to fill the void created by the fantasy of a rational, predictable market.  The prudent investor has shrunk this void with experience and an understanding that in the short term markets are irrational and not beholden to narrative.  Yes, there will eventually be another 15-20% drop in the markets, but the risk/reward machine doesn’t work otherwise.

Risk Revisited

This doesn’t mean we ignore risk.  Investors should approach it intelligently and revisit their risk tolerance and allocations from time to time.

In a recent due diligence meeting a money manager gave an interesting view on the current risk environment.  They said the Federal Reserve’s policy of Quantitative Easing was intended to push investors to allocate to risk assets, but many allocated to cash or Treasurys instead.  Now these investors are looking to deploy their cash after missing huge returns in traditional asset classes.  They are risk-hungry, accepting elevated volatility and/or poor deal structures in exchange for rumors of return.  The manager cited increased allocations to frontier and emerging market private equity deals as well as interest in crypto-currencies.

Investors who take on risk out of desperation are more likely to wind up holding return-less risk.  A prudent portfolio looks relatively boring and stodgy, but the market does not award style points.

Fairway Scorecard 3-31-2018