This seems crazy.
Rocket attack. Photo: Sgt Wilks, No 5 Army Film Unit. Source: Wikipedia. Public Domain.
“In a crisis, all correlations go to one.” That is, a big enough crisis affects us all. That’s what happened with Covid, that’s what happened in the financial crisis, and that’s what happens in wartime. It’s hard to have a functioning economy when rockets are launching. People don’t plan for the future, they just want to have enough food and water and shelter to live. Criminally, sometimes even that is taken away.
But what should we do when we’re not directly impacted? How do we manage our risk when the world is at war?
There are two approaches: personal and systematic. Personally, we should be ready for disruptions. A year ago a ransomware cyberattack shut down a gasoline pipeline system for five days, causing a temporary fuel shortage across the East Coast. Many gas stations ran out of fuel. We ought to keep the gas tanks in our car full. Something that’s been shut down before can be shut down again.
But speaking of cyberattacks, it’s notable that the hackers attacked Colonial Pipeline with a compromised password – one that a Colonial employee probably used on multiple accounts. The hackers also used an external portal that didn’t require multifactor authentication (MFA). I know that this is geek-speak, but don’t reuse passwords and do use MFA. The bad guys want to get into your accounts. Don’t let them. Turn off your computer at night. If it’s turned off, it can’t be broken into. And you’ll save on electricity *and* avoid checking on those off-hours posts. Read a book.
It’s not a bad idea to keep a full pantry – not to be alarmist, but we’re facing uncertainty. Have enough non-refrigerated food to at least last a few weeks. A cyberattack could disrupt a lot of things, including food distribution and the power grid. We live in a part of town where we lose power in storms at least once per year, so we’re used to having candles on hand. But a couple decades ago, we had an ice storm in January that caused power to go out for a couple weeks. Residents of Montreal were in a real fix: most of them get their heat from electricity. Vermont saw a lot of refugees!
Finally, you should at least know where to get cash if you need it. We live in a mostly cashless society, paying for groceries with the credit cards stored on our cell phones, or using payment vendors like Venmo or PayPal. But if a cyberattack takes down the internet, we still need to pay our bills, and we may need to use cash for basic needs.
Systematically, it makes sense to dial in our risk a little bit. But de-risking may look different for different folks. The Fed plans to prune its balance sheet by almost $100 billion per month, reining in some of the $5 trillion in liquidity they’ve added since the start of the Covid crisis. This is good and necessary, but it’s likely to be disruptive. The last time the Fed shrank its balance sheet, it reduced it at half that rate.
Federal Reserve Balance Sheet. Source: Bloomberg.
That may mean having investment cash on hand, even if inflation costing your 7% per year. Short-term Treasury Bills or money market funds pay something, which is better than nothing. But even the safest instruments can be vulnerable in a “liquidity cascade”, which is what we saw when Covid hit us two years ago. There was a mad dash for cash, and even the most creditworthy and liquid instruments in the world (short Treasury Bills) struggled for a week or so. A similar thing happened during the Crash of 1987.
This is the time – not to sell out of fear – but to make sure we have the right balance between safety and growth in our investments. The safest assets may not keep up with inflation, but we can turn them into cash if we need them. That’s why I often suggest that people have a “ladder” of high-credit bonds with successive maturities in their portfolios, so they will have a steady source of cash, even if the market breaks down. In a liquidity cascade, market-makers stop making markets, and the only thing that you can count on is contractual obligations.
Finally, this is a good time to review what *kind* of equities we hold. Are they high-quality, low-debt, high internal cash-flow companies? Or are they low-credit, negative cashflow companies that need to regularly tap the capital markets to fund their operations. High quality often comes at a price, and the price may be higher valuation (and lower expected future returns). But that quality means that company management doesn’t need to live by the “kindness of strangers”, what I’ve sometimes called “Blanche Dubois Investing.”
Blanch Dubois in “A Streetcar Named Desire”. Source: Wikipedia. Public Domain.
This may be more difficult if you only own mutual funds and ETFs, but you ought to be able to understand the focus of your holdings.
Risk management is hard, but it’s really the heart of financial management. A retired US Army general recently commented, referring to the Ukraine conflict, that amateurs discuss tactics while professionals focus on logistics. A similar thing can be said about investing: amateurs worry about investment returns; professionals worry about risk.
Leave A Comment