By John Lunt, Lunt Capital
It is difficult to appropriately recognize those who have suffered losses of loved ones, businesses, jobs, and other opportunities during the Covid-19 Pandemic. In the midst of difficulty and suffering, we have also seen many examples of hope, service, compassion, and courage. I will paraphrase a friend’s comment to clients—you will never forget your experience during the Coronavirus crisis, but in time your investment portfolio will forget and won’t remember this experience.
None of us will ever forget the 2020 Covid-19 Pandemic and all its social, economic, and financial market ills. In time, we expect many investment portfolios will recover and continue their march higher through punctuated moments of crisis and volatility. Long-term returns will mask the panic, uncertainty, and doubts felt by many investors in recent months. We believe there is a long-term, behavioral investment premium that rewards thoughtful, committed, resilient investors.
In the meantime, uncertainty remains. More time, progress and recovery are needed before we can declare victory from a healthcare, economic, or financial market perspective. Here are some brief observations from the Covid-19 market meltdown and subsequent bounce:
A lack of reliable information foments volatility which creates risks and opportunities
There is so much we do not know about Covid-19. I have had many conversations with thoughtful, educated, successful people about all aspects of the disease. Opinions and ideas cover the spectrum. As time progresses, some sources on all sides of the debate are viewed with suspicion. While this lack of reliable information exists for the disease and healthcare data, it is likewise problematic when it comes to the economic and financial data.We can expect volatility to fill this vacuum of trust in information. Investment behavioral risks and opportunities are magnified during crisis. The timing, source, and flavor of risk and volatility may change, but human behavior remains the same. Conquering our natural but often harmful behavior during a market crisis requires emotional steadiness, personal integrity, historical perspective, and subject matter expertise.
The public policy crisis response impacts the short-term at a long-term price.
While there is much we do not know about Covid-19, we know with certainty what happens to economies when governments mandate personal and business quarantines. An unprecedented government-mandated economic stoppage requires unprecedented government monetary and fiscal stimulus. Experts will debate the necessity and effectiveness of the Covid-19 quarantines and policy responses, but quarantines without a strong policy response would have been a disaster. However, the long-term implications of unprecedented stimulus cannot be costless.
People respond to incentives
If I had to sum up the most important lesson from my Economics degree into one phrase, it would be “People respond to incentives.” The entire objective of healthcare, monetary and fiscal policy is to create incentives to drive behavior. Some policies succeed in triggering the wanted behavior. Other policies recognize an attempt to address a specific challenge may create side effects in other areas. Unsurprisingly, some policies target narrow interest groups or are based on faulty assumptions, thus triggering adverse incentives or undesirable behavior. As election season heats up, most issues will eventually take a back seat to one question about perceived incentives. Voters will ask: which candidate’s economic policies will help me recover? On a different note, the incentives created by the new realities associated with Covid-19 have the potential to be a massive catalyst for disruptive innovation and positive economic change. New solutions, new technologies, new strategies, and new companies will emerge.
The inherent instability and sensitivity of mathematical models are underappreciated
At Lunt Capital, we are passionate about building economic, market, and investment models. Decades of experience in model-building highlight a foundational truth: a small change in assumptions can have a massive impact on model outputs. Despite this fact, I am astounded at the mesmerizing effect that highly sensitive, mathematical models have on forming and hardening opinions on all topics. This issue has been front and center as Covid-19 models in all their varieties are dispensed like Halloween candy. In some cases, uncertain assumptions associated with models are acknowledged. In other cases, unstable model outputs are used to push a particular agenda. As Nobel Prize-winning Economist Ronald Coase once said, “if you torture the data long enough, it will confess.” Uncertainty associated with models does not invalidate them. Instead, when model uncertainty is understood it becomes empowered for proper use.
How is success defined and over what time frame is it measured?
One investment question is often ignored but ultimately cannot be avoided: “Over what time frame will an investor measure success?” The follow up question should always be— “How is success defined?” Is success defined as achieving an objective, outperforming a benchmark, or delivering a desired investment attribute or characteristic? Is the definition of success grounded in reality? Our experience suggests the shorter the measurement time frame, the less likely expectations are reliably met for any allocation or strategy. Normal market volatility and ambiguity makes consistent short-term success difficult. Episodes of panic or euphoria may lead to misleading short-term conclusions. As an example, the Covid-19 market meltdown occurred with tremendous speed and magnitude. Tactical changes or rotations that protected from this recent, rapid market drop required a high degree of model sensitivity. This degree of model sensitivity likely came at a cost in recent years (repeated head fakes, whipsaws, or false moves). Connecting investment allocations and strategies with the appropriate investment time frame is THE essential investment skill. Aligning investments and time frame with a reality-based, historically-sound, definition of investment success is among the rarest of investor attributes.
At some point, we expect investment portfolios to forget the market ills of 2020 and continue the long-term (however unsteady) march of investment growth. The saying “history doesn’t repeat itself, but it often rhymes” is attributed to Mark Twain. Investors might not experience something exactly like the Coronavirus crisis again, but lessons learned now will contribute to the successful navigation of the next crisis (which is likely to rhyme with this crisis). I will put my own spin on my friend’s advice to his clients: we need to remember and learn from our experiences during the Coronavirus crisis because we don’t want our investment portfolios to remember this or any future market crisis. Remembering the lessons of the Coronavirus crisis will mean our investments won’t have to.