On Risk. And Uncertainty.
“Risk: We don’t know what is going to happen next, but we do know the data set from which the outcome derives. Uncertainty: We don’t know what is going to happen next, and we do not know what the data set or possible distributions looks like.”~ Frank Knight
Investing is always risky. In financial terms, risk is measurable and is derived from an evaluation of "known unknowns." The ups and downs of a normal business cycle, industry-specific challenges such as the supply chain woes, downturns at a particular company - these are known and measurable risks. All assets are priced based on an ongoing calculation of these quantifiable risks versus reward.
In contrast, uncertainty is what lurks beyond measurable risk. Financial collapse, plague, war? These are risks to an investor’s portfolio as well but are impossible to accurately account for in risk models. For better or worse, investors typically ignore them. Yet, over the span of history, all have left their marks on markets. But because they are (supposedly) infrequent as well as non-recurring, it has become popular to call such occurrences "black swans" - a term coined by Nicholas Nassim Taleb to describe events that are rare enough to be outside of our experience. In older times, they might have been described as "coming out of left field." This is the category of incident that cause investors to lose sleep over their portfolios.
The war in Ukraine, and the consequences of a possible escalation, is one of a million or more rare occurrences that was not possible to account for in risk models. That is, until it occurred. Then, and only then, did investors start madly recalculating in real time what would happen to their investments if this outcome happened, or that outcome happened.
I say all of this to explain what has been occurring over the last several weeks in the markets. The Dow down 500 points one day. Up 500 points another. Simply put, the recent market volatility is a reflection of greatly heightened investor uncertainty over what the eventual outcome of the war in Ukraine will be. And how that outcome will, or won't, alter the risk environment that comprises the basis for making investment decisions.
So what are you, what are we, as investors to do? I am going to sound like a broken record here, but the answer is likely little or nothing.
One positive in a period of heightened volatility like this is that it allows investors to see whether they are as comfortable with their portfolios as they thought they were when markets were more benign. If you are having doubts about your ability to withstand further downside volatility, you should have a conversation with your advisor.
In our client portfolios, we remain slightly overweighted in stocks, although, per our custom VAM Core Models, we have rebalanced some of our Foreign Developed Market exposure (i.e., Europe, Japan) in favor of US equities. We are keeping modest inflation hedges in place in the form of TIPs (Inflation-linked bonds) and commodity exposure. We expect the markets to continue to be volatile until a clear resolution to the conflict in Ukraine starts to materialize.
Written by author: Martin Weil | Senior Financial Advisor, CFP®
*The foregoing content reflects the opinions of Van Hulzen Asset Management DBA "Van Hulzen Financial Advisors" and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.