Experienced investors know that uncertainty is a constant companion. While the human mind craves certainty, there is, unfortunately, little to be found in investment markets.
Looking back over the last few years, Brexit, Trump and COVID-19 are vivid examples of world events that took most people by surprise when they happened.
Uncertainty, however, comes in different flavours. As a former US Secretary of Defence once said, there are known unknowns (the things we know we do not know) and unknown unknowns (the things we don’t know we don’t know).
It’s the former category, the known unknowns, that investors tend to concern themselves with.
As we head towards the end of 2024, concerns about inflation are starting to ease, the US election uncertainty will soon pass, and we’re getting used to a new government in the UK.
How each of these topics will end is unknown, but the element of surprise has undoubtedly passed. They are known unknowns.
With many previous surprises now wearing old, believing that certainty is around the corner is tempting. However, as financial author Morgan Housel states, “History is a constant chain of surprises.”
Unknown Unknowns
While known unknowns get all the attention, it’s the “unknown unknown” that causes investors the most trouble. “Surprise is the mother of all panic,” said Nick Murray, and panic is an emotion that leads to poor financial decisions.
History is full of these surprises.
Latin American countries, having borrowed eagerly throughout the 1970s, faced the music in the 1980s. When Mexico defaulted in 1982, it echoed like a gunshot. As domino after domino fell, the world noted a sobering truth: debt-fuelled growth carried a heavy price.
The market opened abruptly on October 19, 1987. Without warning, the Dow Jones plunged by 22% in a matter of hours. Traders were blindsided, staring at screens flashing red (doom). The culprit? Programme trading—machines executing trades at lightning speed, transforming a ripple of panic into a tidal wave that became known as Black Monday.
In the 1990s, the internet ignited a frenzy. Stocks soared, fuelled by dreams of digital riches. By March 2000, the reality hit hard. The dotcom crash was a harsh reminder: innovation couldn’t replace sound financial fundamentals.
The NASDAQ index plummeted nearly 80% over two years. Startups vanished, and investors faced massive losses.
Then, in the early 2000s, banks handed out mortgages like candy, assuming housing prices would eternally rise. By 2007, cracks appeared. In September 2008, the collapse of Lehman Brothers sent shockwaves across the globe.
Financial markets seized up, and economies plummeted.
In more recent times, an invisible enemy brought the world to its knees. In 2020, the COVID-19 pandemic shut down economies overnight. Markets plunged, unemployment soared, and global supply chains fractured.
Prepare, Don’t Predict
By definition, we cannot predict the next global or financial surprise. Based on the track record of economists and forecasters. It’s not worth searching for the answers in the media, either.
As investors, it’s prudent to assume that we’ll frequently be surprised by the future course of events. How can we prepare for something that we cannot predict?
While we don’t know what will bring the next round of panic, we can reliably predict some of the consequences.
As with previous surprises, market volatility, sharp interest rate increases/decreases, and inflation could all rear their heads. However, like the ship crew that practices lifeboat drills while docked in the harbour, we, too, can assess our preparedness before the storm arrives.
Sensible actions to protect your long-term plan against surprises include;
- Stress-testing your financial plan for its ability to provide long-term returns but also survive frequent temporary declines,
- Maintaining a cash buffer for emergencies,
- Investing enough so that even future personal surprises won’t jeopardise your independence.
The importance of a margin of safety in your financial plan cannot be stressed enough.
Lastly, while the next surprise may shift your focus to short-term survival when it arrives, we encourage you to build your plan around the likely long-term trajectory of financial markets.
When it comes, the next storm will pass like the others before it.
Charles Riches
Director
