Going nuclear

  By Guest Blogger Doug Rowat

Last year was tough. Global equities plunged more than 10%, the US escalated its trade war with China, Brexit dragged on endlessly, Italy and its weirdo coalition government plunged the European Union into crisis, oil dropped 25% and Trump fell in love with Kim Jong-un. In short, it was ugly.

Soon after year-end, I met with a client who seemed puzzled that her portfolio was lower for 2018. I explained that she had capital market exposure and that her portfolio would never be bulletproof in ugly market years. She then asked how her assets could be protected against war. Now, “war” is a very broad term and needs clarification. There’s the so-called salami-style warfare practiced by the Russians where small conflicts are initiated to take a ‘slice at a time’ from the enemy. Russia’s clashes with the Ukraine being a good example. This kind of warfare is troubling, but it’s slow moving, localized and usually doesn’t affect markets much. On the opposite end of the spectrum is all-out thermonuclear war.

At the time I was meeting with my client, Pakistan had (it claimed) shot down two Indian fighter jets over the disputed border region of Kashmir, so to clarify, I asked if she actually meant nuclear war? “Yes”, she replied with complete seriousness.

My best advice when the missiles start flying has always been to simply crack open your best bottle of Scotch, sit back and watch the fireworks. But, from her perspective, this was a serious question, so I attempted a serious answer.

Naturally, there are no comparables for nuclear conflict because a modern nuclear warhead has never been detonated during an act of war. However, we obviously know that the damage would be unimaginable. According to Forbes, even a “small” nuclear war would have horrific consequences and kill hundreds of millions. A single warhead alone, for example, can “burn 500 square miles of a city”. Presently, there are roughly 15,000 nuclear warheads in the world.

While it’s extremely improbable that any government or equity marketplace would remain intact after a nuclear war, the years leading up to, and the first few years of, WWII provide a (very) loose comparable, as this period was probably the most disruptive in modern history. From the start of 1937 to the end of 1941 the S&P 500 plunged almost 50%. So, given this result, and knowing that a nuclear war would be infinitely worse, there can be zero protection against what would be—truly—THE worst-case scenario. Your only hope? Certainly not an investment portfolio. Look instead to alternative lifestyle choices:

Even Warren Buffett acknowledges that some events simply cannot be protected against:

There is, however, one clear, present and enduring danger to Berkshire against which Charlie and I are powerless. That threat to Berkshire is also the major threat our citizenry faces: a “successful” (as defined by the aggressor) cyber, biological, nuclear or chemical attack on the United States. That is a risk Berkshire shares with all of American business.

There is no way for American corporations or their investors to shed this risk. If an event occurs in the U.S. that leads to mass devastation, the value of all equity investments will almost certainly be decimated.

So, risk of war (or other catastrophe) is just a fact of life. And, if there’s nothing you can do to protect your investments from such outcomes anyways, why worry? Warren Buffett doesn’t. Carry on investing with the belief that mankind doesn’t actually want to cook itself to crispy bacon. If you constantly have a nuclear-war-is-coming mindset then you’re not going to make any money. While you’re waiting for the end of the world, paranoia and fear will devastate your finances, not to mention your psyche.

Game theorists Avinash Dixit and Barry Nalebuff aptly highlight the debilitating, and even comical, effects of paranoia in this old story of two rival businessmen who run into each other at a Warsaw train station:

“Where are you going?” says the first man.
“To Minsk,” replies the other.
“To Minsk, eh? What nerve you have! I know that you are telling me that you are going to Minsk because you want me to believe that you are going to Pinsk. But it so happens that I know you really ARE going to Minsk. So why are you lying to me?”

Always assuming the worst of your fellow man leads nowhere. Further, always assuming a catastrophic outcome leads to bad investment decisions. So, when mushroom clouds start dancing in your head, kick back, put your feet up and listen to this:

Life really isn’t so bad.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.