Unknown unknowns

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  By Guest Blogger Doug Rowat

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The biggest dangers are rarely the obvious.

Asking about a Chinese economic slowdown, rising gasoline prices, supply chain disruptions, a Covid variant or the reduction of government and central bank stimulus, while prudent, probably won’t be predictive of the next market calamity.

Availability bias, a behavioural tendency to only view risk in terms of what’s been presented to us recently (on, say, the nightly news) probably won’t capture the next big volatile event. Such information represents only what’s ‘available’ to us. But major risks rarely telegraph themselves this readily. Real risk is usually unforeseeable. The phrase ‘out of left field’ applies here.

To view portfolio risk correctly, let your imagination run wild. What would happen to markets, for instance, if terrorists set off a dirty bomb in downtown Los Angeles? A ridiculous consideration you might say.

But more ridiculous than a global pandemic that kills 5 million and disrupts the entire world for 18 months? More ridiculous than four passenger planes being simultaneously hijacked with two flown directly into the World Trade towers in downtown Manhattan? More ridiculous than Bear Stearns and Lehman Bros, two Wall Street behemoths with a combined history of more than 250 years, going bankrupt in an instant? More ridiculous than a giant wave swamping Japan, killing 20,000 and leading to a nuclear disaster that shuts down the entire country’s nuclear power generation almost overnight?

Proper consideration of risk implies a belief in the fantastic. And knowing that unthinkable events will, with certainty, transpire is why portfolios should always be balanced, holding a meaningful percentage of safe assets. US Treasuries, Government of Canada bonds, provincial bonds and high-quality corporate bonds, for example. All of these assets are painfully boring, but this is the point: a constant allocation of boring assets is what protects best against unforeseeable volatility.

And protects best against the emotional overreactions that come during the volatility. Economist Peter Bernstein in his seminal essay on risk management, The 60/40 Solution, sums it up best:

When [markets] are cascading downward, keeping one’s cool is almost impossible. …how likely would it be that even the most experienced and sophisticated investor would have the self-control to stay 100 percent in stocks, without trading in and out as the market rode up and down its roller coaster? I know I could not have been so calm through depressions, inflations, banking and currency crises, wars, and political disruptions. The crucial element of success is the ability to make decisions without freezing up or slamming the panic button.

In other words, boring as they might be, investors need safe assets to avoid poor investment decisions.

Fortunately, there’s a silver lining to the cataclysmic events that Bernstein mentions. While these events are always unpredictable and idiosyncratic, there’s still a commonality: they’re always temporary. In other words, they shock economies or markets only briefly but never result in irreversible damage or lasting contagion. 9/11, for instance, seemed in the moment like it would lead to endless attacks on many US cities. But, of course, it didn’t. Similarly, Covid seemed poised to derail equity markets for years. But it didn’t.

Markets and economies recover fast from singular events, even serious ones. While we’re consumed by the spectacle of the event itself, we lose sight of the broader economy’s enormous ability to absorb the consequences and move on. The full breadth of history reveals this to be true. Below are the average length of recessions versus the average length of expansionary cycles over the past 75 years or so. You can’t deny it: decades and decades worth of world events tell us that the bad times never last, but the good times do:

US economic expansions and contractions, 1948-2021

Source: Manulife

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On a far less grand topic: I recently cancelled my DAZN sports streaming subscription.

Why should you care? Because I barely even remember subscribing to it in the first place. And, apparently, I’m not alone in this.

Subscription costs not only jumped during Covid, but they did so stealthily. According to the Wall Street Journal, the average American is now paying US$273/month on subscription services, up from US$237/month in 2018. But the more revealing discovery is that “most people thought they were actually spending LESS [emphasis mine] on subscriptions than they did in 2018.”

And it’s no wonder. We simply lose track of our subscriptions (and the cost) because of the sheer number of them. See if your subscriptions fall into any of these broad categories: entertainment and music streaming services (Netflix, Amazon Prime, Crave, Spotify, XM Radio, Hulu, etc.), sports streaming services (DAZN, TSN, SportsNet, NHL, etc.), dating apps (Tinder, Match, eHarmony, etc.), digital information services (New York Times, Washington Post, National Post, Globe and Mail, etc.), gaming services (PlayStation Now, Xbox Live, etc.). And I haven’t even touched on fitness and wellness services, home security services, meal services, book services, cloud-storage services or web-hosting services.

Chances are that during Covid you racked up some of the above subscriptions and at least one of them, when you consider it carefully, is no longer necessary (I’m looking at you Peloton users). Now’s the time to deal with your post-Covid subscription hangover.

Cancel a subscription. Save yourself a few bucks.

(Note that I’ve considered in this post both the epic (dirty bombs in Los Angeles) and the mundane (my DAZN subscription). Please don’t ever say that my posts lack breadth.)

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