There is an obvious evolutionary logic for humans to be drawn to risk assessment. From Neanderthals to Millennials, our health and safety, and that of our loved ones, remains our biggest asset. Indeed, our very existence today is reliant upon centuries of effective risk assessment: lions = bad, water = good. Given that our natural survival instinct is to focus on the potential negative risks, it is no surprise that financial market pessimism sells.
As investors, we are generally paid (via an investment return) to take the risk that bad things could happen. However, the fact that the S&P 500 US Equity Index has an average annual return of +9.4% over the past 94 years (a +511,648% return)1, tells you that many of these scary headlines that we read are rarely as bad as we may initially fear.
Being optimistic in this way can make you sound somewhat naïve. But it’s our own (career) evolutionary logic that got us here. Every day we are bombarded by scaremongering headlines and market pessimism. However, there is greater danger in reacting to every headline that you read. Think about some of the events that markets have worried about over the past six months. Blackouts in Europe, China invading Taiwan, a global recession, a collapse in corporate earnings. All these things could still happen of course, but whilst they have not, global markets are close to 10% off their October lows in sterling terms.
Generally, when assessing the risks, it can be helpful to ask:
a) is it true or just doom mongering?
b) is this risk not already priced into markets?
When applying this filter, you will find that not a great deal makes it through.
Point (a) is generally quite easy to filter – does the author or publication have an obvious bias? How credible is the source? Is the objective of the publication to entertain rather than educate? Point (b) is harder to identify but, generally speaking, if the concerns are front page news, we can assume the market has priced them in. This is not always the case of course - markets can be in collective denial as we saw in the early days of COVID, or in its belief that interest rates would not need to go this high to quash inflation, but these things are the exception not the norm and we lean on our risk tolerance and time horizon for those periods, knowing that tolerating some degree of risk is the only way to generate consistent returns over the long term.
The above is not to encourage flippancy or a reckless attitude towards risks where red flags are consistently ignored in the hope of a recovery. It is important to get two things right to allow you to embrace measured optimism in financial markets – your risk profile and the construction of your portfolio.
Enduring periods of market volatility is inevitable, which is why our investment philosophy looks to invest in high-quality companies with strong balance sheets and resilient business models. This does not mean the portfolios will not participate in market declines, but our belief is that these companies will be better placed to recover during times of market stress over the long term.
Pessimism may generate clicks, but measured optimism wins the race over the long term.
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